How the banks create money

[Sceptic-PK]

That sounds like a first class reason for banning government borrowing.

Sooner or later, the government will have to hold a fire sale of national assets such as these to bring its debt down or it will have to put up these assets as security in order to keep borrowing money.

Or, of course, it can raise taxes and cut spending.

 

[psionl0]

Or, of course, it can raise taxes and cut spending.

 

[Sceptic-PK]

Yeah, no government has ever raised taxes or cut spending

 

[Blue Mountain]

Yeah, no government has ever raised taxes or cut spending

Unfortunately, the ones that raise taxes usually raise spending, and the ones that cut taxes often don't cut spending enough to counteract the loss in revenue. I believe Canada had a Liberal government in the nineties that raised taxes a bit and cut spending dramatically. We went from a 30 billion dollar annual deficit to a budget surplus. Successive governments and the economic woes of the last few years have completely reversed that now.

 

[Sceptic-PK]

But the point is that it's possible, and there is nothing inherent to the system that prevents it.

 

[Finsend]

Hi everybody!

I just read this thread, but find a lot of things very difficult to understand.

I read some about how money came into existence and I think I can understand most of this history (I hope) but from a certain point on I do not understand it anymore.

So I hope all of you don't mind me posting here, being penultimately stupid and so and lacking a lot of knowledge.

As I understand it modern money is created by (central) banks, fiat money is printed and/or created electronically? But it is not backed up by gold anymore.

First people did not really trade, but just helped each other build houses, gathering food (or they used force on each other, like slave labour?) then they started trading (surplus?) goods and then it was pure gold coins (or silver - like with the Romans, who also used slaves I read) and then the humans invented the paper money which was first backed up by gold, but now it is not backed up by gold anymore (this is fiat money, which can be created at will by the government or the central bank?) and now it is some kind of agreement (we trust it is worth something, because ehm... ? because we do and the government says so? Here I already get in trouble!

And this (fiat) money is useful, not only because of the trading (you dont have to drag around use amounts of goods to trade) but also because this way a government - for example - can start public works (by lending/creating? money - from whom, rich people? or can they just print it, the governments?) and this way it can get people to do things, build these roads or a hospital? And then the people who work on these roads can use the money to buy food and a house, a car, etc?

I am (still) not sure to who "we" owe all this debt? I mean I hear about lots of countries that are in big debt - to whom do they own these debt? To the regular banks, to the central banks, private investors, all of these or others? Why is all of this necessary? I mean, I don't really understand economics I guess...

So I think I can understand trading fish for bread and more or less understand gold coins but then I get into trouble a little bit I guess...

Maybe this is not the right place, but maybe it is and maybe someone of you would want to say something about what I ask and write. I hope so!

Greetings,
Finsend

 

[psionl0]

So I think I can understand trading fish for bread and more or less understand gold coins but then I get into trouble a little bit I guess...

Maybe this is not the right place, but maybe it is and maybe someone of you would want to say something about what I ask and write. I hope so!

Greetings,
Finsend

You have asked a number of questions that may have already been dealt with in this thread. You might also want to google "Money as Debt" (a slightly "woo-ish" video that nevertheless gives a reasonable description of the money/banking process). Of course "Modern Money Mechanics" is a must for anybody who wants to know our system.

You might get more useful answers if you ask specific questions about things you don't understand instead of effectively asking for an entire course on money/banking.

Regarding the fish/bread/gold/??? paragraph, you need to understand that money does not need to be a physical medium. As long as people believe that something is valuable, it can be used as money. For example, as long as people believe that Joe Bloggs will give them something they want in exchange for the IOU he wrote, then that IOU is "valuable". (Paper money used to be bank issued IOUs).

 

[Finsend]

You have asked a number of questions that may have already been dealt with in this thread. You might also want to google "Money as Debt" (a slightly "woo-ish" video that nevertheless gives a reasonable description of the money/banking process). Of course "Modern Money Mechanics" is a must for anybody who wants to know our system.

You might get more useful answers if you ask specific questions about things you don't understand instead of effectively asking for an entire course on money/banking.

Regarding the fish/bread/gold/??? paragraph, you need to understand that money does not need to be a physical medium. As long as people believe that something is valuable, it can be used as money. For example, as long as people believe that Joe Bloggs will give them something they want in exchange for the IOU he wrote, then that IOU is "valuable". (Paper money used to be bank issued IOUs).

I understand what you are saying, and I agree.

With regards to the last comment about the fish/bread-thing, I think I understand a little bit that money does not have to be a physical medium, it can be a figure right (on a computer?) or a promise, something like that? We 'believe' the numbers on ours computers and banknotes mean something, is that correct? You can buy things using dollar bills or using (the numbers) on your credit card, etc.

Now with regards to the creation of money I understand that (central / more or less government 'owned' banks) can create (fiat) money (by using a printing press for example), and they can do this on the computer as well (not having to print the actual notes). When banks use the FRB system they get money form somewhere (either form ordinary people who deposit into their accounts or they lend it from the FED or other banks?) and then they can lend this money out again while they have to keep some of it (a fraction) into their accounts/vaults in order to be able to pay out when people ask for their money (digitally or in banknotes). Is this - more or less - correct?

The FED/Government decides whether or not we need more money - eg. to stimulate the economy and/or to make sure there is enough money in circulation (?) so people can trade/buy things/etc.

So the 'private/normal' banks have to have money (in their accounts) in order to be able create new loans (?) A certain percentage they have to keep (in the vault or on the computer) and the rest they could lend out to new customers (with interest)?

Is this correct (over-simply stated?

 

[Luzz]

Now with regards to the creation of money I understand that (central / more or less government 'owned' banks) can create (fiat) money (by using a printing press for example), and they can do this on the computer as well (not having to print the actual notes). When banks use the FRB system they get money form somewhere (either form ordinary people who deposit into their accounts or they lend it from the FED or other banks?) and then they can lend this money out again while they have to keep some of it (a fraction) into their accounts/vaults in order to be able to pay out when people ask for their money (digitally or in banknotes). Is this - more or less - correct?

This is correct. Commercial banks will lend money depending on people making deposits on their banks, they can also get loans from the FED or other banks. It is a multiplier effect. That is how money is created, it is not neccesary to print paper money, banks can create deposit by clicking a keyboard.

The FED/Government decides whether or not we need more money - eg. to stimulate the economy and/or to make sure there is enough money in circulation (?) so people can trade/buy things/etc.

Unfortunately. The problem is they shouldn't be the only entity to decide money supply, because at the end, the creation of money can cause inflation, hyperinflation or stanflation.

So the 'private/normal' banks have to have money (in their accounts) in order to be able create new loans (?) A certain percentage they have to keep (in the vault or on the computer) and the rest they could lend out to new customers (with interest)?

Is this correct (over-simply stated?

Commercial banks only need to keep a small fraction of money at the central bank or FED, just to back up any potential demand of cash by people. But since in our times it is quite unlikely that any intelligent man will withdraw 1 million dollar notes from a bank, since it is easier to make an electronic transaction, then banks only have very little cash at their vaults.

 

[Finsend]

Thanks for the infor Luzz!

This is correct. Commercial banks will lend money depending on people making deposits on their banks, they can also get loans from the FED or other banks. It is a multiplier effect. That is how money is created, it is not neccesary to print paper money, banks can create deposit by clicking a keyboard.

Ok, this is now somewhat clear te me. The banks can lend money themselves, or store money for others which they then can use to create/give out loans e.g. - but they have to keep in mind the percentage levels - they have to keep some % 'real money' (whatever that is in their vaults (or on the computer) so that when people ask for some of their money they actually can deliver that money, or something like that, is they lend out to much they can become unsolvent or something like that and when everybody asks for ther money they will not be able to pay out the money and ehm they go bankrupt Something like that Sometimes it happens (like in Argentina) that banks (or maybe governments as well?) just don't have the money anymore, the money that they kept for their customers.

Unfortunately. The problem is they shouldn't be the only entity to decide money supply, because at the end, the creation of money can cause inflation, hyperinflation or stanflation.

Commercial banks only need to keep a small fraction of money at the central bank or FED, just to back up any potential demand of cash by people. But since in our times it is quite unlikely that any intelligent man will withdraw 1 million dollar notes from a bank, since it is easier to make an electronic transaction, then banks only have very little cash at their vaults.

I think I understand a little bit that when you create much more money very fast, this is not very good in the long run, because the money people have becomes worth less and less (there is no balance between actual economic growth/production/etc and the money supply - to much created to fast, the money gets worth less and less... more or lees like in german weimar or zimbabwe?

Normally all people do not want their money all at the same time, so useally it is safe for a bank to lend some of the money they keep in store to others, or use some of it for their own benefits (like in trading on the stockexchange/etc?).

Now it seems to me that a lot of people like the FED and some (central) banks in others countries have created a lot of money and also there is a lot of debt everywhere (I read this all the time latelely) and all these bad financial products which seem to be ehm worthless now...

So we have a lot of money, and more coming I understand with the QE 1 and 2 etc... Lots and lots of moneys everywhere, but also lots of debts... Now I thought that when you have a debt of say $ 10 and there comes in a lot of new money your debt will be worth less? I mean wouldn't it be easier to pay of your debt is you have more money? I mean all this new money gets into the economy is it not and wages go up during the centuries and prices of stuff as well (I remember buying french fries for one 50 eurocents (then guilders) and now this cost me 2 euros or something (without mayonaise... So more money (the figures are getting higher as well, 2 euro instead of 50 euro cent, etc) but also much more debt... Where the h*ck is all this debt coming from and who owes it to who? I mean I hear all the banks are in trouble but also the governments, they all have big debts, just like most people - SO I DON'T GET IT - If everybody is in debt ehm... to whom do we own all this debt, to whom do governments and banks and peoples have to pay these debt and where are they coming from, did they all borrow much to much?

I read some more, and hopefully I understand 1% of it very soon

 

[psionl0]

Where the h*ck is all this debt coming from and who owes it to who?

Up to 90% of the money we use was borrowed into existence from the banks. So the debt has always been there. Usually, most borrowers are able to service their debts without distressing the banks too much.

However, if even a small percentage of borrowers default then this could trigger a run by depositors as they scramble to withdraw their savings. If the bank is big enough then this would be an economic catastrophe because if a bank folds, then depositors lose their savings and the money that the bank had created disappears. That is why deposit insurance schemes (as well as a blank cheque from the taxpayers) are considered so vital.

As to why new money is constantly being created, it is basically because governments live beyond their means. They can't print their deficits because of the bank multiplier effect so they borrow money (by selling bonds) instead. However, competing with other borrowers in the money market risks causing a credit squeeze and higher interest rates.

To avoid this scenario, the fed monetizes a fraction of this debt by buying some of the bonds back. When someone sells a bond to the fed, his bank account as well as the bank's reserve account with the fed are both increased by the value of the bond sold. This is how *new* fiat money gets created. With the resulting excess in reserves, the banks do the rest of the money creation.

Naturally, this is inflationary but this just means that governments have to borrow even more next time to pay for the higher prices so the spiral continues.

As to who the creditors are, it is mostly banks but a lot of private individuals and corporations buy the government bonds as well.

 

[Blue Mountain]

Visiting this thread is a very Victorian experience.

It's very much like going to Bedlam to watch the inmates.

Finsend, all you're going to get out of this thread is a bunch of conspiracy theories. The level-headed members of this forum (the ones who understand how the banking system really works) have abandoned this thread to the loonies.

 

[psionl0]

Finsend, all you're going to get out of this thread is a bunch of conspiracy theories. The level-headed members of this forum (the ones who understand how the banking system really works) have abandoned this thread to the loonies.

How would you know? You haven't read anything in this thread. You just assume that it is CT.

And even if you did read anything in this forum, I doubt that you would have the critical thinking skills to evaluate its credibility. You are probably one of those people who classifies everything as either "official line" or "conspiracy theory".

 

[Finsend]

Visiting this thread is a very Victorian experience.

It's very much like going to Bedlam to watch the inmates.

Finsend, all you're going to get out of this thread is a bunch of conspiracy theories. The level-headed members of this forum (the ones who understand how the banking system really works) have abandoned this thread to the loonies.

Hi BM, I (think I) understand your point of view and the spoiler was indeed funny, gheheh So thanx for the warning/concern/etc, I will keep this in mind.

Maybe I should mention that I stated visiting this thread because of a combination of coincidence and personal interest. In would like to learn some more about (the creation of) money and banks, economics, etc - but I am also interested in what people think and why they think what they think.

Maybe I should say that I can imagine (after watsching some TV and reading some newsspapers) that some/lots of people are wondering if politicians/fed/banks etc are really trustworthy, fair, honest, wise, etc. don't get me wront I do not believe in big conspiracies, but I do believe in small ones (like with Caesar and when I hear about debt here, bailout here, crisis there, etc all these issues and 'problems' I see on TV and all those people in suits saying it's allright we have it under control (while some of them just drive big cars, eat expensive lunches and seem to take care mainly of themselves and their friends/etc you probably understand this kind of story/viewpoint a bit) it makes some people (especially the poor/dumb? whatever) wonder if everything is ok, honest, fair, etc...

So I do not mind (some) conspiracy things and hopefully I will be able to judge for myself what I consider cr*p beyond sanity and what I consider serious information very soon (probably not very soon since I notice have have much to learn, but I also enjoy reading ad hominems and jokes so watching inmates is new for me and I think I might enjoy it for some time, geheh hopefully I will get out before I get into te Edwardian ehm or Regency Experience, geheh

Once more thanx for the warning and humor (I appreciate that and thanx for your posts as well and sharing your viewpoints!

F

 

[Finsend]

Hi psion0I thanx very much for your reply! I appreciate the time you take to write this for me so I can understand a bit more about this subject and your point of view.

I think I understand (a little bit) more now about fractional reserve banking and money and debt, by reading this thread some books and other internet pages about this subject.

I just read a big part of this thread again and I was wondering if I (or maybe you or somebody else) could SUMMARIZE (sortly, I cannot do that I notice, I need many words always) what are the MAIN DIFFERENCE OF OPINION with regards to the original subject. I write this because I sometimes have the feeling that it is about DEFINITION/words a lot of the times (what is money and what is not, etc - what is creation of money out of 'nothing' (what is nothing, etc) using FRB (so not the printing - this is probably clear to most people, but using FRB) and things like that...

Maybe I am wrong (because I probably do not understand this very well) but it seems to me that a lot of people actually agree (more or less) about the 'mechanics' of the creation of money/credit (by using FRB - giving out loans/IOU/credit and keeping a certain amount as reserve) but that they still disagree about the 'meaning of some words' or about the 'ethical issues' (whether it is a good thing this FRB or a bad thing, etc and whether this system of FED/FRB is a (evil) conspiracy or not, etc) and maybe some personal issues are also coming in now and then, geheh.

I will try to do some of this myself (my way) in the following postings, I hope everybody is ok with that and nobody takes offense or regards this as pollution or something and please ignore me and/or make fun of me, gehehe I don't mind and I know I am not very smart and my English is very bad, etc

F

 

[Finsend]

*Finsend tries to write some about FRB money stuff *

NOTE: I put * in title so everybody can skip my posts on sight, because I know they are probably very long, boring, unreadable and not very interesting for most people!* I have to write things down in my own words to better understand, sorry bout that

I START HERE:

Fractional Reserve Banking

A process that allows the banks to create money out of nothing.

Central Banks apart from creating new money as debt control the ratio of deposits the Commercial banks can lend. This ratio is called fractional reserve banking. This practice allows banks to lend very large sums of money they do not have. Fractional reserve banking allows banks to keep only a fraction of deposits in reserve and lend out the remainder.

This seems to be the first issue/problem, this creation out of 'nothing'... a few quotes I found interesting:

They're not creating it out of nothing. They're borrowing it from the future on the premise that future labor will be more efficient and will create greater return than at present..

I do not understand why this quote states that the 'money is not created out of 'nothing'', but I think I understand that LL is saying that a bank will lend out money only if they expect to get it back (with interest) - so they would lend money (only) to people who do something 'useful/productive' with it and will be able to create more value using the loan and thus will be able to pay it back (with interest / added value)- but I still do not understand how they "borrow it from the future" - don't they just BORROW IT FROM ONE OF THEIR CUSTOMERS who did a deposit first??? I thought they (the banks) use the money people deposit to create new loans / new money/credit/IOU/whatever you name it? So I understand what LL is saying (I hope) ut I disagree that banks literally borrow the money from the future, they borrow it from their customers, don't they (or use ther own money to create more loans? both?)...

Maybe this is a definition/words/viewpoint issue, or am I missing something here?

 

[Blue Mountain]

I do not understand why this quote states that the 'money is not created out of 'nothing'', but I think I understand that LL is saying that a bank will lend out money only if they expect to get it back (with interest) - so they would lend money (only) to people who do something 'useful/productive' with it and will be able to create more value using the loan and thus will be able to pay it back (with interest / added value)- but I still do not understand how they "borrow it from the future" - don't they just BORROW IT FROM ONE OF THEIR CUSTOMERS who did a deposit first??? I thought they (the banks) use the money people deposit to create new loans / new money/credit/IOU/whatever you name it? So I understand what LL is saying (I hope) ut I disagree that banks literally borrow the money from the future, they borrow it from their customers, don't they (or use ther own money to create more loans? both?)...

Maybe this is a definition/words/viewpoint issue, or am I missing something here?

I'll start by saying I'm a systems analyst, computer programmer, and systems administrator: my experience is with the technical world of computers, programming languages, and operating systems. I'm not an economist.

To me, the concept of "borrowing from the future" is shorthand. This is different from a chattel loan such as a car loan, where if you default on the loan the bank takes your car. But banks also loan money to individuals and companies that are starting and running businesses. In this case the bank is on slightly riskier ground, given that there may not be much in the way of goods to repossess if the business defaults. Yet they still make these loans. Obviously they're expecting to get their money back, with interest. What's they're investing in, therefore, is the person or people in the business, and their skill, diligence and work--in other words, labour--that they will be putting into the business. Since that labour is expected to be performed in the near future (over the time the loan is expected to be repaid), in this sense they are borrowing from the future.

The bank is paying now for labour to be performed in the future.

 

[tensordyne]

... and on it goes. Banks create money from nothing every time a loan is made. It is a fact (read my signature, coming from a publication of the Federal Reserve, the horses mouth itself). The problem with the system we have now is NOT that banks create money from nothing, it is that they also require back more then they create. The principal debt gets extinguished but the interest part of the debt does not, necessitating more loans.

ughgh... whatever. Someone should do a documentary on this and ask some bankers point-blank if they make money or not.

 

[Finsend]

ehm I start with sayin I am just a crazy painter so I know nothing@all but I try to understand some of it...

I'll start by saying I'm a systems analyst, computer programmer, and systems administrator: my experience is with the technical world of computers, programming languages, and operating systems. I'm not an economist.

To me, the concept of "borrowing from the future" is shorthand. This is different from a chattel loan such as a car loan, where if you default on the loan the bank takes your car. But banks also loan money to individuals and companies that are starting and running businesses. In this case the bank is on slightly riskier ground, given that there may not be much in the way of goods to repossess if the business defaults. Yet they still make these loans. Obviously they're expecting to get their money back, with interest. What's they're investing in, therefore, is the person or people in the business, and their skill, diligence and work--in other words, labour--that they will be putting into the business. Since that labour is expected to be performed in the near future (over the time the loan is expected to be repaid), in this sense they are borrowing from the future.

The bank is paying now for labour to be performed in the future.

Ok, I understand this concept of "borrowing from the future" as you describe it (labour/business without security e.g), and the difference with the chattel loan (where there is physical object like house or car as security. It is a way of describing future expectations of the bank or something - but what I meant is you cannot borrow anything from the future literally can you? Or can you? So were does the bank get the money from to be able to make the loan?

AND who is really paying, I mean the bank takes the risk but uses the money of it's savers doesn't it?

The bank uses the money it has in it's accounts (those of savers/depositors) to create new loans, and it NEEDS this money - otherwise it is not able to create new loans - without any deposits/any money in their accounts/vaults/etc a bank cannot create new loans. 0 money means no new loans... That's what I understood (?)

So they (THE BANK) actually BORROWS MONEY FROM THEIR CUSTOMERS (the people who made deposits) and then lends this money out as credit/money/whatever to some-one else. This is why some banks get in trouble if they have lots of bad loans - they cannot pay the savers back / etc because they borrowed money from the savers and gave it out as loans to other people which didn't pay these loans back.

So the bank borrows money from the savers but does not discredit the account of this saver (the saver probably doesn't even notice all this happening, geheh) and the saver still sees his total amount at the ATM which he deposited and should be able to withdraw at least some of his cash - again if everybody does this at the same time, some banks will be in big trouble/etc like in Argentina, etc.

So this way a bank creates new money/credit - using the FRB system (it has to keep a certain % of the money of the savers in their vault/accounts/etc as reserve, and the rest it can write out as new loans (new credit/money/iou/etc/whatever) - NEW MONEY Is created from old money according to the FRB rules - so a bank can (sneakily use/borrow certain percentage (say 90% in some countries I think, 80 % in others) money from the savers/depositors and it can then use this money to create loans (new money).

1 more example (just for myself

So I go to the bank deposit $100.

Bank has nothing, but it can now borrow $90 from me (without me noticing, or maybe this is written in small letters somewhere?) keep $10 in the vault as reserve (but my account still says $100) and pass this $90 as a loan to mrBorrower (who gets an account with $90 on it, but also has to pay back this $90 (with interest I guess

So now I have $100 and MrBorrower has $90 to spend ($190 money in circulation), bank has nothing, but will get interest form mrBorrower and has to pay me the saver some interest as well (probably less than it gets from mrBorrower Hopefully mrBorrower will do good business and make money to pay of the loan+interest an hopefully I will not demand my $100 bucks at once, this might be a problem for bank...

Ehm... Is this right, more or less? Maybe I am wrong but this is the (simple) way I understood this FRB thing...

In reality a bank has of course many customers (borrowers and depositors) and I think it does not literally borrow from me (I guess? but from all the depositors accounts in general (?))

But my point was a BANK needs money to create new money/loans by this multiplier formula (the % reserve fraction thing and the bank borrows this money from it's customers... Or maybe if it has money of itself it could use that to create loans, could be I dunno (?).

This "borrowing from the future" is just a concept that states expectations that a borrower will do something with the money to be able to pay it back + INTEREST

They're not creating it out of nothing. They're borrowing it from the future on the premise that future labor will be more efficient and will create greater return than at present.

So they don't create it out of nothing and they borrow it from their customers... Thats what I think at this moment... Is that right? or terribly wrong?

 

[Finsend]

... and on it goes. Banks create money from nothing every time a loan is made. It is a fact (read my signature, coming from a publication of the Federal Reserve, the horses mouth itself). The problem with the system we have now is NOT that banks create money from nothing, it is that they also require back more then they create. The principal debt gets extinguished but the interest part of the debt does not, necessitating more loans.

ughgh... whatever. Someone should do a documentary on this and ask some bankers point-blank if they make money or not.

FOR ALL PEOPLE WHO SAY BANKS CREATE MONEY OUT OF NOTHING explain this:

Reserve Rate = 10%

Bank has $ nothing / zero / 0
Can bank create money/loan now - I say NO.

I goto bank and drop $100.
Bank has $100 in (my) account.
Can bank create moneyloan now? - I say YES -> $90

So mrBorrower comes in and wants loan.
Bank says OK we give you $90 sign this contract right here.

Now mrBorrower goes to ATM gets out $90, burns it and never returns to bank...

NOW what happens?
Can bank say, oh well no problem? Bad luck tralala...

If this is true I think world = crazy and I am on wrong planet!
geheheh

I mean this cannot be true can it? the bank should have a problem then shouldn't it? else it can indeed create money out of nothing...