How the banks create money

[Finsend]

The reality in the current banking system is that there is always a mismatch between the maturity of loans and deposits.

How big.or.small is this mismatch?
Generally spoken of course

 

[Aber]

It varies, as in reality describing how banks manage liquidity risk is complicated as they will have other assets and liabilities other than loans and deposits. For example some of their assets may be government securities with with a maturity of 20 years but which they could sell immediately if needed to repay depositors.

Banks will generally forecast expected payments in and out daily for up to 2 weeks, weekly for up to 3 months, monthly for up to a year etc and ensure that there are enough funds available to cover a reasonable worst case scenario from scheduled receipts from customers, sale of assets, standby borrowings and access to central bank funding etc

Do some research on 'liquidity risk' if you want to learn more.

 

[Finsend]

For example some of their assets may be government securities with with a maturity of 20 years but which they could sell immediately if needed to repay depositors.

Do some research on 'liquidity risk' if you want to learn more.

Thanx for this info.

The government securities to whom would they be selling those?
Do they have a fixed price?
Could it be nobody wants to buy them?

 

[Aber]

The government securities are long term debt used by governments to fund budget deficits. The markets are huge with daily turnover in the UK market of at least £10 billion and so there will always be someone (financial institutions, investment funds, sovereign wealth funds, pension funds) who will buy. Prices are set by supply and demand in the market. Even Greek government securities are still trading, even if at a lower price.

 

[Finsend]

The government securities are long term debt used by governments to fund budget deficits. The markets are huge with daily turnover in the UK market of at least £10 billion and so there will always be someone (financial institutions, investment funds, sovereign wealth funds, pension funds) who will buy. Prices are set by supply and demand in the market. Even Greek government securities are still trading, even if at a lower price.

Thanx for this.
This seems a pretty safe market then, these government securities.
If even the Greeks are able to sell them nowadays.
Although the prices decline a bit, and the Greeks have to pay a lot of interest, I guess?

 

[ufology]

Banks don't create money. That is the job of the mint. Banks create debt.

j.r.

 

[psionl0]

Banks don't create money. That is the job of the mint. Banks create debt.

j.r.

Define "money".

 

[ufology]

Define "money".

I think we all get the picture. Essentially I'm agreeing with the thread, just expressing it differently. You might also want to do a rant on the Futures Trading Commission ... tell 'em all the real reason we're getting hosed at the gas pumps.

j.r.

 

[tensordyne]

banks create money and debt, but more debt then money.

Banks don't create money. That is the job of the mint. Banks create debt.

j.r.

Haha, banks create both debt and money (but not money in its physical form, that really is the job of the mint). The main problem with the arrangement we have now is banks create more debt then money, always. It is built into the very way the system works.

Same story as before, practically no one knows the above, but it is true. It is all in the documents that anyone can find on the internet. Oh well, I guess it takes time.

 

[Finsend]

Hello,

I stumbled onto this lately:

http://en.wikipedia.org/wiki/Glass–Steagall_Act
http://en.wikipedia.org/wiki/Gramm–Leach–Bliley_Act

And noticed there seems to be some different kind of opinions in America about these.
Although maybe a bit off topic it seems to touch at least some of the topic, but I could be wrong since I did not have the time to read all about it - yet.

To me it seems to touch on this subject because it has to do with (investment) banks and if and how they can or may use peoples savings for all kinds of things. But first I read now.

Cheers2uall,
finsend

 

[psionl0]

Haha, banks create both debt and money (but not money in its physical form, that really is the job of the mint).

Actually the mint doesn't create any money. The notes and coins they manufacture are just tokens which the treasury exchanges (directly or indirectly) for credits from the banks' reserve accounts. No new money is created in this process.

The main problem with the arrangement we have now is banks create more debt then money, always. It is built into the very way the system works.

Are you talking about usury? This isn't unique to banks but is a common feature with every institution that lends out money (created or not).

 

[Aber]

Actually the mint doesn't create any money. The notes and coins they manufacture are just tokens which the treasury exchanges (directly or indirectly) for credits from the banks' reserve accounts. No new money is created in this process.

No

Central Bank accounting is quite simple:

Dr Notes and Coins (ASSET)
Cr Money in Circulation (LIABILITY)

and they have just created money. Of course they can also have notes and coins in their vaults which is not money, but that's for the advanced class.

 

[tensordyne]

excess debt.



Before I respond I to psionl0's last response, which I am about to do, I want to say two things.

1. psionl0 and I are pretty much in agreement about banking and how it works so far as I can tell. I have not read anything of his that I could say "No, no, no..." to, or anything. If anything, I think whatever we would debate about would be somewhat hairsplitting perhaps, which is not bad. Actually, I think it would be fun to hash it out with psionl0 for a bit to see what comes of it.

2. I define money as a token (in the anthropological sense a token is a physical object or process that represents something else in an abstract way) used in the exchange of goods and services.

Actually the mint doesn't create any money. The notes and coins they manufacture are just tokens which the treasury exchanges (directly or indirectly) for credits from the banks' reserve accounts. No new money is created in this process.

Well, while I agree the mint does not create 'new' money, it does create money all the same for the purposes and in the way explained above.
I guess this could get hairsplitting, but I love that the word token was used, because money IS a token of a particular type.

Are you talking about usury? This isn't unique to banks but is a common feature with every institution that lends out money (created or not).

Oh usury, that word that has been so fought over throughout history. Is usury the act of charging any interest (as Midieval Jurists would contend), or is it the act of charging too much interest (as argued since the time of Calvin up to today by Neoliberal Economists)?

As for what I was referring to in my post, I was noting that loans of issue (loans that create the money using book-keeping entry as happens in Fractional Reserve Banking) have an interesting aspect to them when interest is also used in said 'loan'.

This aspect in FRB is that more debt gets created then money. The excess in debt over the money never disappears from the system as a whole. This excess debt in the system means new loans must constantly be made or the system will run into problems. In simple words, the system we have now is not mathematically ballanced. This is why so many commentators on FRB have described it as a Ponzi scheme.

Loans of deposit do not have the same feature that loans of issue have when it comes to interest. Since loans of deposit do not create or destroy money, there is no excess debt that gets created. Loans of deposit in the end just shuffle money around. In that sense, these two types of loans have very different characteristics for the greater economy as a whole.

Hope that clears up what I was thinking.

All the best to you all!

 

[ethospete]

Search Google for: "The Goldsmith's Tale" - A simple, yet very profound explanation of how fractional reserve banking works and how the banks simply conjurer up money out of thin air... from debt... You sign a piece of paper saying you want some money and if you don't pay it back they can take your house, car and girlfriend... and they then just type the figures into your bank account and your signature on that piece of paper has created that amount of money... from nowhere... lol ...Crazy, but true...

 

[ethospete]

Also search youtube for 'Economic Armageddon and You' and see what happens when you print too much money and your entire economy collapses... The current USA situation is ten times worse the one in Greece... yet Greece are the ones that everyone is bankrupt... Their problem is simply that they aren't allowed to simply print more and more and more money...

 

[psionl0]

Search Google for: "The Goldsmith's Tale"

You can also search this thread. (Post #956).

 

[psionl0]

Thanks for your largely positive comments TD. Yes, most of our difference of opinions boil down to semantics although one or two are more fundamental . . . . .

I define money as a token (in the anthropological sense a token is a physical object or process that represents something else in an abstract way) used in the exchange of goods and services.

I prefer to use the MMM definitions of money. Not because MMM is the ultimate authority on these matters but because if everybody uses the same definitions then there is less room for misunderstandings. Tokens are definitely money (at least while they are in the hands of the public) but money is not necessarily just tokens.

What makes bank accounts money and not just a record of how much the bank owes a customer is the fact that debts can be settled by a direct transfer of credits from one bank account to another (via cheque or EFT) without involving any tokens. If this were not the case, if the only way to settle a debt was to physically hand over tokens then your definition would be the correct one. (It would also mean that the banks were not creating the money they lend out - merely allowing several people to take turns in handling the same money).

Oh usury, that word that has been so fought over throughout history. Is usury the act of charging any interest (as Midieval Jurists would contend), or is it the act of charging too much interest (as argued since the time of Calvin up to today by Neoliberal Economists)?

I sure walked into that one!

Yes, usury is interest but whether interest is usury depends on your religious beliefs and how much money you stand to make if interest is not defined as usury.

This aspect in FRB is that more debt gets created then money. The excess in debt over the money never disappears from the system as a whole. This excess debt in the system means new loans must constantly be made or the system will run into problems. In simple words, the system we have now is not mathematically ballanced. This is why so many commentators on FRB have described it as a Ponzi scheme.

I am not convinced that we need to create money in order to pay the interest on a loan - even if the loan was created from thin air. If we create "value" (as distinct from "money") then the interest can be paid without the "ponzi" aspect.

The interest bill on a $10,000 loan would typically be about $600 pa. A borrower could service this bill by doing about 2 hours of work per week for the bank (eg cleaner or security guard). This extra production allows the bank to reduce its wages bill which is effectively the same as getting $12 per week from the borrower. The fact that the bank might have created the $10,000 makes no difference in this scenario. No extra money is needed so no "ponzi" is evident.

In practice, the borrower would do his 2 extra hours per week with a different employer but the principle is the same. The borrower is working 6% harder to service his interest bill. Of course, if the borrower can afford a slight drop in his living standard, he needn't do any extra work. He could divert some of his household budget towards making interest payments.

Loans of deposit do not have the same feature that loans of issue have when it comes to interest. Since loans of deposit do not create or destroy money, there is no excess debt that gets created. Loans of deposit in the end just shuffle money around. In that sense, these two types of loans have very different characteristics for the greater economy as a whole.

A borrower can't tell by looking where the money in his account came from so I don't see how that would affect his position. If a loan came in from overseas and all of the interest payments went overseas, this would not necessarily mean that our money was "bleeding out". The extra work that a borrower does to service the debt could result in extra export income which would make loan servicing a zero sum gain.

I think that when people talk about interest multiplying debt, they are referring to the "magic" of compound interest. If people do the same thing as the government and borrow money to pay their interest bill then a debt would grow exponentially until a bank was in the position to seize everything you own.

In that case, it would make a huge difference whether the (borrowed) interest payments go back into the community or vanish overseas.

Hope that clears up what I was thinking.

 

[tensordyne]

I am not convinced that we need to create money in order to pay the interest on a loan - even if the loan was created from thin air. If we create "value" (as distinct from "money") then the interest can be paid without the "ponzi" aspect.

The interest bill on a $10,000 loan would typically be about $600 pa. A borrower could service this bill by doing about 2 hours of work per week for the bank (eg cleaner or security guard). This extra production allows the bank to reduce its wages bill which is effectively the same as getting $12 per week from the borrower. The fact that the bank might have created the $10,000 makes no difference in this scenario. No extra money is needed so no "ponzi" is evident.

A Ponzi scheme is only evident when considered as a whole. Citing the ability or inability of any one individual to repay a loan is irrelevant. When a loan is made, new principal money is circulated into the economy and ultimately extinguished if the loan is repaid.

The interest on a loan is neither created or destroyed in the loan making process, thus necessitating further loans to cover the interest. There is a gap in time between when a loan is made and when other loans will be made to temporarily cover the interest of previous loans. The interest as a whole though is never covered because there is always less money created then debt created by making loans in Fractional Reserve Banking.

That is the main point. Every loan that comes into existence through Fractional Reserve Banking creates more debt then money to cover that debt. Every single one. Mathematically speeking, it could be possible to cover a set of loans that create more debt then money if there were some pool of money to draw from. There is no such pool. Since the inception of FRB untill now, the only way money comes into existence is through loans. There will therefore always be more total debt then total money to cover the total debt, always (in such a system).

Hope that clears things up.
All the best to you all.

 

[Sceptic-PK]

All of your concerns are based upon the erroneous belief that banks create money when in fact they lend excess reserves. I do believe (and correct me if I'm wrong psi) that psi finally accepted that banks lend excess reserves when loans are made.

Yes, this process expands M1 (deposit expansion) but there is nothing that banks do in the loan process that you cannot do yourself, capital permitting of course.

FYI, what the quote in your signature actually means is that when a bank lends my deposits to you, when I look in my account my balance remains unchanged even though you're off on holiday with my hard-earned.

MMM specifically points out that when a loan is withdrawn this withdrawal comes from the bank's reserves.

 

[psionl0]

You “create” new money by crediting the borrower with $9,000.

I do believe (and correct me if I'm wrong psi) that psi finally accepted that banks lend excess reserves when loans are made.

You're not going to start this "banks lend money straight from their vault" spiel again are you?!

ETA: This is what we agreed on:

In short, increasing M1 money causes an increasing velocity of transactions involving bank reserves.