How the banks create money

[Sceptic-PK]

Lulz, my mistake. You're still stuck in the old banks create money canard. Oh well!

Read MMM some more! It states repeatedly that banks lend excess reserves. Best of luck.

 

[tensordyne]

lies and other nostrums

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.

I think psionl0 disagreed with the second sentence above but I for one definitely disagree with the first sentence. From the first sentence of my sig and MMM:

"Of course, they do not really pay out loans from the money they receive as deposits."

Excess reserves plus reserves is the total deposits a bank has. Excess reserves comes from deposits. The sentence above says banks do not pay out loans from deposits, so they sure as hell do not pay out loans from excess reserves.

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.

I can not have you sign a piece of paper and create the equivalent value of money in an account ledger that you could withdraw federal reserve notes from.

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.

That is at best the nonsense way of explaining to people that banks create money from nothing. Break the signature down for me then. It is just three sentences so maybe do a sentence at a time?

MMM specifically points out that when a loan is withdrawn this withdrawal comes from the bank's reserves.

Quite different. I noticed you did not quote exactly where it says this but let me give you a bone and assume the above is true. Withdrawing money from a loan and making the loan in the first place are two different processes. A loan of X creates X new money, X * (1 + i) new debt, assuming i is the interest, and X * i uncovered debt. A withdrawal is zero-sum however. If you withdraw Y from an account with X in it then the account has X - Y in it after the withdrawal with some other account having + Y in it.

All the best to you all.

 

[kowalskil]

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.

For example if the reserve was set to twenty percent, $800 of a $1,000 deposit could be used to lend out to borrowers. This $800 lent out will then become a deposit in another bank. This other bank that receives this can lend out $600 of this $800 deposit as 20% is reserved.

This process will continue untill it reaches its maximum. The maximum amount of total deposits that can be created this way at 20 percent is $5,000 and the maximum increase in the money supply is $4,000. At this rate the banks have fraudulently created $4,000 out of thin air using a $1,000 deposit. The banks create a lot more than this as the reserve rates are much lower.

Over the years the ratio for fractional reserve banking has dropped, in most countries 3% or less is now the norm. This is a very deceitful and dangerous thing to do, as a run on the banks is very possible if large numbers of deposits are removed from banks. Although Central Banks can cover a certain number of withdrawals on behalf of some banks, it does however have a limit. A domino effect is a reality and can occur as banks do not have the money required because of very low fractional reserves. Banks will begin shutting down every where when this limit is passed.

Not many countries have a fractional reserve rate over 3%, interestingly the United States has 10%, China over 20%. When the run on the banks start and it will happen sometime in the future, less than 3% of the money people have deposited there will remain! And guess who is going to guarantee this money? tax payers will guarantee the banks! This way the commercial banks will remain blissfully in operation to continue without risk to themselves to continue to deceive us and to keep us in debt.

This action is most definitely a fraudulent practice and governments all over the world including Australia allow it to happen. It should be called fictional reserve banking. It should be banned! and replaced with Social Credit.

More about Social Credit later.

Thank you for a good short tutorial. My impression was that the term "to create money" refers to printing money. But this is not so, as you explain.

I am not an economist. My understanding is that the amount of printed money should be neither much higher nor much lower than justified by the total economic activity of a country. Too much leads to inflation, too little leads to deflation. Right?
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Breach of rule 6 removed.

Replying to this modbox in thread will be off topic  Posted By: Cuddles

 

[Sceptic-PK]

I think psionl0 disagreed with the second sentence above but I for one definitely disagree with the first sentence. From the first sentence of my sig and MMM:

"Of course, they do not really pay out loans from the money they receive as deposits."

Excess reserves plus reserves is the total deposits a bank has. Excess reserves comes from deposits. The sentence above says banks do not pay out loans from deposits, so they sure as hell do not pay out loans from excess reserves.

Again, you’re misconstruing the meaning of this sentence. Your entire view on this subject relies on this paragraph, and you don’t really understand what it means. I suggest you look at the rest of MMM for the context of this statement. What it’s really saying is that when a bank makes a loan by crediting a borrower’s account, this credit isn’t created with a corresponding debit from depositor accounts.

Whether Stage 1 banks actually do lose the deposits to other banks or whether any or all of the borrowers' checks are redeposited in these same banks makes no difference in the expansion process. If the lending banks expect to lose these deposits – and an equal amount of reserves - as the borrowers' checks are paid, they will not lend more than their excess reserves.

It says it plain as day: When the bank’s loan is spent, they lose an equal amount of reserves.

I’m not sure how much simpler I can put this- look at this exact example used in MMM:

A bank has $10,000 deposits; this is $10,000 in reserves.
The bank loans $9,000 to you by crediting your account.
The bank now has $19,000 deposits, $10,000 reserves, and a $9,000 loan asset.
You then go and buy $9,000 of widgets.
The bank now has $10,000 deposit liabilities, $1,000 reserves and a $9,000 loan asset.

Where is this newly created money???

I can not have you sign a piece of paper and create the equivalent value of money in an account ledger that you could withdraw federal reserve notes from.

Incorrect, of course you can. I can do it easily in an excel spreadsheet. I give you access to the money I have on deposit, without debiting the deposits of my other customers. I have just “created” money for you.

Quite different. I noticed you did not quote exactly where it says this but let me give you a bone and assume the above is true. Withdrawing money from a loan and making the loan in the first place are two different processes.

Yes they are, but it illustrates that money is paid out from a bank’s reserves, which did not change when the $9,000 was credited to you, and only changed when you withdrew the money from the bank. Where is the newly created money? M1 money is tied to reserves. When M1 money (deposits) move, an equal amount of reserves also move through the banking system. MMM makes this quite obvious.

 

[Sceptic-PK]

Thank you for a good short tutorial. My impression was that the term "to create money" refers to printing money. But this is not so, as you explain.

I am not an economist. My understanding is that the amount of printed money should be neither much higher nor much lower than justified by the total economic activity of a country. Too much leads to inflation, too little leads to deflation. Right?
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Ludwik Kowalski (see Wikipedia), a retired nuclear physicist from New Jersey, USA. I am also the author of a FREE ONLINE book entitled “Diary of a Former Communist: Thoughts, Feelings, Reality.”

http://csam.montclair.edu/~kowalski/life/intro.html

It is an autobiography based on a diary kept between 1946 and 2004 (in the USSR, Poland, France and the USA).

If you want to learn about money creation, you’d be well-advised to ignore the nonsense offered by Webb.

 

[psionl0]

A bank has $10,000 deposits; this is $10,000 in reserves.
The bank loans $9,000 to you by crediting your account.
The bank now has $19,000 deposits, $10,000 reserves, and a $9,000 loan asset.
You then go and buy $9,000 of widgets.
The bank now has $10,000 deposit liabilities, $1,000 reserves and a $9,000 loan asset.

Where is this newly created money???

There is an extra $9,000 of "paper money and coins in the pockets and purses of the public". (see MMM)

Think about it: originally there was $10,000 in deposits and $X of cash held by the public.
Then the bank added $9,000 to the total deposits.

Now there is $19,000 in deposits and $X of cash held by the public. (The total money has been increased by $9,000 - ie created).

If I withdraw the $9,000 and spend it then we have $10,000 in deposits and $X + $9,000 of cash held by the public (ie the total money is unchanged).

Withdrawing or otherwise spending money in your bank account does not change the total money supply because "vault cash in depository institutions is excluded" and does not form part of the money supply.

The foregoing is true if you accept MMM's definition of money as including "demand deposits (non-interest bearing checking accounts in banks) and other checkable deposits".

I believe you have your own personal opinion of what checkable deposits are.

 

[psionl0]

If you want to learn about money creation, you’d be well-advised to ignore the nonsense offered by Webb Skeptic-PK.

I couldn't resist.

 

[Sceptic-PK]

There is an extra $9,000 of "paper money and coins in the pockets and purses of the public". (see MMM)

Think about it: originally there was $10,000 in deposits and $X of cash held by the public.
Then the bank added $9,000 to the total deposits.

Now there is $19,000 in deposits and $X of cash held by the public. (The total money has been increased by $9,000 - ie created).

If I withdraw the $9,000 and spend it then we have $10,000 in deposits and $X + $9,000 of cash held by the public (ie the total money is unchanged).

That isn’t money creation. It is deposit expansion. There is no “new” money in the system, just the same $9,000 that has been circulated. MMM clearly states that reserves remain unchanged when the $9,000 is credited, and then reserves go down when that $9,000 is withdrawn. ie no money was created, borrowers were simply given access to the funds of depositors.

There is nothing that banks do that you cannot do yourself.

A bank has $10,000 deposits; this is $10,000 in reserves.
The bank loans $9,000 to you by crediting your account.
The bank now has $19,000 deposits, $10,000 reserves, and a $9,000 loan asset.
You then go and buy $9,000 of widgets.
The bank now has $10,000 deposit liabilities, $1,000 reserves and a $9,000 loan asset.

Deposit expansion.

I couldn't resist.

Hilarious. Especially given your repeated butchering of MMM and refusal to accept banks lend deposits.

 

[psionl0]

That isn’t money creation. It is deposit expansion.

Show me where MMM claims that "deposit expansion" is not money creation.

 

[Sceptic-PK]

Show me where MMM claims that "deposit expansion" is not money creation.

Clearly deposit expansion is M1 money creation, nobody has ever disputed that fact (and you agreed previously that M1 is worthless without reserves). What seems to be confusing the “banks create money” crowd though is where this M1 creation comes from. And it comes from banks lending excess reserves (which constitute customer deposits), they don’t invent it out of thin air. It is the same money being loaned to other customers, without the depositor’s balance changing.

A bank has $10,000 deposits; this is $10,000 in reserves.
The bank loans $9,000 to you by crediting your account.
The bank now has $19,000 deposits, $10,000 reserves, and a $9,000 loan asset.
You then go and buy $9,000 of widgets.
The bank now has $10,000 deposit liabilities, $1,000 reserves and a $9,000 loan asset.

There is still only $10,000 of money in the system, supporting $19,000 deposits after stage 1. But there isn’t actually $19,000 that can be used at the same time. And again, there is nothing special about banks that enable them to do this.

 

[psionl0]

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 pretty much what you claimed earlier and it seems that you believe my example where a borrower creates value through his or her labour is irrelevant to your claim.

So, I have a half-baked example which you might be able to refine to illustrate the ponzi nature of the scheme.

Suppose that you live in a community where there is only one bank. The community has $10,000 in cash and checkable deposits and the bank has $1,100 in cash in its vault and you have no money but the bank is willing to lend you $1,000 (the maximum permissible under 10% reserve ratio).

Before the loan the distribution of money is:
Community: $10,000
Bank: $1,100
You: $0

After the loan:
Community: $10,000
Bank: $1,100
You: $1,000

Since you are part of the community, the total amount of money in circulation is $11,000.

Now at the time you repay the loan we will suppose that you have an interest bill of $100. You can get that $100 from the community by creating something of value (eg your labour) and selling it to the community. After the loan has been repaid you have:
Community: $9,900
Bank: $1,100 + $100 interest
You: $0

So, basically the community has paid your interest bill (but got something of value from you for doing so). If we multiply this scenario by everybody who borrows money we can see a steady stream of interest payments flowing from the community to the bank.

Now, what happens to all of that interest? Well, some of it be spent straight back into the community in the form of wages and other costs associated with running the bank. Local shareholders will also get a dividend (more money back into the community). Some of the interest money will go overseas in the form of dividends to foreign shareholders as well as servicing any foreign liabilities the bank might have. Whatever is left over we could call "undistributed profit" which the bank can add to its reserves.

If we suppose that of the $100 interest you paid to the bank, $50 was spent back into the community, $40 was spent overseas and $10 of undistributed profit remains then this is what we have:
Community: $9,950
Bank: $1,110
You: $0

The extra $10 in reserves means that the bank can create an extra $90 in loans. So the maximum amount of money in the community can be increased from $11,000 to $11,100. This is clearly inflationary and more debt has been taken on by the community to service this interest bill.

The half baked part of this example is that I am assuming that all of this takes place via bank account transfers. Yet the bank has an extra $10 in reserves even though the total amount of base money was unchanged. Where did the $10 come from? Is the community gradually transferring the cash they hold from their wallets to the bank or is there a flaw in my example?

 

[psionl0]

That isn’t money creation. It is deposit expansion.

Clearly deposit expansion is M1 money creation.

Indeed it is.

 

[Sceptic-PK]

Indeed it is.

That’s all you’ve got? Repeating a fact that nobody in this thread has disputed? This debate isn’t about that, it’s whether banks lend excess reserves or invent money out of thin air when they lend. I have proven over and over and over that it is the former, and you’ve shown nothing to dispute that. So what I said originally is true, you do agree that banks lend excess reserves (deposits) when they create new loans.

 

[psionl0]

banks do not lend money straight from their vault!!!!!

 

[Sceptic-PK]

Of course not. They’ve got these things nowadays called computers. They’re just as good as vaults though, better in most respects. And the transactions happen in exactly the same way, just digitally. Banks lend excess reserves.

A bank has $10,000 deposits; this is $10,000 in reserves.
The bank loans $9,000 to you by crediting your account.
The bank now has $19,000 deposits, $10,000 reserves, and a $9,000 loan asset.
You then go and buy $9,000 of widgets.
The bank now has $10,000 deposit liabilities, $1,000 reserves and a $9,000 loan asset.

Which stage are you struggling with?

 

[psionl0]

Which stage are you struggling with?

The part where you equate crediting a bank account with taking money out of the bank's reserves. Only a TOTAL MORON would think that the two are the same thing. I just assumed that you can't be that stupid. It must be a problem with your eyesight.

Depositing, withdrawing or transferring money from bank accounts is not a part of the loan process and has no effect on the total M1 money supply.

 

[Sceptic-PK]

The part where you equate crediting a bank account with taking money out of the bank's reserves.

Luckily I’ve never said this then isn’t it! In case you fail to understand what loans are for- loans are there to be spent. Nobody gets a loan just to keep it in their account. So, when they spend it, where does the money come from? That’s right, the reserves! The reserves that come from customer deposits:

If the lending banks expect to lose these deposits – and an equal amount of reserves - as the borrowers' checks are paid, they will not lend more than their excess reserves

Still struggling? There is nothing that banks do that you cannot do yourself.

The bank credits a borrower’s account, and when the borrower withdraws that money it comes out of the bank’s reserves. Ho hum, I’m surprised I’m having to explain this to you for the hundredth time. You see rather bright otherwise.

 

[psionl0]

Luckily I’ve never said this then isn’t it!

You have never said that banks lend from their reserves?

 

[Sceptic-PK]

You have never said that banks lend from their reserves?

Banks lend from their reserves. However the process of crediting an account with funds for a loan, do not impact the bank's reserves until that credited money is used. MMM makes this quite clear, try and keep up!

 

[psionl0]

Banks lend from their reserves.

Make up your mind!

EITHER banks lend money from their reserves OR they lend money by crediting bank accounts. The two are TOTALLY different. You must choose one option only. What happens to the bank's reserves AFTER the loan has been made is irrelevant. The money has already been created.