How the banks create money

[Sceptic-PK]

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.

Wow. How can you still be struggling with how this works?? I mean honestly *laughing dog* MMM makes it all quite clear.

The bank credits the borrower's account with the value of their loan. From nowhere! From nothing! Oh noes, money creation, end of the world! The bank's reserves, ie the "real" money is unaffected. The bank still has just as much money as it did previously to service the deposits (which have now grown). Oh noes, there isn't enough "real" money to pay out 100% of the deposits, end of the world etc.

Then, the borrower withdraws that loan, and what happens? The bank's reserves go down by that amount.

It is both (lending from reserves and creating bank accounts "out of thin air"). MMM (again) makes this quite obvious. Instead of debiting customer's deposits when they loan those deposits, the bank gives the borrower access to these deposits, without altering the value of those deposits. So when I go to my bank, it still says I have $X, rather than $X - $Loaned.

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 part are you still not getting, lol? There is nothing going on here that is specific to banks. You too could engage in the evils of FRB. Go get your evil on psi!

 

[psionl0]

It is both (lending from reserves and creating bank accounts "out of thin air")

Then you really ARE that stupid.

I know that what you are trying to say is that it isn't a loan until the borrower withdraws the money from his bank account but that is even stupider.

 

[Sceptic-PK]

Not me my friend, MMM.

However, banks are required to maintain reserves equal to only a fraction of their deposits. Reserves in excess of this amount may be used to increase earning assets — loans and investments.

...

It does not really matter where this money is at any given time. The important fact is that these deposits do not disappear. They are in some deposit accounts at all times. All banks together have $10,000 of deposits and reserves that they did not have before. However, they are not required to keep $10,000 of reserves against the $10,000 of deposits. All they need to retain, under a 10 percent reserve requirement, is $1000. The remaining $9,000 is "excess reserves." This amount can be loaned or invested.

...

If business is active, the banks with excess reserves probably will have opportunities to loan the $9,000. Of course, they do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers' transaction accounts. Loans (assets) and deposits (liabilities) both rise by $9,000. Reserves are unchanged by the loan transactions. But the deposit credits constitute new additions to the total deposits of the banking system.

...

In the first stage of the process, total loans and deposits of the banks rise by an amount equal to the excess reserves existing before any loans were made (90 percent of the initial deposit increase). At the end of Stage 1, deposits have risen a total of $19,000 (the initial $10,000 provided by the Federal Reserve's action plus the $9,000 in deposits created by Stage 1 banks).

...

The lending banks, however, do not expect to retain the deposits they create through their loan operations. Borrowers write checks that probably will be deposited in other banks. As these checks move through the collection process, the Federal Reserve Banks debit the reserve accounts of the paying banks (Stage 1 banks) and credit those of the receiving banks.

...

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. Like the original $10,000 deposit, the loan-credited deposits may be transferred to other banks, but they remain somewhere in the banking system. Whichever banks receive them also acquire equal amounts of reserves, of which all but 10 percent will be "excess."

 

[tensordyne]

cognitive dissonance



You are suffering from cognitive dissonance Sceptic-PK. I will use your own words and some basic logic to show that money really is created by bank loans.

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???

Let me break your quote up. Before I do that I want to say that in essence you get the numbers correct but do not see the whole picture because you have not carried everything through to its logical conclusion.

1. A bank has $10,000 deposits; this is $10,000 in reserves.

-- Sounds good so far.

2. The bank loans $9,000 to you by crediting your account.

-- $9,000 new money just got created. This is in question, so for now let's just say this as my interpretation that is contingent upon further information.

3. The bank now has $19,000 deposits, $10,000 reserves, and a $9,000 loan asset.

-- Whaaa? The bank has $19,000 deposits now when in step 1. it had $10,000, and yet, you, Skeptic-PK contend that no money is created in making a loan? Last I checked, 19,000 is 9,000 bigger then 10,000. Last I checked, going from 10,000 to 19,000 is an increase, a kind of "creation". Or is that explained by some form of new math that moves things around increasing them and yet still keeping them the same. I have seen some pretty crazy math in my day but that would be the craziest I have ever seen.

4. You then go and buy $9,000 of widgets.

Sounds good.

5. The bank now has $10,000 deposit liabilities, $1,000 reserves and a $9,000 loan asset.

-- Yep, and the widget seller has $9,000, non, mon fere? Now, in step 1. the bank has $10,000 and the widget seller has, I don't know, X. In this step, step 5., the bank has $10,000 and the widget seller has X + $9,000. This takes me to the next "step".

6. Where is this newly created money???

--- If my math is correct, the total money in step 1. for bank and widget maker is X + $10,000. The total money for bank and widget maker in step 5. is X + $19,000. The difference is $9,000. There is your newly created money, straight from your own words (which you got from MMM as I understand it).

All the best to you Skeptic-PK. I feel more sad for you then anything else. The truth is right before your eyes, and yet, you will not submit to it.

 

[psionl0]

Not me my friend, MMM.

Not one of your MMM quotes says that banks take money out of their reserves when they make a loan.

In fact, from your OWN quote:

Reserves are unchanged by the loan transactions.

 

[Sceptic-PK]

You are suffering from cognitive dissonance Sceptic-PK. I will use your own words and some basic logic to show that money really is created by bank loans.

Whatever you say champ!

1. A bank has $10,000 deposits; this is $10,000 in reserves.

-- Sounds good so far.

Yay!

2. The bank loans $9,000 to you by crediting your account.

-- $9,000 new money just got created. This is in question, so for now let's just say this as my interpretation that is contingent upon further information.

Well sure, M1 deposit money was created, I don't deny this. But reserves have not changed! There is now $10,000 reserves to satisfy $19,000 deposits. $19K > $10K. If everyone wants their money at the same time, what happens? That's right, there isn't enough to satisfy demand, because no new money has been created.

-- Whaaa? The bank has $19,000 deposits now when in step 1. it had $10,000, and yet, you, Skeptic-PK contend that no money is created in making a loan? Last I checked, 19,000 is 9,000 bigger then 10,000. Last I checked, going from 10,000 to 19,000 is an increase, a kind of "creation". Or is that explained by some form of new math that moves things around increasing them and yet still keeping them the same. I have seen some pretty crazy math in my day but that would be the craziest I have ever seen.

The point is, that this isn't new money. It is the same money (the $10,000 in deposits) $9,000 of which has been loaned to the borrower. These are new deposits in the banking system, but not new money. As above, if customers then try and withdraw their $19,000, they'll find the bank comes up short.

You could do this yourself with an excel spreadsheet and a few customers silly enough to give you their money.

4. You then go and buy $9,000 of widgets.

Sounds good.

Yay!

-- Yep, and the widget seller has $9,000, non, mon fere? Now, in step 1. the bank has $10,000 and the widget seller has, I don't know, X. In this step, step 5., the bank has $10,000 and the widget seller has X + $9,000. This takes me to the next "step".

No. The bank now has $1,000 reserves, and $10,000 liabilities it owes to its deposit customers. The widget seller has the $9,000 that was loaned, which reduced bank 1's reserves from $10k to $1k.

--- If my math is correct, the total money in step 1. for bank and widget maker is X + $10,000. The total money for bank and widget maker in step 5. is X + $19,000. The difference is $9,000. There is your newly created money, straight from your own words (which you got from MMM as I understand it).

No.

Bank 1 now has $1,000 reserves, $10,000 deposit liabilities, and a $9,000 loan asset. The widget maker has the $9,000 that came from bank's 1 loan. $1,000 reserves + $9,000 loan = $10,000.

All the best to you Skeptic-PK. I feel more sad for you then anything else. The truth is right before your eyes, and yet, you will not submit to it.

Don't feel sad for me. Unless wasting my time attempting to explain the same concept over and over to people who refuse to understand is deserving of pity. If so, thanks!

 

[psionl0]

5. The bank now has $10,000 deposit liabilities, $1,000 reserves and a $9,000 loan asset.

-- Yep, and the widget seller has $9,000, non, mon fere? Now, in step 1. the bank has $10,000 in deposit liabilities and the widget seller has, I don't know, X. In this step, step 5., the bank has $10,000 in deposit liabilities and the widget seller has X + $9,000.

ftfy.

Skeptic-PK doesn't know the difference between bank reserves and M0 or M1 money so you have to spell it out for him in block letters.

 

[Sceptic-PK]

Read MMM some more psi, you might grasp it eventually.

 

[Gaspode]

Keep it civil please.

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

 

[tensordyne]

Thanx for the fix psionl0. It is in accordance with my own thoughts.

Which takes me to the next step. I think both me and psionl0 agree with the following:

Step 1: Bank deposit liabilities $10,000, widget seller has X.
Step 5: Bank deposit liabilities $10,000, widget seller has X + $9,000.

According to your logic Sceptic-PK, what should those numbers read? Assuming of course that in the system you advocate existing they are relevant numbers.

 

[Sceptic-PK]

Thanx for the fix psionl0. It is in accordance with my own thoughts.

Which takes me to the next step. I think both me and psionl0 agree with the following:

Step 1: Bank deposit liabilities $10,000, widget seller has X.
Step 5: Bank deposit liabilities $10,000, widget seller has X + $9,000.

According to your logic Sceptic-PK, what should those numbers read? Assuming of course that in the system you advocate existing they are relevant numbers.

What I’m curious about is why you continually ignore the value of bank reserves in your silly little game? Obviously deposits have expanded, $10,000 deposit liabilities, widget seller has X + $9,000 (presumably to become new deposits in another bank), and the bank’s reserves have gone down by $9,000. So, where did the money come from? That’s right, the bank’s reserves! Which I have been stating for a long long time. Which part are you not grasping? Nobody has disputed the process in deposit expansion that occurs with FRB. This process is no different to anything you or I could do.

Are we there yet?

 

[tensordyne]

Um, I wish Sceptic-PK you could follow directions better. The format I was looking for was

Step 1: Bank has deposit liabilities (insert here), widget seller has (insert here).
Step 5: Bank has deposit liabilities (insert here), widget seller has (insert here).

(insert here any relevant addenda).

Since I have been accused of not paying attention to reserves, perhaps I should address that here. First off, I think your idea of how reserves works is incorrect. You are mixing up reserves and deposits in an intermittant manner.

Reserves is not "the actual money a bank has on the books to loose by lending it",
reserves are "the amount of money a bank has that it can create."

 

[Sceptic-PK]

Um, I wish Sceptic-PK you could follow directions better. The format I was looking for was

Step 1: Bank has deposit liabilities (insert here), widget seller has (insert here).
Step 5: Bank has deposit liabilities (insert here), widget seller has (insert here).

You’ve already done that for me and I have stated (repeatedly) that you got it correct (whilst ignoring reserves). The bank has $10,000 deposit liabilities and the widget seller has $9,000.

Since I have been accused of not paying attention to reserves, perhaps I should address that here. First off, I think your idea of how reserves works is incorrect. You are mixing up reserves and deposits in an intermittant manner.

Reserves is not "the actual money a bank has on the books to loose by lending it",
reserves are "the amount of money a bank has that it can create."

Well, you’re wrong. MMM says you’re wrong. And I don’t know how many more ways I can explain it.

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.

 

[Startz]

Let me ask, with some trepidation since I don't want to be a wet blanket on a fun discussion...

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.

When you bought the $9,000 worth of widgets, what happened to those funds? Did they end up as deposits in another bank? Cash in circulation? Something else?

 

[Sceptic-PK]

Let me ask, with some trepidation since I don't want to be a wet blanket on a fun discussion...

When you bought the $9,000 worth of widgets, what happened to those funds? Did they end up as deposits in another bank? Cash in circulation? Something else?

Well, that depends on the widget maker obviously, but presumably it will end up as another deposit at some stage in the future. That deposit increases the reserves (and deposit liabilities) of the second bank by $9,000, of which that bank may then lend $8,100 (and so on).

so, bank 1 has $10,000 deposit liabilities, $1,000 reserves, and the $9,000 loand asset.

bank 2 has $9,000 deposit liabilities, and the same $9,000 as reserves.

At this stage there is still $10,000 reserves in total between the two banks, $19,000 deposit liabilities, and the $9,000 loan asset. If bank 2 loans the maximum, there would then be $27,100 deposit liabilities, $10,000 reserves, and $17,100 loan assets. And so on.

 

[Startz]

Well, that depends on the widget maker obviously, but presumably it will end up as another deposit at some stage in the future. That deposit increases the reserves (and deposit liabilities) of the second bank by $9,000, of which that bank may then lend $8,100 (and so on).

so, bank 1 has $10,000 deposit liabilities, $1,000 reserves, and the $9,000 loand asset.

bank 2 has $9,000 deposit liabilities, and the same $9,000 as reserves.

At this stage there is still $10,000 reserves in total between the two banks, $19,000 deposit liabilities, and the $9,000 loan asset. If bank 2 loans the maximum, there would then be $27,100 deposit liabilities, $10,000 reserves, and $17,100 loan assets. And so on.

Makes perfectly good sense to me

 

[tensordyne]

I just want to be perfectly clear on something Sceptic-PK, if you do not mind. Maybe I am coming around to your viewpoint. The 1,000 you are calling reserves, is that the totality of reserves left after the loan we are talking about, the total reserves?

 

[Sceptic-PK]

I just want to be perfectly clear on something Sceptic-PK, if you do not mind. Maybe I am coming around to your viewpoint. The 1,000 you are calling reserves, is that the totality of reserves left after the loan we are talking about, the total reserves?

Yes, that is the total amount of reserves left after the loan has been withdrawn from the bank. Obviously when that loan money is spent and deposited in a new (or the same) bank, then overall banking system reserves return to their original value ($10,000) assuming the entirety of the $9,000 loan is re-deposited.

 

[psionl0]

I just want to be perfectly clear on something Sceptic-PK, if you do not mind. Maybe I am coming around to your viewpoint. The 1,000 you are calling reserves, is that the totality of reserves left after the loan we are talking about, the total reserves?

This is a more sensible interpretation of what Skeptic-PK is trying to say:

• The bank lends money by crediting the borrower's account
• This directly increases M1 money because the total of all the bank accounts is increased.
• This causes the amount of M1 transactions to increase.
• Some of these M1 transactions involve inter-bank transfers.
• Assuming that bank reserves move simultaneously with interbank transfers, this causes increased reserve activity.
• There will also be more cash deposits and withdrawals due to the increase in M1 money.

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

 

[Sceptic-PK]

I’m not sure that’s more sensible at all, it is far more convoluted. But I don’t think there’s anything terribly wrong with it, though redundant in places.