How the banks create money

[psionl0]

You've made this potentially quantitative by setting up some equations. (As I said before, I like that.) So you say it "can't go on indefinitely." If interest rates are five percent per year (or four or six or whatever), how long can it go on for?

If I were to make a prediction of when (or if) the existing system were to collapse, I would need a lot of hard data, considerably more complex equations and a powerful computer to crunch the numbers.

However, that wasn't the purpose of my post. I took an engineer's approach and used the simplest model of the financial system that I could find in order to see where problems might exist and if a solution to those problems is possible. (This is the same approach that an engineer would use to analyze the switching response times of a transistor for example).

My model is certainly not flawless by any means. One potential weakness is the assumption that at least some of the interest that a bank receives is disappearing down a "black hole" (something still awaiting verification). Another potential weakness that you have identified is that it might not be handling the "flows" correctly. (Maybe you could refine the equations to correct this).

I have on my computer a file called "moneybankinghistory.pdf" which is a book titled "FRACTIONAL RESERVE BANKING AS ECONOMIC PARASITISM" by Vladimir Z. Nuri.
This book treats money as a "fluid" and uses standard scientific formulae to analyze its sources, sinks and flows. I haven't studied it yet (I am a bit put off by its woo-ish title ) but it should help me refine my model.

 

[tensordyne]

Response to Tippit, part I

Money originated out of barter, with the goods having the most desirable characteristics for money (scarcity, durability, divisibility) gradually supplanting the others as a medium of exchange, and store of value.

Spoken like a true Austrian Cultist. I said that Zarlenga makes a strong case that money originated with temples and religions (just one of possibly many theories on the origins of money btw), and instead of saying "Oh yeah, what proof is there of this?", or "Well, perhaps, but there are probably many theories as to the origination of money. Maybe others should be considered as well...", or, something to that effect. Something someone would say if they were not brainwashed.

What do I get instead of the above? The Austrian School company line. You sound like you are channeling Rothbard or something. For the statement above there is no evidence, just a flat statement of fact, as if that makes it so. I guess the fact that for thousands of years it was the sacred prerogative of the highest temple authorities to mint gold must never have come before your eyes.

Or that cattle were used as trade, and for sacrifices. That the idea of interest itself in all likelyhood came about because cattle could reproduce, so part of the stock would be given back to increase fertility, after a trade or loan was made. All this under the rule of local city-states whose power resided in kings and the temple, and supposedly some crusty old god or other.

Or that debts in Mesopotamian temples were denominated in barley and silver. Or that temples were often places not just of worship, but of trade and commerce (storage areas for grain products as well). Or...

Nope, automotan speaking: "Money originated out of..."

The decline of Rome corresponded with the debasement of its currency - coin clipping. Contrast this with the Byzantine Empire which lasted for ~1100 years, thanks to Diocletian and the gold solidus, a pillar of monetary stability and fairness.

Pretty standard Austrian style response above. Flashes over a lot of history. The Byzantine Empire was the last part of the Roman Empire, btw.

Rome had a problem, Gold was locked up in the temples to the East. Rome's second King, King Numa, used bronze bars called nummi or nomisma instead of gold, thus lessening the power of the rulers of the East over Rome. (A kind of correction here in case anyone will notice, Lycurgus was from Sparta and not Rome. He did influence Early Roman monetary policy though, along with Solon and some other big names from the Greeks.) Then King Servius also made some changes to money in Rome by changing the size of the bars and impressing certain designs on them called Aes signatum by modern scholars.

Then came the Aes grave, Romes first coin. It was made of the same material as the bars and were in general worth 1 nomisma, convertible to 30 ounces of bronze. There are many other economic developments between these forms of money and The Roman Republic's first truly fiat money, but perhaps I should just skip ahead.

According to Del Mar, "...the Roman monetary system was a numerary one, and the numismatic relics which have so long been regarded by the learned world as copper coins, were essentially irredeemable notes stamped (for lack of paper) on copper, and divised and designed to pass in exchanges for a much greater value then that of the material of which they were composed." There goes your 'inherent value' theory of money Tippit. Oh yeah, the weight of the Aes grave coin several times was reduced without changing the monetary unit it was worth. The Romans never complained about it either.

Rome then started a campaign to unify the Italian Peninsula. The Roman Soldiers billeted in lands far from Rome where silver and gold coinages were used, wanted money that could be used where they lived.

Rome then issued the Romano coins. They were used for foreign trade and were not marked with units, instead they were of a consistent weight.

Next, Rome took on Carthage, whose influence in the Mediteranean Seas was growing fast. It was here that they made a huge mistake, they introduced the silver Denarius. Then things got worse with the introduction of the Gold Denarius. Pliny had some rough words to say about the introduction of such coinage, "The Next Crime commited against the welfare of minkind, was on the part of him who was first to coin a Denarius of gold... would that gold could have been banished forever from the Earth, accursed by universal report, reviled by the reproaches of all the best men, and looked upon as discovered only for the ruin of mankind." Rome got a taste of the Midas touch it seems.

In the conquests that followed, Roman generals started issueing their own coinage (with tacit state approval) based on the spoils they recieved in war. The victorious generals made a fortune by issueing their coinage by first selling it to the mint for its full monetized value, which was greater than the money's commodity value. The issue of these coins was not limited either. This started the trend of the concentration of wealth in Rome.

Rome's fiat money (as all money is really fiat) went from nonconvertible to commodity based. After that, Rome went on one conquest after another to get these precious metals. The lesson of King Numa being forgotten, since the metals were concentrated in eastern hoards, the Eastern Cults started to influence Rome like never before. A plutocratic class also becomes evident at this point.

Skip forward, past the 2nd Punic war, the Macedonian war, the rise of the Latifundia, the Gracchan revolt, and we come to the Caesars. Caesar gets assasinated by Brutus. Differing factions form, each minting their own money, vieing for power. A series of Caesars follows, whose lineage can be traced all the way into the Byzantium Empire, whose seat of power was Constantinople. More on that in a bit.

During the early part of the Roman Empire, the older bronze moneys still circulated. Diocletian initiated many reforms, resigning from Emporer to be a farmer because of his disgust of the Empire he formerly ruled (he was a prior slave too). The flow of precious metals led Constantine to change the seat of the Empire to the east of Rome to what is now Istanbul, then known as Constantinople.

Constantine held the office of Pontifex Maximus called also the Basileus, which came with it the money power.

In the East of the Empire, rule of law still held on (Constantine took gold from the temples to inaugurate his Bezant coin), but in the West, things continued to degenerate. The gold money of Constantine was not treated as equivalent to a commodity. It was illegal to melt the money into bullion or otherwise deface it (penalty: Death). This shows, even then, that the legal aspect of
money, was in full force.

The 'pillar' spoken of before was cracked some by Abd al-Malik ibn Marwan. He coined money with his own imprint, starting a war (he broke a peace treaty to pay in gold coins imprinted with Roman designs, he chose instead to imprint them with a man on a horse holding up a sword - message recieved).

By this time, the Western end of the Empire was essentially disintegrating, while the East stayed the course through the corrupt practice of having a different silver to gold ratio than in India. The 'fair' empire that Diocletian belonged to had many problems: money, increased use of slavery, Eastern religious cults that changed the Roman public service ethic, Moslems at their doorstep (lead poisoning?).

Perhaps though the thing that ended the Roman Empire, and her Republic, more than anything else, was the use of precious metals as money. Abd el Melik used the gold/silver ratio as a monetary attack against Eastern Rome. The other problems of Rome, her plutocracy and growing slavery, all might be symptoms of a greater disease, commodity money. Whatever the case may be for Roman and Byzantine decline, Constantine instituted strict controls on the content of his Bezants.

The problem for Constantine was there was a decline in the supply of gold for his Bezants. Wear and tear alone had reduced the coinage, but there was also the concentration of wealth. The Church sucked in a vast amount of wealth, and coin. Tippit, the Empire you speak so approvingly of, because it kept its weights pure, went into a deflationary spiral.

Yeah, such a great example to use Tippit. Try again.

It's the same thing that central banks have always done, only on a larger scale. Whether the central bank monetizes assets, issues loans to member banks, or lowers reserve requirements, it is effectively creating (counterfeiting) money on behalf of insiders.

Oh, now its the same, only on a grander scale. Before it was, you were an idiot who knew nothing if you did not understand how QE/ZIRP worked because it was so god-awful important to how banks operated.

Good to know.

That's ridiculous. Fiat means "by decree", which usually implies the use of sufficient force in order for it to be accepted. Do you support forcing people to use the paper or electronic money that you think is best? I advocate monetary freedom, and save gold and silver.

Fiat means "let it be done." The sufficient force you are speaking of may be as simple as no one will accept your 'money' in preferrence to some other money. Realistically though, money is a legal power exerted by a given society. Powers can be used for good or for evil. Until decreed by a society, gold and other minerals are merely commodities. Useful in electronics and for making jewelry.

If a majority of people vote to use a particular kind of money, whatever it will be, I will use it. I may complain about it, but what other choice do I have? What other choice do you have? I have no problem with people trading and bartering in whatever items or services they want (no slavery of course).

Brass tacks though, money is a legal function. If you go to court and the other party offers to settle in money, it must be accepted. Oh, that sounds so unfair no? Too bad. What is the other option? You could offer goats, "no, I do not like goats". How about silver? "No thanks, have plenty of that already." What about... I think you get the picture.

You know what though, let's just barter for everything, and government, rule of law, that is so last millenia. I pay for the police I want on a really free market, judges too... why not? The market is free... weeeee! We don't need no stinking government, the market will provide all.

Monetary freedom is like the kind of freedom in the paragraph above. Sounds good when you hear it, but does not make a lot of sense when you really think about it. I could relate how the Wildcat period of US monetary history led to Company towns with their own 'money', and how utterly crappy it was. The problem is you are not considering power, instead your thoughts are only of erstwhile freedoms. If you give economically powerful people the freedom to do what they want, then you will loose your freedom, and livelihood.

I don't subscribe to any "school", but I borrow from many. I'm an independent thinker. I think your assessment of our political system is pretty accurate. We have the worst possible aspects of two failed ideologies, and nobody seems to notice in between all of the finger pointing and polarized rhetoric.

Well, I have some sympathy for the sentiment of borrowing from many schools of thought. People are asked to believe all sorts of things without first-hand knowledge these days. A school of thought helps to act like a filter, sifting through the good and bad. Peace be upon your multi-schooled, independent mind.

Reforming money won't solve all of the world's problems, though it will go a long way. Like I said, I've thought long and hard about various proposed solutions, and all fiat money solutions require me to entrust politicians, bankers, or both with a monetary printing press. You admittedly don't
understand how the central bank robs people, or especially the scope, yet you criticize real money because one author made a lot of sense to you. The Monetary Reform Act, another fiat solution endorsed by Friedman, made a lot of sense to me too, for awhile, but then I recognized it for what it is, flawed, just like the humans to whom we would be entrusting our purchasing power.

That is an interesting assessment. I never admited that I do not know how the current system robs people, Thanks for the vote of confidence though.

I am glad you have thought long and hard about such issues. My own independent thinking made me realize that all economic systems are flawed, just some more than others. Commodity money is up there with the most flawed unfortunately.

So you want to arbitrarily cap interest rates and reserve ratios? What are the optimal numbers, in your estimation?

Eh, it is hard to say. It is not as important what the numbers are as that they are constant throughout time. I would want an interest and reserve ratio sufficient so that bankers earn what an average white-collar worker makes, nothing more, say 5% and 9:1 reserve ratio. Additionally, the bank has to have the amount of the loan to make the loan, setting it aside in case of loan default. The bank originates money through loans, but the amount would have to be covered for default losses, in which case the bank looses that amount as it will get deleted by the government.

I hope I am doing my numbers right above!

This is highly convoluted, and requires massive government intervention to say the least, all to balance a "debt equation" that doesn't need balancing. Interest isn't a black hole, and exorbitant bank profits are ultimately either spent back into the economy or wind up in asset prices. The problem is bank profits are too high, because they have an unfair advantage over other lenders. They can lend other people's money, and let them spend it at the same time in a demand account, effectively a license to print money. All we need to do is abolish fractional reserve banking, and let people choose their own money.

I can understand the complaint of it being convulated. My goal was to take FRB and modify it so that it was in line with Colonial Pennsylvannia banking where debt and money creation are balanced.

The government action involved would be laughably minimal when compared to other things governments do. The debt equation does need balancing. Here, I think, you, and pretty much everyone else on this forum, really does not understand how FRB actually works. It is very simple, banks create money, destroy it when a loan is repaid, but not all of the debt. I will try to show this in a response to psionl0's response later. Right now I have so much to respond to here, I do not have time to go over that.

More later in part II...

All the best to you all!


p.s. I got a whole lot of the information above from Zarlenga's book. Thought I should be scholarly-like and make note of that.

 

[tensordyne]

Outline

Getting an idea across can be difficult at times. You often use equations to describe what is happening in the banking system so maybe if I do likewise, you will understand me better.

At its most basic level, a bank's assets consist of its reserves (R) and the debts of its borrowers (D). On the liability side, a bank owes money to its depositors (M) and also to its shareholders (S). The "M" is of course, part of the total money supply. Note that the banks do not actually have to pay out their liability to their shareholders. A bank's board of directors will use the "S" in a way that is in the best interests of the bank (eg give themselves a big fat bonus).

So the balancing equation is: R + D = M + S

Any interest payment the bank gets will more than likely come from its depositors' bank accounts which directly reduces the total money supply. However, it doesn't change the bank's assets (reserves and debts of borrowers remain the same) so the only way to balance the equation is to add the interest payment to what the bank owes its shareholders. In other words, an interest payment (i) transfers some of a bank's liability from its depositors to its shareholders.

So the balancing equation becomes: R + D = (M - i) + (S + i)

This balancing equation is that of all the banks taken together but Tippit raised the question of what happens if an interest payment came from another bank? In that case the interest payment would be added to the bank's reserves but not its depositors' bank accounts. It (again) gets added to the bank's liability to its shareholders.

The balancing equation: (R + i) + D = M + (S + i)

Although the amount of money owed by bank A to its depositors is unchanged, the amount of money owed by bank B has decreased by the amount of the interest payment so the total money supply is still decreased.

Since bank A's reserves have increased it can engage in a round of deposit expansion and you know how that works.

The end result for bank A is: (R + i) + (D + k*i) = (M + k*i) + (S + i)

Bank A's deposit expansion is counteracted by Bank B's deposit contraction because bank B's reserves are reduced by the amount of the interest payment.

If a borrower uses cash to make an interest payment then you get the same balancing equations as you get from an inter-bank transfer.

Notice that in every case, interest payments are taken from the total money supply and the bank is free to do what it will with it.

If the bank spends the interest money back into the economy, it is effectively transferring its liability from its shareholders back to its depositors.

So the balancing equation becomes: R + D = ((M - i) + i) + ((S + i) - i)

or more simply: R + D = M + S

THIS IS THE ZERO SUM GAIN WE NEED TO KEEP THE FINANCIAL SYSTEM STABLE.

Of course, the bank will do no such thing. The most likely scenario is that the bank will create new debt-based money to replace that which was taken out by the interest payment.

This gives the following balancing equation: R + (D + i) = M + (S + i)

which restores the money supply but increases the debt to money ratio.

If the government were to create money to replace that lost by interest payments then it wouldn't work because it doesn't stop the banks from doing the same thing. Any money the government creates will invariably be deposited into bank accounts which increase the banks' reserves. This is the same scenario as for bank A above except that now it applies for all banks taken together. If the banks are also creating money to replace interest, then after the deposit expansion, this is what the final balancing equation looks like:

(R + i) + ((D + i) + k*i) = ((M + i) + k*i) + (S + i)

and when the government removes the "i" the "k*i" also gets removed.


As you can see from the above equations, in the early stages of the boom/bust cycle, there is plenty of money to service the debts. However, once the aggregate interest collected by the banks exceeds the value of their reserves, there is no longer enough money in the bank accounts to repay the debts. There is still some M0 money laying around but soon the debts will grow bigger than that too.

If this explanation makes any sense to you, I will discuss the "greenbacker" solution in another post.

Cheers.

I think I agree with the general outlines of the information above. The difficulty in modeling FRB is that one should really have a multitude of banks, some starting with money close to the source in the Fed, others further down the line, and so on.

I think it is important to also understand the three main actions that can occur in banking. A new loan can be made, part of a loan can be repaid and money can be transferred from one bank to another. I think the general ideas associated with each are covered in the post above.

The biggest part I agree with above is your conclusion section at the end.
At some point the interest makes paying off all loans impossible. I myself am pretty well acquainted with greenbacker ideas. I certainly agree it would be a vast improvement to the system we have now. It would be worthwhile to go over greenbacker ideas anyways though, if for nothing else for stevea.

For my part, I think a greenbacker + Pennsylvania-like banking system would be nice. The greenbacker part so that there would be money in the system for people to retire on, and the Pennsylvania part so that average people would help in determining how much money there is in the system (assuming of course you keep debt and money creation ballanced).

I want that PDF you have too!

All the best to you my good friend psionl0.

 

[psionl0]

Nice to see that I am now speaking the right language.

I'm not sure what you mean by "some starting with money close to the source in the Fed, others further down the line, and so on". All banks have an account with a central bank so in a sense, they all have a direct line with the central bank. Subsidiary branches would (probably) only have an account with their parent bank but I'm not sure that we need to treat those in isolation.

I have yet to acquaint myself with the Pennsylvania model but I will do so once I have analysed the full reserve model.

The main thing to conclude so far is that under FRB, it is pretty much impossible to stop debt rising exponentially in relation to the money supply. If the banks choose to re-lend the interest they collect then it is not even apparent that interest would be disappearing down a black hole.

Next up, full reserve banking.

PS: If googling the file name or title of the PDF doesn't bring you any joy then PM me with an email address and I will upload the file to you.

 

[psionl0]

Full Reserve Banking Part I - The Balancing Equation

Since full reserve banking is not currently practised in the western world, it is instructive to develop a balancing equation in an analogous fashion to the one I developed for the fractional case in post#1136.

Any bank will of course have its own capital (C) which represents the total money invested into it by its shareholders and its accumulated profits. This money it owes to its shareholders (S).

So the initial balancing equation is: C = S.

A bank will also have money (M) deposited into its demand deposit accounts by its customers. Under full reserve banking, there must be a one to one correspondence between the money in its demand deposit accounts and its reserves (R).
So, R = M (ALWAYS)
and the balancing equation becomes R + C = M + S.

The bank will also have money that was deposited into its "investment" accounts (I) which is not part of the bank's reserves.

So the balancing equation becomes: R + C + I = M + I + S.

The bank is free to lend out the entire C + I to borrowers in exchange for the borrowers IOUs. These IOUs represent the debts (D) of its borrowers. Although IOUs are "tradeable", they (like reserves) are not in circulation so they do not add to the money supply.

The balancing equation is now: (R + C + I) + D = (M + C + I) + I + S.

Since the C + I has been absorbed into the bank's reserves (and demand deposit accounts) it is much simpler to write a balancing equation for all of the banks taken together:

R + D = M + I + S.

If we include the money that is not in the banking system (M0) then we can develop a balancing equation that represents the entire money supply:

(M0 + R) + D = (M + M0) + I + S.

"Base" money (MB) is defined as the notes and coins in circulation as well as banks' reserves (MB = M0 + R) and M1 money is defined as M0 money as well as the money in the demand deposit accounts (M1 = M + M0).

So the final balancing equation for the entire money supply is: MB + D = M1 + I + S.

(Aside: M1 + I = M2 or M3 depending on the nature of the investment accounts).

This final balancing equation is the one I will use to explore the effect of interest in part II.

 

[tensordyne]

Response to Tippit, part II

Even more convoluted government intervention. Doesn't the reserve requirement already set aside reserves?

Yes, but if the bank has a borrower who defaults on a bank loan, from what I have been able to gather, banks have as a requirement that they must at least 'try' to zero out the principal, before writing off a FRB loan. They do this by obtaining rights to the the collateral of the loan, sell it, and use the proceeds to zero out some of the principal.

Anything left over is theirs as a profit, if the amount does not zero out the loan, then the debt and the principal that is left is simply written off. Defaults are bad for banks mostly because it effects their credit rating (unless you are one of the big banks, then you pretty much own the credit rating agencies, so, what ev!).

We could also just abolish the fractional reserve system, thereby forcing banks to loan their own paid-in capital or term deposits, and let regulators enforce existing anti-fraud laws.

True, we could, more or less.

Then, when they fail, we wave goodbye to them and their unfortunate depositors, instead of socializing the risk and losses.

One option. The general principle of having banks, in whatever system, once failed, of loosing depositer money, is interesting. I would have to think through the consequences more to give an adequate response. I have heard that the FDIC is broke, and that by law they should have taken over a
number of the current zombie banks. I have also heard that the government backup of banks failing leads to irresponsible loans.

It can be argued that customers should keep track of their balance before they write checks. Certainly the banks are legally stealing from people using this method, I agree. If we declaw and liberalize the bank industry, real competition should make this a moot point. It's the consolidation of the banking industry and the resultant lack of competition that is causing all of these immoral and regressive bank policies to stick.

Thanks for the agreement. All I can say is, I really do not like the ABA.

I prefer my solution, yours is too convoluted, and makes too many assumptions about how government and banks should and will act. Abolish fractional reserve banking, and have government return to constitutional money and honest weights and measures.

Fair enough. I have thought for some time that so many people in the monetary reform groups should stop trying to fight each other so much and at least agree on some sort of changes to work toward.

Austrians, Greenbackers, the LETS people, etc., etc. can probably agree at least on some of the worst aspects of the current system and how to change it for the better. Even if it is things like just getting rid of some banking fees. Numbers and pressure is what causes political change.

I'm not cynical of any of those things. I'm cynical that an unjust government will justly enforce the law.

Haha, I am not the one who said saving in gold and silver is a cynical indictment of human nature. Everything else I listed is just a logical extension of this cynicism.

Really? I think the banksters are quite happy with the current scam - practically unlimited fiat money for insiders. They have surpassed the alchemist's dream, of converting lead into gold.

They've convinced legions of people like you that paper, even cheaper than lead, is better than gold! Granted, as they now make money ample for their own benefit, they have and would attempt to make gold and silver scarce, for their own benefit, but there are ways around this which don't require scapegoating real money.

The problem is that your valuation of money, both in practice and in theory, is incorrect. Money gets its value from who backs it and how much of it their is. Money is abstract, just like numbers are abstract. If I say something is an inch long, does it matter if the ruler is made of gold, lead or wood? Of course not. If anything, the best 'unit' for money would be time.

Plus, the logic of the response above is odd in a sense. I said that sometimes money comes along that works for the people, did you think I meant the current system? Have I not made it abundantly clear I do not like the current system? I see, perhaps it is because you lump all so called 'fiat' money systems together (better to call it nonconvertable, for it is not convertable to something else, like a commodity such as gold).

There are many differences between, for instance, goldbacker money and the current system's money. Then again, considering such differences would mean you would have to consider matters other than the ones you probably want to concentrate on: they are both nonconvertable. Oh yes, of course, when you read money that works for the people, you think of your gold ingots, but then, I did say "slavery to gold or debt inducing currency." Debt inducing currency is the current system and slavery to gold is meant as a referrence to the system you advocate for.

Here is a hint, when I said money that works for the people, I did not mean the current system and I certainly did not mean commodity 'money'. Bringing up the current system in response is bizarrely disingenuous.

Lincoln conscripted troops and caused riots, before embarking the nation upon a bloody, senseless civil war. No fake money, and war must be paid with real money, which is extremely unpopular, as it should be. Fiat money is the currency of warmongers.

Lincoln saved the Union from disintegrating. The riots were started by the rioters themselves. He paid for the war with the best form of money the US has ever had and saved the US for at least a little while from domination by the british oligarchs (the creation Fed is when that battle was lost, for now...). Lincoln was not a warmonger. He did all he could to not let war start but once it got going, he saw it through to the end. Unfortunately, at first he did not even care about the question of slavery. Lincoln did not want to have the Union weakened so that the Brits could have their way with the US.

But you know what, let me just for a moment buy into this overtly racist "Northern Agression" narative, even then, the Greenback was an economic wonder. It worked so well it started a new political party named after it, inspired a song and allowed the US not to go into debt to any lenders while winning a war. Something done also during the War of Independence, or are you against that bloody, senseless war too? Death to all Tyrants

He oversaw the rebuilding of a Germany that was first destroyed by the Weimar hyperinflation, a direct consequence of the fraud and looting that fiat money enables. He then later went on to start World War II. And you're using this as an example of success?

The Weimar hyperinflation happened after the Reichsbank was turned over to private hands from public hands (don't trust the government huh). Do you know how to differentiate economic policies from war policies? I guess not.

That is right, Hitler oversaw the rebuilding of a Germany destroyed by the policies connected with one type of 'fiat' money, and rebuilt it in record time with high employment, with the policies associated with another type of 'fiat' money. Maybe the fiat part is not as important as the other parts, the policies? Noooo.... that can't be.

The use of colonial scrip was predicated by the tyranny of King George, taxing all of the colonists gold and silver to where they had none. The colonists would have been better served by simply denying King George their gold and silver, although it is debatable whether they could have funded the revolutionary war otherwise. In any event, we know the Continental was debased to a tiny fraction of its original value and destroying the wealth of many Americans, leading to the phrase "not worth a Continental".

Here is a quote to consider:

"Experience, more prevalent than all the logic in the World, has fully convinced us all, that paper money has been, and is now of the greatest advantages to the country."

The scrip and the other moneys created in the Colonies were not created because King George taxed the gold and silver of the colonists (he was not even around for some of these moneys), it was created because they simply did not have enough money to use in the first place. Then King George did create a tax or two (with the Parliament, lest it be forgottent), but the main thing he did was force the Colonists not to be able to use their own money, causing economic hardship.

The Colonies wanted paper money so badly because they knew first-hand what it could do for the good of the average person in terms of livelyhood. That is why the started the war, and it is what helped to end the war with the Colonists winning. So the Colonists did not win the monetary war against the continental because it was counterfeited so much. That is a technical issue of making notes hard to counterfeit and not an issue of paper money in general. If any money, no matter what it is made of, is made too abundant, it will loose its value.

I would put it as having little to do with a lack of regulation, and everything to do with a lack of justice.

Perhaps so. There can be a million good regulations on the books, but if no one enforces them, what good are they? William K. Black should be Secretary of the Treasury. Then you will get some justice.

And those who hold the printing press now get to make the laws. They will emit more and more currency to their cronies until the economy collapses. The way out of this morass is sound money, and abolishing the fractional reserve system, after we hang the banksters and politicians who put us in this mess.

The printing press is in private hands currently (by proxy of government lands). So by the logic above, if the printing press were truly put into the hands of the public, they would make the laws.

Sounds good to me.

The bankers and politicians that got us into to the Fed are probably pretty much all dead. I like the sentiment, but why don't we just try and have laws either changed that need changing, or exercised if, they are good laws not being enforced?

The question of "legitimacy" is irrelevant. The only thing that matters is the fact that your dollar buys a tiny fraction of what it originally did.

The question of legitimacy is everything. If you have a dollar in your pocket and it is a forgery, are you going to tell me it is irrelevant?

The reason the dollar buys a tiny fraction of what it originally did is because of the policies associated with the Fed and how FRB works. The Pennsylvania Colonial money kept its value and would be described by you as fiat. The people used it and one Governor of that time period, Belcher, even disobeyed orders not to use it issued from the Lords of Trade because he believed very fervantly in its necessity.

The problem is you still have a fractional reserve system with all its attendant bank profits, and socialized risks, which you attempt to make up for with byzantine regulations plus the faith that the banks and the money supply will actually be regulated. You know, the Federal Reserve as it was conceived was dramatically different than it is now. It has slowly devolved into the monster it is, and all of the legal "checks and balances" are gone, which is exactly the same fate that would await your attempt at reform if it were enacted.

I have desocialized the risks in the system I advocate for, thank you very much. Banks should make some sort of profit if they do work and have actual risk (as would be the case in the system I advocate for), but the most obvious thing of all from the comments above is a total lack of historical perspective.

Some systems are self correcting, some not. The Pennsylvania Banking system is self-correcting, and I based my general ideas on that system. All of the gold convertible currencies have failed. All of the currencies that did not have strong stewardship to keep the money involved not over-issued, have
likewise failed.

The system I am advocating for is based on a system that worked so well that even Adam Smith, one of your fellow Goldbug friends, would note that, "The early notes of the colony seem to have kept their credit...". Wierd huh?

So here you reveal that you really have no concept of the regressive inflation tax, or, you simply don't care.

The statement above would be galling if it just wasn't so inane.

One, I said get rid of the income tax.

Two, in a system where all the debt that gets created is equal to all the money that gets created (perhaps with a pool of nondebt backed money for retirement, this is not an exact science after all), even if there was inflation or deflation (both being unlikely in the long run is my estimation), it would be due to market forces and not money creation. Why? Because all money would get deleted eventually.

Three, I said get rid of taxes on labor wages and profits earned by loaning items. Only tax profits due to merely owning land or their equivalents. That means that your labor could not be taxed; movie rentals could not be taxed; there could be no sales taxes; there would not be quite a few taxes that
currently exist. The taxes that would be left would be of the kind that tax incomes that siphon off wealth from the greater economy, while not adding anything back in return.

One of the ways in which modern banks make money is through real estate investments. The rule of real estate investors is Other Peoples Money (OPM) and getting a loan that will cost no more than the rental value of the real estate in question. The investor buys the house with the bank's money, pays
off the loan with rental incomes for a while and hopes to sell it for more then bought for (robbing the community of wealth returns since a lot of the value of a piece of land is associated with development around that land). Tax that, then you will see your hated banksters really through a hissy fit.

Monopolies and cartels should be abolished, their operators thrown in jail, and their assets seized and used to fund legitimate, constitutional government.

First off, wow, you really like putting people in jail or hanging them. Maybe you should consider first going through the legal channels of getting whatever they are currently doing to be illegal before you mete out punishment. Just a thought.

As for Cartels, yes, get rid of the lot of them. State sanctioned monopolies, bye bye too (do both wisely and over a judicious time period is my suggestion, so as not to upset the economy too much).

Seriously though, I hope you are aware of the fact that there are market monopolies. Maybe you should factor that in when considering siezing their assets for basically the 'crime' of out-competing everyone else.

While I may be "crazy", I'm not a banker. I have to live with the results of my own decisions, whether I'm right or wrong. I can't walk between the raindrops, and have someone else assume my losses. So equating me with central bankers is not only totally inaccurate, it's unfair.

If you say so (not being a banker that is, as I can neither prove nor disprove such a conjecture). The comparison is that at least one central banker likes to read from similar material as you probably do. Like it or lump it, but it is a fact.

I have noticed that a decent percentage of the populace, when analyzing something that is in essence abstract, try to make the thing under consideration concrete, and conversely, when something that is not understood is concrete in nature, they attempt to make it seem abstract. The error of the Austrian, and to a large extent the Neoclassical School as well, is of this kind. The essentially abstract nature of money disquiets the mind that is want to make this abstract/concrete mismatch error.

I leave you with the words of Plato - "...it has the name nomisma - because it exists not by nature, but by law (nomos) and it is in our power to change it and make it useless." He was referring to money, for all money is by fiat of the law.

Please Tippit, stop listening to these intellectual Pygmies, the Austrian Schoolers. Otherwise, we all might end up on a cross made of gold.

All the best to you all!

 

[psionl0]

Full Reserve Banking Part II - The effect of interest.

In my previous post I showed that when all the banks and all the circulating notes and coins are taken together, the money supply in a full reserve system can be modeled by the following equation:

MB + D = M1 + I + S

Any interest collected by the banks on the debts (D) of their borrowers comes out of the M1 money supply. Out of that money the banks have to pay their running expenses and also pay interest on the money in their investment accounts (I). Since the banks expect to make a profit, there will be a net interest (i) in the banks' favour which is deducted from the M1 money supply. This will loose the same amount of money from their reserves which form part of the money base (MB). This money becomes part of the banks' capital which they owe to their shareholders.

The balancing equation becomes: (MB - i) + i + D = (M1 - i) + I + (S + i)

Naturally, the banks can re-lend this interest which restores the money base as well as the M1 money supply but adds to the total owed by the banks' debtors.

The balancing equation: MB + (D + i) = M1 + I + (S + i)

So far we have the same problem that we have under FRB - the total debt increases but not the money supply. If the money supply is fixed (eg it is based on a fixed commodity like gold or the government never runs a deficit budget) then our options are limited. Either we "plug the leak" or the debt will rise exponentially to unsustainable levels.

However, if the base money is entirely fiat then it is possible for the government to introduce new debt free money (N) into the system.

This gives us the following balancing equation: (MB + N) + (D + i) = (M1 + N) + I + (S + i)

If N is big enough then it will stop the debt to money ratio from rising. Of course, it is not quite that simple. Some of the new money will almost certainly find itself in the investment accounts where it can be lent out again. This is not deposit expansion because the newly lent money would almost certainly not end up in investment accounts (only a fool would borrow money to put into an investment account that pays less interest than he is paying). There could be secondary effects but these would be relatively minor.

If we assume that at the end of the day, half of the new money ends up in investment accounts then we get the following balancing equation:

(MB + N/2) + N/2 + (D + i) = (M1 + N/2) + (I + N/2) + (S + i)

and when that investment account money has been loaned out we get:

(MB + N) + (D + i + N/2) = (M1 + N) + (I + N/2) + (S + i)

Note that the debt is still rising more slowly than the money supply so we can still keep the debt to money ratio down. Unfortunately, this newly created money came straight off the printing presses and didn't accompany an increase in goods or services so it is inflationary - the dreaded "inflation tax" (I don't know why Tippit doesn't call it the "counterfeiting tax" ). This is the "greenbacker" solution.

Hopefully tensordyne, I have demonstrated the essential difference between fractional and full reserve banking. Under FRB you can't stop the debt to money ratio from rising by creating new money because the new money is created as debt. In a full reserve situation, the newly created money is substantially debt free so the financial system can be kept stable - albeit with perpetual inflation.

(If you want me to discuss this from a political angle then I will put forth my views in response to some of the things you have raised in another post).

 

[tensordyne]

How the banks create money (destroy it, and are owed more than ever was created)



Well psionl0, It looks for now like Tippit, stevea and everyone else is gone after other fry. It either means they think we are so crazy with woo that there is no point debating us, or perhaps either or both of us have scared them away with indubitable use of logic , yeah, chance of that is about 0.

I have to say, I am going to have to sit down with pen and paper and go over your posts to date. I would not have chosen the names you gave to your variables, but that should hardly matter.

Let me make my own foray into the equation method by explaining what I have been able to figure out from MMM. First off, with respect, the Khan Academy video is putting out false information. Ughghg.

Mr. Khan believes in the same kind of banking model that Sceptic-PK believes in. Actually, it would have been in Sceptic-PK's interest to point to that video. Oh well.

I am going to use variable names that are whole words, or even phrases, so that there can be as little confusion and work on the part of any member of my audience as possible. The model I am going to cover is how FRB is supposed to work under ideal settings. Steve Keen likes to point out that banks do not really care about the reserve requirements anymore and will loan to anyone willing to take a loan, if I understand him correctly.

Each bank follows a type of accounting that is NOT the same as how people balance a checkbook. The type of accounting is called double-entry book-keeping. In double-entry book-keeping one has 'Liabilities' and 'Assets'. In Liabilities there are one or more Demand Deposit Accounts (other things too? Not in this case...). In Assets one has Reserves as well as 'Loans and Investments'.

Since this is an idealized case, let's just stay with Loans only instead of other investments.

Liabilities = Deposits
Assets = Reserves + Loans

The Reserves is also known as 'Total Reserves', to distinguish from 'Required Reserves' and 'Excessive Reserves'. In general we have

Reserves = 'Required Reserves' + 'Excessive Reserves'

The ratio of Excessive to Required Reserves is supposed to have a maximum ratio, such as 2:1, 9:1, or whatever. Why should one care about such a ratio though? I will follow the examples set in MMM to explain the significance of the ratio. I will use 9:1, which means that

'Excessive Reserves' = 0.9 * Reserves
'Required Reserves' = 0.1 * Reserves

So we start out with a bank that is Capitalized to $10,000. From here out, all units will be in dollars($), not that it really matters, so long as it is some kind of monetary unit. It does not matter where the money comes for the example, but the most likely case is as a loan from the Fed. The general equation to always satisfy is

Assets = Liabilities.

So starting off we have no Loans.

Assets:
Reserves = Required + Excessive = 1,000 + 9,000 = 10,000
Loans = 0

Liabilities:
Deposits = 10,000

Now there are three actions a bank can take in FRB. A bank can make a loan, transfer money from one account to another (possibly at another bank), or have some portion of a loan repaid.

Bank makes a Loan.
------------------

The maximum amount a bank is supposed to be allowed to loan is the Excessive Reserves. They always show banks loaning out this amount in the examples. This is somewhat unrealistic because the money in the bank must be used to pay expenses. Let's say the bank above makes a loan of 5,000. The numbers change in the following way.

Assets:
Reserves = Required + Excessive = 1,000 + 9,000 = 10,000
Loans = 5,000

Liabilities:
Deposits = 15,000

Now, by the rules of the game, the bank could make another loan, but chances are the bank will not.

The reason is that the loan will most likely go to another bank. First off, please notice that the difference of Deposits and Loans is equal to Reserves.

Bank transfers deposit money.
-----------------------------

So the borrower wants to buy something with the 5,000. In this case Deposits and Reserves go down by 5,000. The difference of Deposits and Loans still equals Reserves. In general, if Total Deposits is D and Total Loans is L with Total Reserves R, then D - L = R (a form of Assets = Liabilities).

In the loan creation one had total loans and deposits increase by the same amount. Let a prime mean previous values.

D - L = (D' + 5,000) - (L' + 5,000) = D' - L' = R' = R.

That is for loan origination. During a transfer (out of a bank, if the transfer occurs from one deposit account to another in the same bank, total numbers do not change), Total Deposits and Total Reserves both decrease by the same amount. So, in this case, chances are that the 5,000 will be transfered to another bank.

D - L = (D' - 5,000) - L' = R' - 5,000 = R, but notice that D' - L' = R', as it must.

After the Bank Deposit Transfer one has

Assets:
Reserves = Required + Excessive = 500 + 4,500 = 5,000
Loans = 5,000

Liabilities:
Deposits = 10,000

Bank borrower repays part of the Loan.
--------------------------------------

This process is like the opposite of the Loan Origination process. Say the borrower gets 500 selling goods and want to pay off some of the loan. Without taking interest into consideration, if the 500 goes to paying off the principal on the loan, then what happens is Deposits and Loans go down by the same amount (in this case 500).

D - L = (D' - 500) - (L' - 500) = D' - L' = R' = R

We get

Assets:
Reserves = Required + Excessive = 450 + 4,050
Loans = 4,500

Liabilities:
Deposits = 9,500

Interest for the loan acts like a bank transfer, in case anyone is interested, with the interest adding to the deposit account that the bank has with itself (part of Total Deposits).

That is about it. The myth is that this is a balanced situation. The problem with this conviction is that when a new loan is added to Loans in the Assets side, it does not add in the interest. Since all money is created as part of a bank loan in terms of principal (even for the Government), and bank loan repayments get rid of this created principal, there is a deficit between how much is owed and how much is created.

By the way, due to transfer of funds from Deposits, it is possible that if the bank is not careful, the Total Reserves might go negative. When that happens the bank is insolvent. To stop from being insolvent banks can get a loan at the discount window of the Fed. Banks do not go bankrupt (since supposedly they always have perfectly balanced books (*laugh*)), they go insolvent, or technically not supposed to be able to make loans.

psionl0, I will analyze what you wrote so far, but I am wondering if you could have a look at the above and compare it to your own models. I hope my numbers and equations are pretty easy to follow so that this will be easier for you to do than for me to do (although, I still will, it will just take longer I think).

All the best to you all!

 

[psionl0]

Well psionl0, It looks for now like Tippit, stevea and everyone else is gone after other fry. It either means they think we are so crazy with woo that there is no point debating us, or perhaps either or both of us have scared them away with indubitable use of logic , yeah, chance of that is about 0.

I guess that stevea thinks I'm too much of a retard for him to respond to nowadays and no doubt, Tippit has formed the same opinion about you.

OTOH you can't argue with mathematics so maybe that is why they stopped posting on this thread?

Let me make my own foray into the equation method by explaining what I have been able to figure out from MMM.

There are two factual errors in your analysis:

'Excessive Reserves' = 0.9 * Reserves
'Required Reserves' = 0.1 * Reserves

Required Reserves = 0.1 * Deposits.

So we start out with a bank that is Capitalized to $10,000.

In fact, the bank has started out with $10,000 in deposits. This is an inexactitude rather than a straight out error. However, banks don't have to pay out from their capital, only deposits - on demand!

At this point, I will write the corrected version of your equations:

So starting off we have no Loans. (this part is correct)

Assets:
Reserves = Required + Excessive = 1,000 + 9,000 = 10,000
Loans = 0

Liabilities:
Deposits = 10,000

Bank makes a Loan.
------------------

Assets:
Reserves = Required + Excessive = 1,500 + 8,500 = 10,000
Loans = 5,000

Liabilities:
Deposits = 15,000

Bank transfers deposit money.
-----------------------------

After the Bank Deposit Transfer one has

Assets:
Reserves = Required + Excessive = 1,000 + 4,000 = 5,000
Loans = 5,000

Liabilities:
Deposits = 10,000

Bank borrower repays part of the Loan. (principal only)
--------------------------------------

We get

Assets:
Reserves = Required + Excessive = 950 + 4,050
Loans = 4,500

Liabilities:
Deposits = 9,500

In all of the above equations, (total) Reserves = Deposits - Loans.

Interest for the loan acts like a bank transfer, in case anyone is interested, with the interest adding to the deposit account that the bank has with itself (part of Total Deposits).

The deposit account that the "bank has with itself" should not be considered "part of Total Deposits". It is actually the bank's capital - the sum of its paid in shareholder capital and undistributed profits. (Undistributed profits are also known as the company's "reserve" which is not to be confused with the reserves that the bank holds to back its customer deposits).

The point is that banks do not have to make a "demand" withdrawal from this capital account. So whenever money is transferred from the bank's customer deposit accounts to its capital account it decreases the bank's required reserves and increases its excess reserves.

Bank borrower makes an interest payment of $100
--------------------------------------

We get

Assets:
Reserves = Required + Excessive = 940 + 4,060
Loans = 4,500

Liabilities:
Deposits = Demand + Capital = 9,400 + 100

Notice that the total Reserves are now the difference between the bank's Demand+Capital deposits and the bank loans.

That is about it. The myth is that this is a balanced situation.

In double-entry bookkeeping, the accounts always balance. This is because every debit in one account is matched by credits in other accounts and vice versa.

The problem with this conviction is that when a new loan is added to Loans in the Assets side, it does not add in the interest. Since all money is created as part of a bank loan in terms of principal (even for the Government), and bank loan repayments get rid of this created principal, there is a deficit between how much is owed and how much is created.

This is the part that you want to describe with your mathematical equations. Hopefully, by adding the interest payment case to your equations, I have helped show you how *I* account for it.

By the way, due to transfer of funds from Deposits, it is possible that if the bank is not careful, the Total Reserves might go negative. When that happens the bank is insolvent. To stop from being insolvent banks can get a loan at the discount window of the Fed. Banks do not go bankrupt (since supposedly they always have perfectly balanced books (*laugh*)), they go insolvent, or technically not supposed to be able to make loans.

If total reserves go down to zero (they can't go negative) then we are in the middle of a bank run ("TAXPAYERS TO THE RESCUE!" ). Inter bank loans or loans from the fed can help a bank through a temporary liquidity problem but they can't bail out a failing bank.

Books always balance. The key is the bank's capital account (excess of assets over liabilities). If this account does not have a credit balance then the bank has more liabilities than assets and is insolvent.

psionl0, I will analyze what you wrote so far, but I am wondering if you could have a look at the above and compare it to your own models. I hope my numbers and equations are pretty easy to follow so that this will be easier for you to do than for me to do (although, I still will, it will just take longer I think).

Always happy to criticize! Seriously though, take all the time you need to come to grips with your equations and mine. Once you have done this you should be able to return the favour (criticize me!)

 

[Tippit]

I guess that stevea thinks I'm too much of a retard for him to respond to nowadays and no doubt, Tippit has formed the same opinion about you.

I don't think either of you are retards. Most of the name calling and vitriol has come from tensordyne. It's a long and tiresome thread about a subject that has been beaten to death, and while there is much we agree on it's probably better to just agree to disagree about the rest.

 

[tensordyne]

Guilty!

I don't think either of you are retards. Most of the name calling and vitriol has come from tensordyne. It's a long and tiresome thread about a subject that has been beaten to death, and while there is much we agree on it's probably better to just agree to disagree about the rest.

Guilty as charged! Vitriol is anything caustic or acidic. If the acid of reason must be applied to get to some version of reality, then I say bring out the acid. As for the name calling, eh, I probably do skirt the lines of what is supposed to be acceptable on JREF. It blows off some steam.

I am willing to beat this subject to dust if that is what it takes for me to understand it. I find that by debating the subject my assumptions are challenged and I have to rethink things several times. A good example of this will hopefully be my next post where I cover reserve requirements.

All the best to you Tippit!

 

[tensordyne]

so many things!

I guess that stevea thinks I'm too much of a retard for him to respond to nowadays and no doubt, Tippit has formed the same opinion about you.

So, now we know that Tippit at least does not think of either of us as being retarded (at least that is what Tippit said). I do not think Tippit commented on either of our woo factors though. I have a woo factor myself of somewhere between 0.1 to 0.2. I will leave it to you to determine how one determines woo factor, or what yours is. That is half the fun of having a woo factor!

OTOH you can't argue with mathematics so maybe that is why they stopped posting on this thread?

Maybe. I read in the intro to a book an author (please do not ask me who, just take this as apocryphal) who said each equation in a book cuts readership in half (E = mc^2 too?). To be honest, the first post you did with equations I looked at for quite some time, mostly I think because of variable naming (I think I have my head wrapped around it, but I still have yet to do pen and paper examination). The next two threads after that seem like a blur of equations because I am finding it hard to get context for the equations. I feel bad about that, but hopefully I will rectify that soon.

While it is true you can not argue with correctly applied math, I think it is definitely possible to argue against the assumptions used before any math is applied Often it is paramount to do so in fact, lest the math amplify initially false ideas into monstrously false conclusions.

There are two factual errors in your analysis:Required Reserves = 0.1 * Deposits.

I have to say, this caused me to go into deep analysis mode. I looked over MMM and found several quotes saying what the reserve ratio meant. It said that the reserve ratio was of reserves to deposits (I will find the quotes if desired). After that, I did some number crunching / numerology on the steps they give in MMM. What I figured out was that for any given bank the following is supposed to be true:

R / D > 0.1

(assuming a 9:1 ratio, R is Reserves, D is deposits, plus let RR be required reserves and ER be Excessive Reserves)

Given the formula above, the smallest R can be without breaking the inequality (assuming D is positive of course, which it must be), is 0.1 * D. This is the required reserves. So,

RR = 0.1 * D.

In the post it was said there were two factual errors. You only listed one. Let me give the other correction I think you were probably referring to.

ER = R - RR.

By the way, MMM kind of sucks as a document to understand FRB. It is long, boring, not many equations, and presents such simplified scenarios that one could easily misinterpret things if one does not read between the lines.

In fact, the bank has started out with $10,000 in deposits. This is an inexactitude rather than a straight out error. However, banks don't have to pay out from their capital, only deposits - on demand!

This introduces Capital. I am wondering if you can tell me where in MMM or somewhere else they talk about bank capital. I am now getting to the point where I feel much more confident that I understand how FRB works, to the point that I want referrences!

That said, from what I have read, a bank's reserves is all vault money (coin, which is actually coins and physical notes), money held in an account with a local fed branch bank, or money the bank has on its own accounts with itself (although, I have not found a referrence about banks holding accounts with themselves, so maybe that is a fiction of my own imagination, I have found quotes of banks holding accounts with central banks so that part is presumeably safe).

At this point, I will write the corrected version of your equations:

Let me introduce here all the equations and some motivation behind them. psionl0, I think this part is the most important part of this post. I hope you will give it a good look over.

First off though, let there be a triple (R, D, L), which represents one bank's reserves (R), loans and investments (L), and deposits of various kinds (D). Each of these quantities can be made up of a number of other quantities, but I will not cover that (for instance, D is made up of all the deposit accounts of bank account holders, say D = D1 + D2 + ... etc. That kind of thing...).

Basic Equations:

R = D - L
RR = r * D

r is reserve ratio, which for M:N reserve ratio means

r = N / (M + N)

ER = R - RR


Now come the actions a bank can do. Some are multistep in a sense.


Transfer money:

Let (R1, D1, L1) be the triple for bank 1 and (R2, D2, L2) be the same for bank2. Let the transfer amount be t. Let the transfer be from bank 1 to bank 2. Then the two triples will change like so:

bank 1: (R1, D1, L1) -> (R1 - t, D1 - t, L1)
bank 2: (R2, D2, L2) -> (R2 + t, D2 + t, L2)

Possible problems: If t > R1, If t > ER1, or in words, if the transfer is for more then the bank has in reserves or if the transfer amount is greater then the excessive reserves of bank 1 then the bank will not meet the reserve requirements or even have a run on its hands.

Make a Loan:

Let the loan amount be q. The bank triple will go like the following.

(R, D, L) -> (R, D + q, L + q)

Possible problems: after most bank loans a transfer occurs to another bank, or possibly even into cash (several other less likely scenarios, the loan money stays at the originating bank or even is transfered to several other banks, which might happen with a signature loan, for instance).

Covering the most likely scenario then of transfer of funds to another bank, we should set up two banks like before. The series of transforms of each bank triple then becomes as follows (bank1 originates the loan, bank 2 recieves the transfer after the loan).

bank1: (R1, D1, L1) -> (R1, D1 + q, L1 + q) -> (R1 - q, D1, L1 + q)
bank2: (R2, D2, L2) -> (R2 + q, D2 + q, L2)

There is no downside to this for bank 2, but for bank 1 the possible problems for it are the same as occured before, but with q replacing t. In general then banks should look at their ER and make sure that q < ER (and then some probably, because the bank will have other expenses that can mess with reserves).

Pay off part of loan:

I do not want to get into the whole P/P+I dilemma of FRB yet. I am holding off on that for a section below. Let this then just be pay off loan while only taking into consideration principal and not the interest (as per noted by you previously). The most likely scenario is that the loan will be paid from the same bank that originated it. I will also include the case of this not being true.

So let the principal part to be repaid on a loan be p.

One bank case:

(R, D, L) -> (R, D - p, L - p)

Two bank case:

Principal p on a loan is being paid from bank 1 to bank 2. Note that first a transfer happens, and then part of the loan is paid.

bank1: (R1, D1, L1) -> (R1 - p, D1 - p, L1)
bank2: (R2, D2, L2) -> (R2 + p, D2 + p, L2) -> (R2 + p, D2, L2 - p)

hmmm... or is this the way it goes? Well, a point to debate about I suppose.

It is interesting that in the scheme above total reserves stayed constant, total deposits and total loans went down by p, which is very much similar to the one bank case.

So starting off we have no Loans. (this part is correct)

Assets:
Reserves = Required + Excessive = 1,000 + 9,000 = 10,000
Loans = 0

Liabilities:
Deposits = 10,000

Bank makes a Loan.
------------------

Assets:
Reserves = Required + Excessive = 1,500 + 8,500 = 10,000
Loans = 5,000

Liabilities:
Deposits = 15,000

Bank transfers deposit money.
-----------------------------

After the Bank Deposit Transfer one has

Assets:
Reserves = Required + Excessive = 1,000 + 4,000 = 5,000
Loans = 5,000

Liabilities:
Deposits = 10,000

Bank borrower repays part of the Loan. (principal only)
--------------------------------------

We get

Assets:
Reserves = Required + Excessive = 950 + 4,050
Loans = 4,500

Liabilities:
Deposits = 9,500

In all of the above equations, (total) Reserves = Deposits - Loans.

Agreed to section above. Thanks for the correction. I love being shown I am wrong because then I learn something. I do not love being shown I am wrong too often though, because it means I am either crazy or lazy in my analysis. Either way, my honor is intact (I hope some of the other subscribers learn something here, it is *good* to admit when you are wrong! Tippit, Sceptic-PK, lomiller), so all is good.

The deposit account that the "bank has with itself" should not be considered "part of Total Deposits". It is actually the bank's capital - the sum of its paid in shareholder capital and undistributed profits. (Undistributed profits are also known as the company's "reserve" which is not to be confused with the reserves that the bank holds to back its customer deposits).

Again, I am concerned somewhat with the term capital for the moment.

The point is that banks do not have to make a "demand" withdrawal from this capital account. So whenever money is transferred from the bank's customer deposit accounts to its capital account it decreases the bank's required reserves and increases its excess reserves.

It seems capital would be reserves? Whatever the case is for the above, bank customer withdrawals lead to reduction in reserves and deposits in equal amount.

Bank borrower makes an interest payment of $100
--------------------------------------

We get

Assets:
Reserves = Required + Excessive = 940 + 4,060
Loans = 4,500

Liabilities:
Deposits = Demand + Capital = 9,400 + 100

Notice that the total Reserves are now the difference between the bank's Demand+Capital

deposits and the bank loans.

hmmm, still just not sure where this capital thing fits in exactly.

In double-entry bookkeeping, the accounts always balance. This is because every debit in one account is matched by credits in other accounts and vice versa.

This is the part that you want to describe with your mathematical equations. Hopefully, by adding the interest payment case to your equations, I have helped show you how *I* account for it.

Oh, but I never said the books don't balance, I said the situation is unbalanced, two very different things. If the books do not include something relevant then even if what is covered balances, the things the books do not cover might or might not ballance.

If D is the total deposits in the system and T the total debts, then T is always greater than D (T > D). The amount that T is greater than D is the interest, I. In the *books* used for FRB, there is no column for T or I (at least, not that I have seen, correct me if you know better).

Let's say X dollars is created by a government selling bonds to a central bank. The government then gives someone X dollars for some good or service. This someone puts the money in a bank.

The bank then has the (R, D, L) of (X, X, 0). Now, at this point the situation is already unbalanced, the money created is X, which is less than the debt T the government owes back! The books are ballanced though!

Then the bank does its thing and makes someone a loan of L (assuming that all rules are being followed here). The loan means that the triple becomes (X, X + L, L). Now, MMM does not cover how interest works as far as changing the triple, but it seems that the most logical possibility is that the interest subtracts from deposits and adds to reserves.

(R, D, L) -> (R + i, D - i, L)

The problem is banks charge a lot of interest! That and the imbalance that occurs due to government borrowing makes for a very unbalanced situation, with the banks being on the top no doubt.

Now, about the solution I presented.

I have to admit that there are two things I was incorrect about, so far as I can tell, up until now. The first is the formulas for excessive and required reserves. The second is in considering exactly how interest worked. In this error I think it was a lack of consideration in that I did not consider how interest worked and therefore how things might even out because of it (aka, the bank spend the i back into D from R as it were). As far as I can tell though the other fomulas involving (R,D,L) are correct (as per MMM).

That said, it is interesting that after looking at the solution I have advocated for I still think that it might be sound. The complaint given before about the government spending the interest into existence was that the banks would just use it to make more loans.

For starters, if the government spends money into existence instead of borrowing it (one of the main ideas in terms of Greenbacker notions btw), the main blackhole (a real debt blackhole as it were, instead of the kind-of debt blackhole of interest payments, which to be honest, is still in all likelyhood a serious black-hole in its own way -- more hardcore analysis required {or what of the other blackhole of debt, derivatives?}) would be eliminated.

But what of the new interest money?

Well, I am sure banks would use whatever money they can get their hands on to increase loans. The second part of the plank of ideas was to only have certain types of taxes be the only ones allowed, ever! (taxes on monopolies, financial instruments and profits accrued due to ownership of natural resources).

These taxes would not include the productive economy (ughgh, psionl0, you really should read Henry George. I am sure his ideas would nock your socks off. It is from his work I am advocating these types of taxes), no sales taxes, no wage taxes, as well as many others. The taxes I outlined would be on the main ones banks actually make money from. So while the government spends into existence interest, it taxes it into nothing back again. The rate of money creation / destruction would be of main concern then. But this would be determined by the people democratically choosing how many loans they want to go into.

To make sure banks do not make irresponsible loans (still possible in the system so far covered without any added rules), there would be two main types of reserves. The first would be a default reserve, the second a fractional reserve. The fractional reserve would act like how the total reserves acts now (with excessive and required reserves and all of that).

The default reserves would be in place so that if a borrower does not repay (subject to standardized default rules), the money comes from the default reserves. Since a bank would be allowed to move money from default to fractional reserves if requirements are met (I don't know, just think about what sounds reasonable here with the main hint being some of the default reserves would be covering loans, some of it would not, so the part that is not is rightfully the banks to do with what it wants), and defaulting would eat into this money, hopefully banks would act more responsibly.

The other thing that recently occured to me was that there is a problem when it comes to how banks currently foreclose on houses. If you spend 20 years on a 30 year home loan as a good borrower but you loose your house because you loose a job, it hardly seems right that the bank will just foreclose on your house, sell it as quickly as it can and then you loose that 20years of value.

I think the correct solution is that the house gets sold and from the proceeds of the sale the borrower gets whatever percent they spent into the loan, the bank a nominal fee (minus default reserve coverage), and whatever is left (if any is left) goes to the government to spend into the economy (apply as necessary to other types of loans). Any deficit comes from default reserves as noted parenthetically above. Benifit of the doubt goes to the borrower, and everyone gets what they rightly deserve.

But, now I come back to reality. The chances of the above ideas coming true are about a zillion to one. As an excercise in logic though it is at least fun to think about. I know it probably sounds complicated but it is really just taking the knowledge of how FRB works and changing FRB so that everyone gets what they really deserve.

{ Sorry for the wall of text above, I have at least tried to make it readable }
{ by breaking things up and doing my best to make it flow somewhat........ }

If total reserves go down to zero (they can't go negative) then we are in the middle of a bank run ("TAXPAYERS TO THE RESCUE!" ). Inter bank loans or loans from the fed can help a bank through a temporary liquidity problem but they can't bail out a failing bank.

Well, I think we are more or less on the same page here. I should note that if a bank even has its reserves go below required reserves too often (discount window to the rescue) the bank should be considered insolvent, put into recievership, and so on. I am sure Stephen K. Black has quite a number of things to say on this matter.

Books always balance. The key is the bank's capital account (excess of assets over liabilities). If this account does not have a credit balance then the bank has more liabilities than assets and is insolvent.

Sounds good to me, make sure and tell your democratic representatives and I will tell mine and then nothing much is likely to happen about it! Sorry, we have so many insolvant banks right now it is like whak-a-mole except no one seems to have the will to hammer them down.

Always happy to criticize! Seriously though, take all the time you need to come to grips with your equations and mine. Once you have done this you should be able to return the favour (criticize me!)

Just did! Tomorrow I will start up on the other posts of yours. Sorry, best I could do. I kind of wanted to cover this first as it was on my mind. All the best to you all!

 

[Tippit]

So, now we know that Tippit at least does not think of either of us as being retarded (at least that is what Tippit said). I do not think Tippit commented on either of our woo factors though. I have a woo factor myself of somewhere between 0.1 to 0.2. I will leave it to you to determine how one determines woo factor, or what yours is. That is half the fun of having a woo factor!

Why do you feel the need to qualify what I've said with "at least that's what he said"? That's the second time you've insinuated that I'm dishonest. The first time was when you remarked that I may be a banker, despite me specifically claiming I'm not. If I thought you were retarded, I would say so, and wouldn't waste anymore keystrokes on you at all. I realize that most of the so-called skeptics on this forum believe anyone who disagrees with them to be either stupid or crazy, but I'm not one of those people. Don't let your contempt for gold or silver cloud your judgement. I'm not "the enemy". I have a fundamentally different understanding of the history of gold and silver, and the history of fiat money than you do. Lets leave it at that.

 

[tensordyne]

You're too serious all the time Tippit! I tell you what, if there are any parts of "Man, Economy, and State" I don't get, I will make sure and send over a pm to you to get clarification. On the other hand, if you haven't even checked up on some of Zarlenga's essays, well... that is being intellectually dishonest (that is why I am reading up on the main Austrian School work myself, wouldn't want to be intellectually dishonest, which by the way is different then normal dishonesty such as telling a flat out lie).

The only real enemy is ignorance and avarice, agreed.

But, onto other things... while I would imagine that you do not agree with possible solutions I would offer to fix the way banking works now (and I emphatically do not agree with yours), perhaps you can still comment on my analysis of how FRB supposedly works (remember I am covering an idealization of it), which is after all, supposed to be the main topic.

~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~

 

[tensordyne]

Oh, I did not answer a question of yours Tippit: "at least that's what he said"? Because thinking and feeling are two different things. You can think we are not retarded but feel like we are. Hope that helps! Oh, and as far as dishonesty goes, I have no doubts you are most likely a very honest person. The camp of people you've decided to go with when it comes to Economics though are very intellectually dishonest (think of being intellectually dishonest like being a bad scientist that will not let go of a favored theory even when there is ample evidence to argue against it).

And finally, I think I can tell I must have phased you some Tippit. It is because when I have argued against other people and they have no good replies left (you never usually really win debates except in debate club), they say things like "we just have very different ideas and let's leave it at that." Oh really? Hmmm, maybe let's not. Oh well, seeds, they start off small and get bigger from there if planted in suitable soil.

~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~

 

[tensordyne]

Oh, I love your signature quote Tippit. Freaking Krugman said recently we should go to war to help start the economy. Maybe the formula is have some bubbles, let them pop and when things get out of hand go to war.

 

[psionl0]

I have a fundamentally different understanding of the history of gold and silver, and the history of fiat money than you do. Lets leave it at that.

Let's take it a little further than that.

I can see a hard gold standard working. What I can't see is how we would transition towards it - especially if we don't have the gold.

You have argued that people should be free to use any currency they choose. Again I don't see that helping the cause of a hard gold standard. Historically, it seems, fiat currencies tend to displace commodity-based currencies. (The more usual way this "law" is expressed is, "whenever 'bad' money is introduced into a society, 'good' money gets withdrawn" ).

At least a full reserve fiat only system seems implementable. Ideally, a central agency would figure out how much money needs to be created each year to keep the economy functioning at optimum levels. In practice, politicians would never cede the power of the money press to an autonomous agency. The chancellor would probably want that power for himself.

Politicians in charge of the money supply? Most people would shout "Noooooooooooo!!!" However, money needs to be created to keep debt levels down to a reasonable level (compared to GDP for example). The natural avarice shown by politicians would actually work in our favour. Ultimately it would be up to the voters to decide how much of their taxes they want to pay directly and how much through inflation.

 

[psionl0]

Let me introduce here all the equations and some motivation behind them. psionl0, I think this part is the most important part of this post. I hope you will give it a good look over.

I have. Unfortunately, I seem to understand your equations better than you understand mine. Hopefully you will be able to change this situation as time permits.

First off though, let there be a triple (R, D, L), which represents one bank's reserves (R), loans and investments (L), and deposits of various kinds (D).

As we shall see, it might have been better to introduce the triple (R, -D, L) so that each letter can represent a positive number.

It is not apparent from your triple that Reserves and Loans are assets to the bank and Deposits are liabilities for the bank. Assets and Liabilities must always equal each other in the business's books. In other words, assets and liabilities are a zero sum gain. In your triple, you would have R+D+L=0 indicating that at least one of the letters is a negative number (credit balance). With the modified triple, you would write R + (-D) + L = 0 leaving no doubt which of the quantities is a liability.

All of your equations are correct with the exception of accounting for the dreaded "interest". I need to digress a little here to explain why.

In business, All Assets = All Liabilites (ALWAYS). So anytime there is a business transaction, one of 4 possibilities arise:
- Assets and Liabilities go UP by the same amount (eg the business buys something on credit)
- Assets and Liabilities go DOWN by the same amount (eg the business pays a bill)
- Money is transferred from one Liability account to another Liability account (eg the business writes a PN to settle a bill)
- Money is transferred from one Asset account to another Asset account (eg a business's debtor pays cash to settle a bill).

(It is not quite that simple because businesses also have accounts for income and expenses but the balances of these accounts are transferred to asset/liability accounts at the end of the accounting period).

With that in mind, let's see what you have done:

Let's say X dollars is created by a government selling bonds to a central bank. The government then gives someone X dollars for some good or service. This someone puts the money in a bank.

The bank then has the (R, D, L) of (X, X, 0). Now, at this point the situation is already unbalanced, the money created is X, which is less than the debt T the government owes back! The books are ballanced though! (I don't think that shows an unbalanced situation but this is not the point I want to deal with right now)

Then the bank does its thing and makes someone a loan of L (assuming that all rules are being followed here). The loan means that the triple becomes (X, X + L, L). Now, MMM does not cover how interest works as far as changing the triple, but it seems that the most logical possibility is that the interest subtracts from deposits and adds to reserves.

(R, D, L) -> (R + i, D - i, L)

Can you see what you did here? You took money from a liability account and added it to an asset account. You can't do that because it destroys the balance between assets and liabilities. The modified triple might make this clearer:

(R, -D, L) -> (R+i, -(D-i), L) What was a zero sum equation now adds up to 2*i!

Actually, you more or less nailed it in an earlier post:

Interest for the loan acts like a bank transfer, in case anyone is interested, with the interest adding to the deposit account that the bank has with itself (part of Total Deposits).

Unfortunately, when I called "the deposit account that the bank has with itself" a "capital" account, I inadvertently pressed a "too hard" button. Sorry about that.

You are not likely to find anything about this in MMM since MMM is dealing with macroeconomic issues while how a business structures its internal accounts (the "chart of accounts") is a microeconomic issue. If you want to know exactly how a bank accounts for its transactions then you will need a big thick textbook. I actually have one - "Economics Of Money Banking And Financial Markets.pdf" by Frederic F. Mishkin (warning! it's not as interesting as MMM).

Now, about the solution I presented. *snip*

I'm too single-minded to deal with the rest of your post here but, rest assured, I have read it and I find it interesting. I will deal with some of your proposals in a future post.

 

[tensordyne]

The Dreaded Interest! The DREAD! THE DREAD!!!!

I have. Unfortunately, I seem to understand your equations better than you understand mine. Hopefully you will be able to change this situation as time permits.

Nice to see you back psionl0! I am working on a response to your first equation using post of the three from the recent posts.

As we shall see, it might have been better to introduce the triple (R, -D, L) so that each letter can represent a positive number.

Eh, depends on how you want to look at it. I like my numbers to be put in positively if possible.

It is not apparent from your triple that Reserves and Loans are assets to the bank and Deposits are liabilities for the bank. Assets and Liabilities must always equal each other in the business's books. In other words, assets and liabilities are a zero sum gain. In your triple, you would have R+D+L=0 indicating that at least one of the letters is a negative number (credit balance). With the modified triple, you would write R + (-D) + L = 0 leaving no doubt which of the quantities is a liability.

Well, again, I like my numbers to be positive if possible, doing any subtraction after the fact, as needed. You are correct of course that

Assets = R + L
Liabilities = D

Think of my triple (R,D,L) as representing R = D - L.

I don't understand why my triple would have to represent the sum (R + D + L), that is only one possibility out of a huge infinity of possibilities for an invariant function that the triple R,D,L might have. If F is an invariant of R,D,L then whenever R,D,L changes to say R',D',L' then F(R,D,L) = F(R',D',L'), or some other representation of the same idea.

It is an equation that is equivalent to R + (-D) + L = 0, so both are the same, and as I am the originator (sorry, not going to change on this one) of using a triple as it were, at least for this forum, I think pride of place should go to my notation.

In another way, the reason I like the R = D - L form of the equation (although it should not really matter of course), is that it makes it clear to minds like Sceptic-PK that what is involved with banking is not conservation of a sum (as would be the case if banks really did loan out the money they have), but instead, conserving a minus.

I like it because it is reminiscent of Special Relativity (as I explained to Sceptic-PK in another post). In Special Relativity (with c = 1) propre-time squared is the difference of clock-maker time squared and distance traversed squared. In a way, this is similar to how R = D - L works.

All of your equations are correct with the exception of accounting for the dreaded "interest". I need to digress a little here to explain why.

Ughgh, yep, I was going to write a correction because it occurred to me in the middle of writing a response to your first equation post that I had broken the cardinal rule of

R = D - L (or what is equivalent the equation Assets = Liabilities)

It occurred to me that if you use D = M + S, then as described in your first equation post that the normal depositer accounts go as M - i, and the other as S + i, thus keeping the main R,D,L equation above true.

In business, All Assets = All Liabilites (ALWAYS). So anytime there is a business transaction, one of 4 possibilities arise:
- Assets and Liabilities go UP by the same amount (eg the business buys something on credit)
- Assets and Liabilities go DOWN by the same amount (eg the business pays a bill)
- Money is transferred from one Liability account to another Liability account (eg the business writes a PN to settle a bill)
- Money is transferred from one Asset account to another Asset account (eg a business's debtor pays cash to settle a bill).

(It is not quite that simple because businesses also have accounts for income and expenses but the balances of these accounts are transferred to asset/liability accounts at the end of the accounting period).

Hmm, so not just banks use T accounting it would seem then. No wonder then that some accounting types have come on here and say normal businesses could act like banks and therefore banks do not make money.

What the heck does PN stand for? The parenthetical note is interesting too. Seems maybe you have taken some accounting classes?

With that in mind, let's see what you have done:
Can you see what you did here? You took money from a liability account and added it to an asset account. You can't do that because it destroys the balance between assets and liabilities. The modified triple might make this clearer:

(R, -D, L) -> (R+i, -(D-i), L) What was a zero sum equation now adds up to 2*i!

Yeah, I know. I feel like I am being clubbed up-side my head a bit, but oh well.

(R, D, L) = (R, M + S, L) -> (R, (M - i) + (S + i), L) = (R, D, L).

Actually, you more or less nailed it in an earlier post:Unfortunately, when I called "the deposit account that the bank has with itself" a "capital" account, I inadvertently pressed a "too hard" button. Sorry about that.

OK, so S is the capital account. R is the account (mostly, include vault cash) that the bank has with a central bank or one of its main branches, D is made up of capital and demand deposit accounts (among some other kinds of accounts from what I have read), L is loans and investments (some of the investments can be the bank's own or of one of the account holders I think I have also read).

Oh, there is probably never a too hard button, just a confusion button. As I understand the main points of General Relativity and Quantum Mechanics at a graduate level I am pretty sure the basic maths used in low-level banking economics should be no problem.

Speaking of which, Steve Keen's book "Debunking Economics II" is coming out on October 4th! It covers the crappy math the Neoclassical school uses and all of that. I did not read his first book, but maybe that is OK because this second one is a revised edition covering everything the first one does (microeconomics) plus new stuff (macroeconomics). Man, I can't wait myself!

You are not likely to find anything about this in MMM since MMM is dealing with macroeconomic issues while how a business structures its internal accounts (the "chart of accounts") is a microeconomic issue. If you want to know exactly how a bank accounts for its transactions then you will need a big thick textbook. I actually have one - "Economics Of Money Banking And Financial Markets.pdf" by Frederic F. Mishkin (warning! it's not as interesting as MMM).

Huh, did you mention this book before in this thread? I will see if I can find the pdf online. Quoting from it maybe could have been useful in various past arguments. Not as interesting as MMM? The book must be god-awful boring then. If I do not find it I will send a PM.

I found the other pdf you listed. It looked well presented, following the format of papers I have seen online, but there was definitely something quackish about it. Like the work of a well-informed amateur who worked hard not to seem like a quack but around the fringes, it showed some definite wear. It was readable all the same though. I could tell it took a crap-load of work to do.

All the same, I think the assumption of trying to treat economic systems in light of statistical mechanics or thermodynamics to be not too bad of an idea. I mean, if a Demand versus Supply diagram does not remind one of a P-V diagram, then one must never have seen that physics before.

I'm too single-minded to deal with the rest of your post here but, rest assured, I have read it and I find it interesting. I will deal with some of your proposals in a future post.

Sounds good. It is good that that the interest question is out of the way, as well as your agreement with the other equations. It makes my response to your first equation post easier to do, I think. I should say the following: I reserve the right to change my mind about anything, at any time, if given new evidence.

I am glad you find my proposals interesting too, by the way.

ALL THE BEST TO ANYONE WHO MAY BE READING!

 

[tensordyne]

Oh, I think I should note, I think this is the first time in this whole 1159 post thread that any two participants are in agreement on the basics of how FRB works. Something of a milestone I would say.