How the banks create money

[tensordyne]

High powered money is another term for "base" money - bank reserves plus the notes and coins in the hands of the public (M0).

Setting up a balance sheet for a central bank is different to setting up a balance sheet for an ordinary bank. There are no reserves for one thing and the central bank only deals with base money. Mishkin gives a simplified balance sheet as shown below:

Assets
Government Securities:
Discount loans:

Liabilities
Currency in circulation:
Reserves:

The "Reserves" are the reserve accounts of the banks and the discount loans are the monies loaned by the central bank to the banks. These liabilities (combined with coins issued by the treasury) constitute the "high powered money".

In theory, these should balance without having a capital account. Purchasing securities or issuing discount loans increases the banks' reserves by the same amount. Banks exchanging reserves for currency is a zero sum gain. One thing I haven't been able to find out yet is how the balance sheet is affected when a bank goes kaput. Such a bank is likely to owe more in discount loans than is owed in reserves so there will be a net loss of assets not matched by a reduction in liabilities.

Very interesting about the Central Bank balance sheet. Of course, as usual, psionl0, your scholarship makes mine look awful, but I am glad to know how the above balance sheet works. Sorry for not responding lately, I needed to take a break.

I see Tippit is back to stir up trouble, good for him. I have a few thoughts on both of your recent posts but I am going to do the 2nd and 3rd equation posts first. Until then,

All the best to psionl0 and Tippit. May you live long and prosper.

 

[psionl0]

If Federal Reserve Notes are IOUs, anything can be an IOU and the acronym loses its meaning. Once again, accuracy in definitions is important.

If we used a credit-based money system, for instance, if the Fed simply conjured up money out of thin air and used it to buy vacant houses instead of bonds, would a Federal Reserve Note be an IOU? The answer, in both cases, is no.

Federal reserve notes are listed as liabilities in the fed's own BALANCE SHEET just like IOUs would be. It makes no difference whether they were used to acquire houses, bonds or any other asset.

 

[Tippit]

Federal reserve notes are listed as liabilities in the fed's own BALANCE SHEET just like IOUs would be. It makes no difference whether they were used to acquire houses, bonds or any other asset.

Liabilities are denominated in dollars, yes? That doesn't make dollars "IOUs". If they are IOUs, can you tell me exactly what is owed, who it is owed to, and where this is specified on the note? I'm fairly certain that I owe exactly nothing to all of the people with whom I have exchanged dollars for goods and services. Again I'm not trying to be pedantic, or split hairs, I'm trying to resolve the question.

As much as I detest fiat money and fractional reserve banking, fiat money is payment for goods or services rendered, by law. I may not like the fact that my employer pays me by essentially having a few bits in a bank computer rearranged on my behalf, but I consented to that when I accepted the job. I think Mishkin is simply conflating the notion that the money created to monetize debt (IOUs) is itself an IOU, which clearly at least to me, it isn't.

Can you help me understand the logic behind your position, if you still disagree?

 

[psionl0]

Liabilities are denominated in dollars (units of currency), yes? That doesn't make dollars (federal reserve notes) "IOUs".

Is this what you mean?

 

[Tippit]

Is this what you mean?

Yes. Also I noticed that Federal Reserve Notes are listed as liabilities on the Fed's balance sheet, as per your link. Who does the Fed owe those dollars to? The great money fairy? I'm pretty sure that's how any central bank has to account for counterfeit dollars that they conjure into existence in order to enable and monetize practically unlimited government debts - on the liability side of the balance sheet. However, that doesn't mean they're IOUs.

Edit: Under the weak gold standard, gold notes issued by the central bank were listed as a liabilies too, because they were redeemable in gold. In this case, the actual notes (currency) were IOUs. Fiat money is not redeemable, or if the Treasury will redeem it, it will only be in other denominations of fiat money. Hence, they are not IOUs in any meaningful sense. I think this should clear up the confusion.

 

[psionl0]

Yes. Also I noticed that Federal Reserve Notes are listed as liabilities on the Fed's balance sheet, as per your link. Who does the Fed owe those dollars to? The great money fairy?

Every time you use the word "dollars" it seems to have a different meaning to the previous time you used that word. Words who's meanings are not clear are the enemy of critical thinking.

You know very well that there is no actual "money" in this current financial system - only debts. If I hold an IOU that was written by you that doesn't mean I owe anybody anything. If I use your IOU to settle a debt then my debt is cleared and I don't owe the creditor anything anymore. You become the new debtor. What I have done to settle my debt is to do a "novation" (substitute your debt for mine).

A similar thing happens when I transfer "money" from my bank account to my creditor's. Instead of me owing the creditor money, the bank does instead. And if I "pay" my debt with fiat money? Then the government becomes the new debtor. In each case, the debt is settled by doing a novation.

In the days of commodity based currency, a government "banknote" was a genuine IOU. They promised to exchange the note for gold (which was considered money). The principal difference today is that there is no "money" to exchange for a federal reserve note so the IOU can never be redeemed.

 

[Tippit]

Every time you use the word "dollars" it seems to have a different meaning to the previous time you used that word. Words who's meanings are not clear are the enemy of critical thinking.

"Dollar" and "Federal Reserve Note" are synonymous for the purposes of this discussion. I have used the terms consistently, so I don't know what your complaint is about. The enemy of honest debate is avoiding specific questions when asked. If a dollar is an IOU, please describe who is owed what, and when. Then please show where this is documented on the dollar.

You know very well that there is no actual "money" in this current financial system - only debts. If I hold an IOU that was written by you that doesn't mean I owe anybody anything. If I use your IOU to settle a debt then my debt is cleared and I don't owe the creditor anything anymore. You become the new debtor. What I have done to settle my debt is to do a "novation" (substitute your debt for mine).

So you've gone from claiming that dollars are IOUs (with no evidence), to disclaiming the existence of "actual money". That's quite a leap. Once again, just because fiat dollars are created to monetize debts does not make them debts. Only the debts are debts. If all debts were instantly forgiven, the dollars would still exist. The problem, is that if all debts were paid, we would not have any money in circulation (unless the Fed, unbeknownst to us, has been monetizing things other than debt). So while the circulation of dollars is dependent on debts never being paid or else being forgiven, actual dollars are irredeemable, and hence cannot themselves be IOUs. I don't want to belabor this point.

A similar thing happens when I transfer "money" from my bank account to my creditor's. Instead of me owing the creditor money, the bank does instead. And if I "pay" my debt with fiat money? Then the government becomes the new debtor. In each case, the debt is settled by doing a novation.

The money is not the debt, the debt was the promissory note you signed for the creditor. If you pay your debt with fiat money, the government owes the creditor nothing, because fiat money is irredeemable. The government owes who ever holds the outstanding Treasury note that was born in correspondence with the money. Fiat money is not an IOU, it is a token payment, recognized by the same decree that accompanied it when it was first spent or borrowed into existence.

In the days of commodity based currency, a government "banknote" was a genuine IOU. They promised to exchange the note for gold (which was considered money). The principal difference today is that there is no "money" to exchange for a federal reserve note so the IOU can never be redeemed.

The Federal Reserve Note is not an IOU, it is fiat money. There is absolutely nothing on its face that implies any obligation what-so-ever. Government issued gold or silver certificates were IOUs (receipts), and they were clearly marked with the governments obligation to redeem in specie. You are confusing the fiat tokens issued concurrently with the IOUs they were originally exchanged for, for IOUs. This is not the case. I'm not sure why you insist this is the case. The fact that the token must eventually be repaid (or debt forgiven) does not make the token the IOU. Apples are not oranges.

Note: There actually is a difference between the irredeemable fiat Federal Reserve Note and the "dollar". The original dollar was the spanish mill dollar, which contained 271 grains of fine silver. I have used the term dollar consistent with what most people perceive the dollar to be. A Federal Reserve Note could be a dollar, or a higher denomination.

 

[psionl0]

If you want to argue that an "irredeemable" IOU is not an IOU then that's fine.

The fact remains that federal reserve notes are still liabilities on the fed's balance sheet.

 

[Tippit]

If you want to argue that an "irredeemable" IOU is not an IOU then that's fine.

I'm arguing that they're not IOUs at all, and clearly they're not. They are token payments. Fiat money.

The fact remains that federal reserve notes are still liabilities on the fed's balance sheet.

I agree, that is a fact. However, it is just a bookkeeping entry to account for the fact that they were conjured out of thin-air at the public's expense in order to pay for (monetize) debts (actual IOUs). The Federal Government created IOUs, and the Federal Reserve created money.

Can I ask what the point of this is? Are you any closer to realizing that irredeemable money is fraudulent and prone to failure, whether it is issued by private banks, politicians, or the non-institutional kind of counterfeiters? It took me quite awhile to arrive at that conclusion, myself, after much time spent thinking that the Monetary Reform Act would be a good solution. Sound money is certainly not without its problems, and we know it will fail under a fractional banking regime, but at least it puts constraints on the kind of widespread systemic economic rape that is occuring today. And we can always come to our senses and abolish fractional reserve banking.

 

[psionl0]

I agree, that is a fact. However, it is just a bookkeeping entry to account for the fact that they were conjured out of thin-air at the public's expense in order to pay for (monetize) debts (actual IOUs). The Federal Government created IOUs, and the Federal Reserve created money.

This isn't the first time I have seen someone argue that the accounting (bookkeeping) is irrelevant.

Can I ask what the point of this is?

No point. I merely observed that a text book described FRNs as IOUs and notes that FRNs are liabilities. You are the one who has made several lengthy posts arguing that FRNs don't satisfy the criteria to be IOUs.

 

[Tippit]

This isn't the first time I have seen someone argue that the accounting (bookkeeping) is irrelevant.

Sometimes bookkeeping entries, are just bookkeeping entries. Clearly private bank deposits are someone's liability. That doesn't make the ethereal FRNs on deposit "IOUs", the IOU, is the bank statement that gives the depositor title to the money. Money is only an IOU when it is fiduciary, in the form of a receipt. Fiat money has no such property, nor do rational people assign it such a property.

No point. I merely observed that a text book described FRNs as IOUs and notes that FRNs are liabilities. You are the one who has made several lengthy posts arguing that FRNs don't satisfy the criteria to be IOUs.

Textbooks can be wrong. I've asked you three times now to tell me where on Federal Reserve Notes it indicates any obligation what-so-ever, and to whom. So far you're 3-3 ignoring the question. I agree that the existence of FRNs is encumbered by the fact that they represent tokens corresponding with debts which can never be completely paid back without collapsing our money supply. But that is a function of the debts, and how the Federal Reserve operates (extinguishing principal), not the notes themselves.

 

[ngc6205]

No point. I merely observed that a text book described FRNs as IOUs and notes that FRNs are liabilities. You are the one who has made several lengthy posts arguing that FRNs don't satisfy the criteria to be IOUs.

FRNs are a paramount lien on all the assets of the Federal Reserve district bank that issued them.

 

[psionl0]

I've asked you three times now to tell me where on Federal Reserve Notes it indicates any obligation what-so-ever, and to whom.

FRNs have the words, "legal tender" written on them (but we already know that). They neither have the words "promise" nor "fiat" written on them. They are simply negotiable instruments.

 

[psionl0]

FRNs are a paramount lien on all the assets of the Federal Reserve district bank that issued them.

You mean, like IOUs?

 

[tensordyne]

I have to say, I do not find it that interesting debating whether FRN's are debts or not, although technically, a note is an IOU, and FRN's are Federal Reserve Notes. The following quote did pique my interest, however.

I agree that the existence of FRNs is encumbered by the fact that they represent tokens corresponding with debts which can never be completely paid back without collapsing our money supply. But that is a function of the debts, and how the Federal Reserve operates (extinguishing principal), not the notes themselves.

Can you expand upon this somewhat Tippit? I am merely asking for clarification.

 

[Finsend]

Hai!

I'm right here.
Saying: NICE hard WORK over here.

(Some) People put quite a lot of effort, energy and time in their posts.
AND nice graphics + some humor as well.

Thanx4That!

The level is going UP as well, or so it seems, 2me.
Even more out of my reach
But I have time.

Because all these words are some-times becoming one big chunk of plasma to me I say:
Let's rrrrrrrrrumble for the FRB Heavy Weight Title of The WORLD!

*** The-Cold-Hard-Numbers-Challenge ***

I did not miss it, did I?!
If so: Were can it be found?
Else: When will it be?


Que sera sera,
Finsend

 

[Tippit]

Correction:

The actual definition of the "dollar", based upon the spanish mill dollar, is 371.25 grains of fine silver, as per the coinage act of 1792, not 271 grains as I posted earlier.

 

[chazwyman]

Correction:

The actual definition of the "dollar", based upon the spanish mill dollar, is 371.25 grains of fine silver, as per the coinage act of 1792, not 271 grains as I posted earlier.

Naive

 

[psionl0]

Naive

So what is the "non-naive" definition of the dollar?

 

[Finsend]

Just some thoughts...

Hello,

I think we might be concluding that when talking about MONEY et al it is about TRUST and REALISTIC REFLECTION OF OTHER THINGS like LABOUR/services, RESOURCES, INFORMATION, weapons, etc.

Will I pay you back? etc.

From some perspective I write this, of course - I am not a mathematician of prof. dr. Economics. But still I want to post here sometimes as well! So I dive into the words now and (low level monetary-FRBphilosophy-areas, if you all don't mind. On my own of course, don't worry! No need to read or answer as well - as always!

One could own an IOU some PAPER for example with WORDS and or NUMBERS / pictures etc printed/written ON IT.

I might say I will give you 100 chickens in the (near) future, because you eh... sBLEEP!ed eh.. I mean you cleaned my house. So I write the note saying Mr. Cleaner (you) will get 100 chickens next week on friday 12:00 AM, etc. You already cleaned the house for me! Thanx

Now we get into the TRUST-Thing. The note has VALUE when trusted in. Trust YOU have in ME. And the back-up of words and numbers with goods/services/info/etc - these are connected

The IOU-note might have even a broader scope of value. When not only you, but several/a lot of people trust me and my notes (and/or you). So you could PASS IT ON to your cousin, because you had to pay him for services or goods - So he gets the note (and hopefully the 100 chickens) ETC.

So the IOU-note equals 100 chickens - in a pretty UNSTABLE WAY some-times. When all chickens die for example, pretty suddenly, well... I (and you) might have a problem. So when I don't have the chickens or I am not able to lay hands on them before friday next week 12 AM WE have a (big) PROBLEM. You and me, or you me and your cousin, maybe even more people depending on this CHAIN (of events) etc.

More or less - The SAME THING WITH ordinary MONEY - I believe. Banknotes, creditaccounts with banks, etc.

I am wrong?

We see these same things over and over during history, bankruns, people not able to come up with the goods/services/etc, money increasing in value or diving down the drain.

So what is the exact DEFINITION of a DOLLAR, or EURO?
Good question! Hard to answer imho.

And what does it mean the FED can print money out of the blue and what does it mean yar-local-BANKS can use FRB banking to add more credits to society in general? Exactly the way they do this of course - see rest of thread! A lot has been said here, very useful stuff most of the time, imho.

So once more Thanx2 all the people overhere contributing on these subjecst and others!
Cheers4now! Going down here in Europe! Ghehe, or NOT?
finsend