How the banks create money

[Finsend]

Money is related to other things like services and goods for example. Future promises most of the time?

One could have a note saying one will get an amount of XXX Dollars in the future at the age of 65 (a pension) but there are no guarantees or whatsoever that the amount will not be YYY Dollars.

These are all calculations and predictions and (future) promises.
Want some Weimar notes? Zimbabwian banknotes?
How many do you wish to have when you are 65?

Governments, Central Banks, Normal Banks should be guarding these things and do the math.
It is their job after all. And since they are only human they make (big) mistake once in a while.
Check out yar local history book.

So a question might be whether FRB and the way "our" system works nowadays is a good reflection of (future) reality including things like labour, production, food, resources and other thingies. It might also be interesting to think about money/debt creation (using FRB and/or printing it up) and it's scales and limits.

I could be wrong, but to me it seems some banks and maybe even central ones have messed it up (?) quite a bit lately. If not, why do I read about it in the paper almost everyday? All these debts and money-related-problems? WHY IS THAT? Oh yeah, I know! bizarre financial constructions like some derivates, CDS's, add some bad loans, a bit of greed and the rest of it And maybe even FRB? In a way(?)

 

[Finsend]

The non-naive definition of the Dollar:

What you will be able to get for it (when you need it most) in a certain place and time.
Something like that!

 

[tensordyne]

It is interesting that Tippit defines money the same way all Austrian School types do, by relating it to some concrete (vs. abstract, as Finsend has been doing) thing, so many grains of this or that.

Non-naive: a dollar is an abstract unit.

 

[psionl0]

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

I like reading your musings as you come to grips with this subject finsend. The word "trust" is a good one to use in relation to how money works. Another common word to use is "faith" - faith that there will be 100 chickens to pay back when the time comes and faith that the debtor won't use those chickens for something else instead.

In the days of commodity based money, the faith was that gold was this substance called money.

 

[psionl0]

It is interesting that Tippit defines money the same way all Austrian School types do, by relating it to some concrete (vs. abstract, as Finsend has been doing) thing, so many grains of this or that.

Whenever Tippit has used the word "dollar", it has had one of three possible meanings: a unit of currency, a federal reserve note or a coin with 271 grains of silver. Since it is not clear from the context which meaning he has in mind when us uses the word "dollar", it makes his writings difficult to follow.

Ironically, he had the exact opposite attitude when is came to fiat note vs IOU. He was so pedantic in his insistence that the two were totally different that I ended up discovering that the fed itself considers federal reserve notes liabilities. This means that every holder of a $1 FRN is owed $1 by the fed. The fact that the fed will never pay this debt doesn't mean that it isn't a debt.

The accounting by the fed shows that there is no substance called "money" - just IOUs. Maybe Tippit doesn't like this accounting inference because it also invites the conclusion that gold isn't a money substance.

 

[Tippit]

Whenever Tippit has used the word "dollar", it has had one of three possible meanings: a unit of currency, a federal reserve note or a coin with 271 grains of silver. Since it is not clear from the context which meaning he has in mind when us uses the word "dollar", it makes his writings difficult to follow.

I think it's only difficult to follow if you intentionally make it so, in an effort to make it appear as if I'm trying to deliberately mislead you. Clearly for the purposes of our discussion, a dollar and Federal Reserve Note are synonymous. I added the historical definition of a dollar to show that a dollar used to be worth something tangible.

Ironically, he had the exact opposite attitude when is came to fiat note vs IOU. He was so pedantic in his insistence that the two were totally different that I ended up discovering that the fed itself considers federal reserve notes liabilities. This means that every holder of a $1 FRN is owed $1 by the fed. The fact that the fed will never pay this debt doesn't mean that it isn't a debt.

I'm not "insisting" anything. I don't care if you believe it's an IOU or not. It's not really that important. There is absoutely no obligation listed on the Federal Reserve Note, and we know that if the US government debt that was issued in exchange for it were forgiven, it would exist as "credit-based" money. The idea that every holder of a $1 FRN is owed $1 is nonsensical. What's the point of redeeming something in order to receive the exact same thing? If Federal Reserve Notes are debt, then anything I exchange with you for an IOU is also debt, which is of course, ridiculous.

The accounting by the fed shows that there is no substance called "money" - just IOUs. Maybe Tippit doesn't like this accounting inference because it also invites the conclusion that gold isn't a money substance.

Accounting for fiat money as a liability is the only way the Fed can make their balance sheet balance after their legalized counterfeiting. Claiming that fiat money is actually an IOU is a falsehood, when in reality fiat money is no promise to pay anything.

Once again it doesn't really matter what you think of gold, I'm very secure with what gold is and isn't. Gold is or is not money, depending on your definition of money. Is it a medium of exchange? Yes, but it is not as widely accepted as fiat currencies for which acceptance is forced to satisfy debts. Is it a store of value? Absolutely. History has proven this. Is fiat money? Yes. It's a medium of exchange, and a limited store of value. Physical gold is simply an alternative currency with no counterparty risk, and no issuing country.

I think the question of whether fiat money is an obligation of some kind is beating a dead horse. Lets agree to disagree, unless you can come up with some kind of philosophical reason for why the question is important. I can think of plenty of reasons to criticize the dollar and the banking system without having to mischaracterize what the dollar is or isn't.

 

[Tippit]

Some common definitions of the term "IOU" to hopefully resolve this once and for all:

Wikipedia:

An IOU (abbreviated from the phrase "I owe you")[1] is usually an informal document acknowledging debt. An IOU differs from a promissory note in that an IOU is not a negotiable instrument and does not specify repayment terms such as the time of repayment. IOUs usually specify the debtor, the amount owed, and sometimes the creditor. IOUs may be signed or carry distinguishing marks or designs to ensure authenticity. In some cases, IOUs may be redeemable for a specific product or service rather than a quantity of currency.[2]
​

The Free Dictionary:

A promise to pay a debt, especially a signed paper stating the specific amount owed and often bearing the letters IOU.
​

Merriam-Webster:

a paper that has on it the letters IOU, a stated sum, and a signature and that is given as an acknowledgment of debt
​

If you don't like the definition of the term "IOU", then please redefine it as you deem appropriate and explain why. Otherwise, it's pretty clear that FRNs are not IOUs.

 

[psionl0]

Some common definitions of the term "IOU" to hopefully resolve this once and for all:

How about "acknowledgement of a liability"?

Bank account balances are clearly liabilities for a bank despite the lack of a redemption date. Whether a bank writes IOUs to customers or credits their bank accounts makes no difference to how the "money" works in society. Debts are settled by transferring the banks' liabilities.

 

[Tippit]

How about "acknowledgement of a liability"?

Can we agree that Federal Reserve Notes are not IOUs, or are you too committed and must save face? Lets be honest here, and call a spade a spade. I already agreed that all bank account balances (deposits) are liabilities *except* where the central bank is concerned. All deposits held by the central bank by member banks are truly liabilities, in the sense that those deposits are clearly owed to those member banks by the central bank. However, in order to make the central bank's balance sheet actually balance, it has to record money that it has conjured out of the ether on its liability column, in exchange for the government bonds (or member bank loans) on its asset column. These are clearly not liabilities, because they are not owed to anyone at all! It is merely a bookkeeping entry. They exist purely by decree. Fiat money. In both cases the Federal Reserve Notes themselves are not liabilities, the claim by a member bank on its own deposit is the liability. The thing owed is not the thing which documents the liability!

Bank account balances are clearly liabilities for a bank despite the lack of a redemption date.

I agree.

Whether a bank writes IOUs to customers or credits their bank accounts makes no difference to how the "money" works in society. Debts are settled by transferring the banks' liabilities.

Debts are settled by payment according to the terms of the debts. Fiat money is not in and of itself a liability, but liabilities are often denominated in it. The fact that I am passing my bank's liability from me to you, thereby becoming your bank's liability to you, is irrelevant. Fiat tokens are not debts, they are payment under the law, even when they only exist as ethereal bits in a bank computer.

 

[psionl0]

Can we agree that Federal Reserve Notes are not IOUs, or are you too committed and must save face?

The principal difference between an IOU and a FRN lies in the legal definition of an IOU. Legalese has nothing to do with reality.

According to the mathematics, the only way to account for a FRN is to record it as a liability. Legalistic word games are a poor excuse for critical thinking. I will go with the mathematics every time.

Central banks create base money in exactly the same manner that banks create M1 money - by crediting the accounts of its depositors. ie by creating a liability for itself. If the asset that was used to back up the created money disappears the liability still remains. If a bank exchanges some of its central-bank credits for FRNs the liability of the central bank still remains.

This is not some fiction with numbers. It is pure unadulterated logic.

 

[psionl0]

One thing the mathematics/accounting is showing is that it is not possible create money that has an intrinsic value. You have to make what you create valuable either by being willing to give something of value for it or forcing somebody else to give something of value for it.

If there is a significant difference between FRNs and IOUs it would be that with FRNs, it is the "someone else" and not the government that gives value for it.

 

[Finsend]

Dollar/Money definition

It is interesting that Tippit defines money the same way all Austrian School types do, by relating it to some concrete (vs. abstract, as Finsend has been doing) thing, so many grains of this or that.

Non-naive: a dollar is an abstract unit.

Actually for me money is both abstract and concrete at the same time.
Money is both a physical object and a mental something - existing in the brains of humans in the form of expectations and believes for example.

Physical concrete aspects and more Abstract ones.

Money could of course be a note, a coin, a digit on pc, a bit or byte, etc, physical stuff. Whatever the value of a 1 dollar note one could light the fireplace with it.

Money also represents (almost) every-thing else, like goods and services. One is able to (hopefully) EXCHANGE money for (some fluctuating amount) of other goods and services. So money has a certain fluctuating "value" and gives you (most if the time a certain fluctuating 'storage capacity' for "wealth" (future goods, services, etc).

But it is (by definition) impossible to anchor money to anything else. In essence not for more than one unit of time. Some amount of money can be worth 100 chickens or 10 euros, 10 dollars or a house - at a certain moment. Maybe this is more or less the case during a (short) period of time. But we all know it cannot be done much longer than for lets say the blink of an eye - during certain eras and in certain places.

So I see money as some kind of possible "option" one might have on (future) stuffs - no guarantees. You might get this or that for a dollar, depending on the situations (the market and environment) and possibly other things. The environment (a tsunami) and believe-systems (expectations, speculations) change all the time, and so does the value of money.

So according to you (tensordyne) the non-naive definition of a dollar is: an abstract unit.

But a unit representing what (other unit)?
All Units are always defined by other one(s), aren't they?
Like the SI units used in physics for example.

So what does it (a dollar) represent in terms of other "things/words"?
Besides being physical it has also a very concrete relation to (my/our) reality.

I can hold it, see it and buy (trade) stuff for it. I can trade it for bubblegum, light my fireplace with it, or look at it on my pc screen.
And in these ways it not so very abstract for my. In other ways it - of course - is.

cheers2u,
finsend

 

[psionl0]

Actually for me money is both abstract and concrete at the same time.
Money is both a physical object and a mental something - existing in the brains of humans in the form of expectations and believes for example.

Money is purely an abstract concept. In reality, there is no physical substance called money. The notes and coins that you handle are called tokens (not money). They represent a certain amount of money but don't have value in themselves.

Some commodities like gold, tobacco or alcohol are highly desired and as a result have "intrinsic" value. This means that they can be used as money (but doesn't mean that they are money).

Unlike physical units of length, mass, charge or time (and units derived from these), units of money have no relationship with the physical world. A monetary unit is worth whatever people say it is at the time. Therefore, money is susceptible to inflationary and deflationary pressures.

The form in which we access money is not that important in the big picture. Some forms (eg cash) are useful if anonymity in transactions is important. Other forms such as internet banking are handy for sending money over long distances. The important aspect of money is how liquid it is (how easy it is to spend). Some forms of money are more liquid than others and that needs to be taken into account when deciding how you will store your money.

 

[psionl0]

And eh... you double posted! Gehehheh

Not any more.

 

[Finsend]

Money is purely an abstract concept. In reality, there is no physical substance called money. The notes and coins that you handle are called tokens (not money). They represent a certain amount of money but don't have value in themselves.

Ehm... I slightly disagree, maybe? For me it is both abstract and concrete, still.

Oxford dictionary:
http://oxforddictionaries.com/definition/money

Money = a current medium of exchange in the form of coins and banknotes; coins and banknotes collectively:

some other dictionary says
mon·ey =
1.
any circulating medium of exchange, including coins, paper money, and demand deposits.
2.
paper money.
3.
gold, silver, or other metal in pieces of convenient form stamped by public authority and issued as a medium of exchange and measure of value.
4.
any article or substance used as a medium of exchange, measure of wealth, or means of payment, as checks on demand deposit or cowrie.
5.
a particular form or denomination of currency.:
http://dictionary.reference.com/browse/money

ETC.

So when I talk about money, I mean money in the way ''ordinary people' like me use it, at least most of the time Have some money for a beer? etc. I know it is important to be precise, but eh... well Uknowme. As long as I understand myself, gheheh

Some commodities like gold, tobacco or alcohol are highly desired and as a result have "intrinsic" value. This means that they can be used as money (but doesn't mean that they are money).

Yes, I agree, but maybe it all depends on how one defines money, etc. Semantics
But I myself see money as different from tobacco or a piece of gold (in a fuzzy way of course).
I use the word money as most people use it (so the coins and notes and credit-cards etc - I know this might be vague, but wth?.

Unlike physical units of length, mass, charge or time (and units derived from these), units of money have no relationship with the physical world. A monetary unit is worth whatever people say it is at the time. Therefore, money is susceptible to inflationary and deflationary pressures.

Exactly The same with a meter, 1 kg and a second as you might know. Their definitions depend on on one another and are not absolute (think of a meter in a singularity, geheheh - you have to be able compare them to something else, or not? Imho, they are dependent on each other and the current situation/ your point of view, etc.

So units are human definitions which fluctuate and depend on each other. With money it is the same thing as you (and I) said. They are agreements, viewpoints, etc. Not reality itself.

QA monetary unit is worth whatever people say it is at the time. UQ
This is what I was also (trying) to say previously, but I guess I was not very clear - as always.
This (the monetary unit) defines a part of "money" doesn't it they have a relationship?

The form in which we access money is not that important in the big picture. Some forms (eg cash) are useful if anonymity in transactions is important. Other forms such as internet banking are handy for sending money over long distances. The important aspect of money is how liquid it is (how easy it is to spend). Some forms of money are more liquid than others and that needs to be taken into account when deciding how you will store your money.

Agreed.
And eh... you double posted! Gehehheh

 

[psionl0]

So when I talk about money, I mean money in the way ''ordinary people' like me use it, at least most of the time Have some money for a beer? etc. I know it is important to be precise, but eh... well Uknowme. As long as I understand myself, gheheh

Sure, in everyday conversation when we talk about money we are referring to the total of our notes and coins or our bank account balance. There is nothing wrong with this. However, if you want to understand how economics works, you need a better understanding of the concept of money than you will find in a non-economics dictionary.

Exactly The same with a meter, 1 kg and a second as you might know. Their definitions depend on on one another and are not absolute (think of a meter in a singularity, geheheh - you have to be able compare them to something else, or not? Imho, they are dependent on each other and the current situation/ your point of view, etc.

No, units of physical measurement have precisely defined values that don't depend on human interpretation. We basically measure physical things by comparing them to other physical things (that are presumably of a "standard" size). However, since money is not a physical substance, we can not meaningfully compare it to any physical substance. All we can do is hope for a consensus on its value and know that the value will be different tomorrow.

 

[Tippit]

The principal difference between an IOU and a FRN lies in the legal definition of an IOU. Legalese has nothing to do with reality.

According to the mathematics, the only way to account for a FRN is to record it as a liability. Legalistic word games are a poor excuse for critical thinking. I will go with the mathematics every time.

Central banks create base money in exactly the same manner that banks create M1 money - by crediting the accounts of its depositors. ie by creating a liability for itself. If the asset that was used to back up the created money disappears the liability still remains. If a bank exchanges some of its central-bank credits for FRNs the liability of the central bank still remains.

This is not some fiction with numbers. It is pure unadulterated logic.

Words have meaning. Logic dictates that a liability must have a creditor. If you can't show the creditor, there is no liability. It's just that simple.

 

[Tippit]

One thing the mathematics/accounting is showing is that it is not possible create money that has an intrinsic value. You have to make what you create valuable either by being willing to give something of value for it or forcing somebody else to give something of value for it.

No, you're confusing an accounting trick with logic. One could just as easily balance the liability column using equity. If I own a stack of gold free and clear, I can simply account for it by putting the number of ounces in the asset column, and equity in ounces in the liability column. That doesn't mean it's a liability, it's accounting convention.

Strictly speaking Federal Reserve Notes have intrinsic value. They have BTUs and can be burned, they can be used as toilet paper, you can write little notes or messages on them, and they serve as pretty portraits of historical figures. Most of their value is extrinsic, as a function of law, of course.

If you create something that is accepted widely as money, and has some other potential use, then you have created money that has intrinsic value.

If there is a significant difference between FRNs and IOUs it would be that with FRNs, it is the "someone else" and not the government that gives value for it.

The significant difference between FRNs and IOUs, is that they don't describe any debtor/creditor relationship at all, and they don't say "IOU". FRNs are payment (or pseudo-payment, since fiat money is no promise to pay anything).

The government is precisely what gives value to fiat money, because if it weren't coerced into circulation by legal tender and income tax laws, it wouldn't be accepted.

 

[psionl0]

Words have meaning. Logic dictates that a liability must have a creditor. If you can't show the creditor, there is no liability. It's just that simple.

The creditor is the bank account or IOU holder. It's just that simple.

 

[Tippit]

The creditor is the bank account or IOU holder. It's just that simple.

Yes. We already agreed on that, *except* for that portion of FRNs that are used to monetize government bonds, and not owed to member banks. We might as well call that "equity", whether or not the Fed labels it a liability, because it's not owed to anyone. It only becomes a liability after the government spends the money, it gets deposited in a bank, and the bank deposits it back with the Fed. Even then the original equity still exists, as long as the bond exists. Understand?