Split Thread Fractional reserve credit vs. derivatives

[Francesca R]

I have no objection to ETFs (even the nonstandard ones like SLV), I have a problem with the way specific ETFs like SLV are being managed.

Perhaps another topic, but why are synthetic derivatives in silver, or stocks and bonds OK, but the same derivatives in money (credit expansion via fractional reserve requirements) not?

Whether you believe me or not is inconsequential to my arguments about how the silver market should react if the fraud is indeed occuring.

Agreed.

Split from: Silver Over 40.00

Posted By: Gaspode

 

[michaelsuede]

Perhaps another topic, but why are synthetic derivatives in silver, or stocks and bonds OK, but the same derivatives in money (credit expansion via fractional reserve requirements) not?

Agreed.

I never said derivatives are inherently bad.

Derivatives of private debt products or shares of ownership are an entirely different beast from fractional reserve credit expansion due to the fact that our current incarnation of fractional reserve banking is predicated on the use of violence.

For example, I have no choice in the money I use. I must pay my taxes in dollars and if someone tries to settle a debt with me in dollars, I must accept payment of those dollars as settlement.

This is imposed upon me through the court and legal systems against my consent in the form of legal tender laws.

That is why fractional reserve credit expansion is bad.

If people freely chose to accept and use fractional reserve credits as money then that's totally fine by me.

Of course, given the choice, no one in their right mind would do so if a gold backed option existed.

 

[Francesca R]

[ . . . ]

How do you get from "money is the unit of account by fiat" to "therefore credit creation is bad"? The first is a correct statement; the second is an assertion. But the assertion does not link to the statement.

The standard anti-FRB objection to FRB is that private banks create synthetic assets (lend money) to private agents collateralised by real liabilities (deposits) to other private agents. And this can be repeated by other combinations of private agent and private bank until the limit is reached whereby total assets and liabilities in the system are 1/[reserve requirement].

This is fraud and a Ponzi according to the objectors.

According to what you've written it should be fine. The fact that the asset and the liability is fiat currency, rather than the synthetic price of something else isn't relevant. At least, you've not made it relevant.

 

[michaelsuede]

How do you get from "money is the unit of account by fiat" to "therefore credit creation is bad"? The first is a correct statement; the second is an assertion. But the assertion does not link to the statement.

The standard anti-FRB objection to FRB is that private banks create synthetic assets (lend money) to private agents collateralised by real liabilities (deposits) to other private agents. And this can be repeated by other combinations of private agent and private bank until the limit is reached whereby total assets and liabilities in the system are 1/[reserve requirement].

This is fraud and a Ponzi according to the objectors.

According to what you've written it should be fine. The fact that the asset and the liability is fiat currency, rather than the synthetic price of something else isn't relevant. At least, you've not made it relevant.

Sure, it's fine.

Of course, it would never occur if there was a free market in money.

The market would put a halt to such nonsense rapidly, since the money would undoubtedly depreciate in value rapidly (as we are experiencing now).

Thus, no one would chose to use such garbage as a currency.

 

[Francesca R]

I think that is a baseless assertion.

But now it is not clear whether credit creation is fine or bad.

Credit creation in other assets and in commodities does not have any systematic relationship with their value depreciating, or appreciating for that matter. Supply and demand and expectations of future cash flows (where relevant, so not for commodities) do that.

 

[michaelsuede]

I think that is a baseless assertion.

The price of silver and gold says otherwise.

But now it is not clear whether credit creation is fine or bad.

Credit creation in other assets and in commodities does not have any systematic relationship with their value depreciating, or appreciating for that matter. Supply and demand and expectations of future cash flows (where relevant, so not for commodities) do that.

Debt creation is not inherently bad at all, and in fact plays a coordinating role in the structure of production.

However mixing and matching private paper debt issuance (which people voluntarily engage in) with fiat money creation through debt issuance is totally inappropriate.

One is voluntary, the other is not.

Market participants have an incentive to insure that any private paper debt issuance is properly collateralized and assume all risk of not being paid back VOLUNTARILY.

This is not true with fiat money creation, in which the money supply is continually debased, interest rates are artificially suppressed, and people are FORCED to accept depreciating dollars as payment of debts.

No one would use such junk as a currency voluntarily unless they were masochists.

 

[michaelsuede]

It is interesting to think about how things would look if the US currency was General Electric commercial paper.

Let's say GE was in the same position as the US government is now, with yearly expenditures of 6.16 trillion and revenues of 4.46 trillion and a debt burden of 14.2 trillion.

For some reason I don't think the market would put up with such nonsense.

Of course, GE doesn't have weapons by which it can extract wealth from the entire population to pay its debts. I guess that's why the market is putting up with the outrageous nonsense of the US government right now. People are in fear for their lives.

 

[Francesca R]

I am not referring to the central bank's ability to change the monetary base, but to fractional reserve requirements and credit creation by private banks. The latter does not change base money. You are conflating the two.

It may be that you are not against less-than-full reserve requirements? I kind of assumed that you would be since this position is almost always adopted by an-cap adherents.

Please clarify, and there is no need to bring up base money and the Federal Reserve, or government borrowing, on this point.

 

[michaelsuede]

I am not referring to the central bank's ability to change the monetary base, but to fractional reserve requirements and credit creation by private banks. The latter does not change base money. You are conflating the two.

It may be that you are not against less-than-full reserve requirements? I kind of assumed that you would be since this position is almost always adopted by an-cap adherents.

Please clarify, and there is no need to bring up base money and the Federal Reserve on this point.

I'm against fractional reserve lending of any type because the bank is inherently in a state of bankruptcy.

If we assume a gold standard for ease of explanation, fractional reserve lending is tantamount to a bank issuing more paper notes than the bank actually has in specie.

It should be abundantly clear that doing so:

1. artificially inflates the money supply

2. creates a state of affairs where the bank can not pay off all of its depositors - ever.

3. artificially lowers interest rates


This leads to:

1. reduction in the value of money over time

2. harms savers and investors

3. distorts the structure of production


Any other type of industry that engaged in such nonsense would be immediately charged with fraud.

If a grain warehouse operator sold grain contracts above the amount of grain they actually had and a run on the grain warehouse ensued, they would be hauled before a court and thrown in prison.

The same should be true of banking establishments that engage in fractional reserve lending.

Of course, the only reason fraud charges would need to be brought is because the free market was not allowed to operate. A free market would prevent the banks from getting away with lending above their reserves because as soon as people found out about it, they would immediately make a run on the bank and force the bank into bankruptcy.

 

[NewtonTrino]

If we assume a gold standard for ease of explanation, fractional reserve lending is tantamount to a bank issuing more paper notes than the bank actually has in specie.

Can you clarify this point with an example of how this works? I'm having a hard time wrapping my head around where it's creating more paper..

 

[michaelsuede]

Can you clarify this point with an example of how this works? I'm having a hard time wrapping my head around where it's creating more paper..

Let us say the Acme Bank has 100 ounces of gold on deposit with it and say 1 Acme Bank Note is worth 1 oz of gold.

So if someone walks into the bank with a Acme Bank Note, they can redeem that Acme Bank Note for an ounce gold coin.

Now in order for the bank to be a 100% reserve bank, the maximum the bank could lend out at any given time is 100 Acme Bank Notes.

If the bank were to lend out more than 100 Acme Bank Notes at any given time, it would have created "fake" Acme Bank Notes that would be unbacked by any gold. This is the essence of fractional reserve banking - the creation of "fake" money out of loans.

If the bank were to do this, it now faces a possible bank run because there are more Acme Bank Notes in existence than there are ounces of gold in Acme Bank's vaults.

If customers holding Acme Bank Notes knew this, they would immediately run to get their money (the real gold money) out of the bank by redeeming their notes because they don't want other people to get all the gold out first before Acme goes bankrupt.

 

[psionl0]

I am not referring to the central bank's ability to change the monetary base, but to fractional reserve requirements and credit creation by private banks. The latter does not change base money. You are conflating the two.

It may be that you are not against less-than-full reserve requirements? I kind of assumed that you would be since this position is almost always adopted by an-cap adherents.

Please clarify, and there is no need to bring up base money and the Federal Reserve, or government borrowing, on this point.

Actually government borrowing is a key element to this discussion. If it wasn't for fractional reserve banking the government could simply print 100% (instead of about 10%) of its deficit and not have any debt at all. The inflationary effect would be similar to what happens now.

FRB exists only for the benefit of banks and the taxpayer (through interest on government borrowings) is contributing to their bottom line.

 

[Francesca R]

It should be abundantly clear that doing so [ . . . ] artificially inflates the money supply

It inflates credit (a higher multiple of base money). That is its purpose. It does not inflate the monetary base. Similarly, derivatives on financial assets and commodities inflate synthetic outstanding long and short exposures but do not change the underlying net asset value.

You need to explain why the latter is fine and the former is not. Please do this without resorting to spurious excuses such as "ZOMG banks are in a state of bankruptcy111". Address the mechanism.

creates a state of affairs where the bank can not pay off all of its depositors - ever.

And the same is true in derivatives markets where open interest is a multiple of net asset value. And the reason in each case--which should be obvious--is that some of the long exposures are lent out by informed consent.

artificially lowers interest rates

Incorrect. In a derivative synthetic longs are always equal to synthetic shorts. In banking, gross lending of "synthetic cash" is equal to gross borrowing of the same.

Any other type of industry that engaged in such nonsense would be immediately charged with fraud.

Incorrect. Airlines routinely sell more tickets than they have seats for, creating liabilities and assets out of thin air. Restaurants and hotels frequently take more reservations than they can handle, making potentially irredeemable promises out of thin air. The concept of fractional reservation happens routinely in many industries.

If a grain warehouse operator sold grain contracts above the amount of grain they actually had and a run on the grain warehouse ensued, they would be hauled before a court and thrown in prison.

That would depend on their forecast grain income stream. You will be aware that a farmer will routinely sell forward a harvest that has not yet occurred. Thus the asset she sells exists only in thin air.

Your claims do not stand up.

The same should be true of banking establishments that engage in fractional reserve lending.

Wrong way around. Why do you single out banking as the only sector in which synthetic creation and forward trading must be outlawed.

It does not make any sense. It never has when this has come up before.

A free market would prevent the banks from getting away with lending above their reserves because as soon as people found out about it, they would immediately make a run on the bank and force the bank into bankruptcy.

Demonstrably untrue given the voluntary operation of other derivatives markets.

I would argue that forward markets and leverage cannot effectively operate without comprehensive rule of law and contract sanctity and independent arbitration and some regulation. But those things enable voluntary choice rather than stifle it, as their absence can.

 

[Francesca R]

If it wasn't for fractional reserve banking the government could simply print 100% (instead of about 10%) of its deficit and not have any debt at all. The inflationary effect would be similar to what happens now.

Incorrect. Credit creation by private banks has nothing to do with whether or not the central bank holds government debt on its balance sheet. If private institutions buy government debt from the government that reduces credit multiples.

You can protest the latter and government borrowing all you wish but they are off topic to the subject here.

 

[michaelsuede]

I'm talking about fractional reserve banking and you respond by conflating fractional reserve banking with derivatives.

The two are not the same.

Do you even understand what fractional reserve banking is?

You actually state that it doesn't lower interest rates by providing a derivative example - which makes me think you don't have the foggiest notion of what fractional reserve banking is. I actually shot coffee out my nose from laughing when you claimed that FR doesn't lower interest rates by providing a derivative example.

 

[Francesca R]

If you continue to evade answering I shall conclude you have no coherent justification to oppose credit creation via fractional reserves.

That's OK; no an-cap or gold-bug before you has been able to either.

 

[michaelsuede]

If you continue to evade answering I shall conclude you have no coherent justification to oppose credit creation via fractional reserves.

That's OK; no an-cap or gold-bug before you has been able to either.

Keep congratulating yourself on your own ignorance if it makes you feel better.

I just explained exactly why fractional reserve credit creation distorts markets and is a form of fraud.

Here's an entire book on it:

http://www.fascistsoup.com/2010/10/03/murray-n-rothbard-the-case-against-the-fed/

So you actually think artificial credit creation doesn't lower interest rates?

How do you suppose Acme bank in my example would ration who gets loans if it was a 100% reserve bank?

If Acme was operating a 100% reserve bank, they would ration lending based on savings by setting interest rates higher as their reserves decreased. As they approached their legal lending limit, they would be demanding very high rates.

Now suppose Acme and its competitors are not constrained by any reserve requirements at all, would they ever bother to raise rates?

Further, suppose Acme lends out thousands of notes, do the people holding Acme notes stand to be big losers if just a small fraction of people redeem those notes for the 100 gold pieces Acme has in its vault? Further, you are claiming this act of lending out more notes than specie is the same as an airline overbooking a flight (both are totally legit?)

If fractional reserve lending is not a form of fraud, in a gold standard, why do people make runs on banks who lend above their reserves?

Further, if Acme creates notes out of thin air in order to meet the demand for loans, have they provided a legal form of consideration? For example, if Acme creates a thousand dollar loan that is unbacked by gold and then gets a house as collateral on that loan, why should Acme get the house if the owner defaults? What did Acme do to get the money it lent in the first place? Didn't it simply add some money to its books out of thin air?

 

[NewtonTrino]

Let us say the Acme Bank has 100 ounces of gold on deposit with it and say 1 Acme Bank Note is worth 1 oz of gold.

So if someone walks into the bank with a Acme Bank Note, they can redeem that Acme Bank Note for an ounce gold coin.

Now in order for the bank to be a 100% reserve bank, the maximum the bank could lend out at any given time is 100 Acme Bank Notes.

If the bank were to lend out more than 100 Acme Bank Notes at any given time, it would have created "fake" Acme Bank Notes that would be unbacked by any gold. This is the essence of fractional reserve banking - the creation of "fake" money out of loans.

If the bank were to do this, it now faces a possible bank run because there are more Acme Bank Notes in existence than there are ounces of gold in Acme Bank's vaults.

If customers holding Acme Bank Notes knew this, they would immediately run to get their money (the real gold money) out of the bank by redeeming their notes because they don't want other people to get all the gold out first before Acme goes bankrupt.

Hold on, in your original example you were talking about current normal banks, not a bank issuing currency based on gold. In this example what are people depositing? Are they depositing gold or are they depositing paper?

I don't think you adequately explained how *new* paper is created in a fractional reserve system like we currently have (there is no gold involved in the current system).

So again, I ask, how does *new* paper get created by a normal bank by fractional reserve banking?

 

[NewtonTrino]

I think the critical thing you are missing here Mike is that money doesn't need to be backed by anything other than the fact that people are willing to accept it. In the case of say, the USA, this is done through legislation as you've pointed out. Basically the money supply is just the liquidity in the economy and needs to grow/shrink with the economy. It's pretty difficult to do this when you are using a commodity (gold for example) for your liquidity. If we went back to a gold standard how do you propose that we grow the supply of money at the rate the economy grows? Or do you not consider this a problem? I certainly do...

 

[michaelsuede]

Hold on, in your original example you were talking about current normal banks, not a bank issuing currency based on gold. In this example what are people depositing? Are they depositing gold or are they depositing paper?

I don't think you adequately explained how *new* paper is created in a fractional reserve system like we currently have (there is no gold involved in the current system).

So again, I ask, how does *new* paper get created by a normal bank by fractional reserve banking?

In my original example I was talking about gold standard banks, which is why I said:

If we assume a gold standard for ease of explanation

The new money comes from the issue of loans above a bank's reserve holdings.

It is much easier to see where the new money is being created by fractional reserve lending by looking at a gold standard bank.