How the banks create money

[psionl0]

Good luck paying your electric bill by mailing them cash.

Bitcoin is a proposed peer to peer network that allows money to be transferred from one person to another without the need for a central authority (banks). You can find the specification for this at http://www.bitcoin.org/sites/default/files/bitcoin.pdf. Beta software for this is also available at http://www.bitcoin.org/.

If banks are not needed for transferring money then the only use for banks would be for creating money - unless there is an alternative.

 

[Tippit]

Which, as I understand it, is how Social Credit is supposed to work. The role of creating new money is assigned to the government. I'm a little hazy on the details, but IIRC, the government is supposed to pay new money out to the people in a dividend or something. I don't know whether it's really a viable system or not, as it's never actually been implemented. In this regard, the social credit people aren't quite as bad as the Austrian School, who think that the money supply should be constant and think a completely free market allowing prices and wages to fall will cope with deflation. I think with contracts for future goods at a set price, it would be nearly impossible to make a fixed money supply with falling prices work.

The efficiency of fixed nominal contracts depends on the stability of nominal spending, not the general price level. Read Selgin on Deflation to understand why. Your understanding of social credit is essentially correct. As society reaps the benefits of productivity, under the Austrian school the gains accrue to the currency holder/saver - your money buys more as prices fall due to deflation which is the result of the productivity norm. Social credit seeks to distribute these gains equitably via monetary inflation, perhaps in the form of a dividend, while at the same time keeping prices stable. This would be a significant reform in light of the current system, in which the gains are taxed away by bankers, government, and other friends of the Federal Reserve.

IMO, fractional reserve banking is the engine that drives all modern economies. It is not fraudulent at all. However, it does have an element of risk: If too many people default on loans, an economic crash can happen (as has happened recently with the US housing bubble, and as happened in the early '30's after the stock market crash). If the money supply is allowed to expand faster than the economy grows, inflation can result. It is the function of the Federal Reserve, and other central banks to try to manage the money supply so that neither of these things happen. Sometimes they aren't successful.

The driver of modern economies isn't fractional reserve banking, it's entrepreneurship and private risk taking. FRB is the source of systemic risk, and the essence of "too big to fail". Of course, FRB wasn't the sole cause of the financial crisis, which is and was the Fed's long term and persistent monetary inflation that resulted in asset price inflation of the housing market. But the bank bailouts were justified by all the counterparties that would lose if some of the biggest Wall Street banks were allowed to fail, a direct result of FRB. Note that credit itself isn't dependent on fractional banking, it would still exist in the form of time deposits, private loans, and banks loaning their own paid-in capital. While this would result in a contraction of credit, it would also be sustainable, and there would be fewer bad loans overall.

Finally, the biggest bonus of abolishing FRB would be the ability to abolish the central bank entirely, as it would have no excuse to monetize and socialize the theft, fraud, and mistakes of Wall Street.

 

[webb5]

That's right.

You yourself can create new money out of thin air by simply writing an IOU.
An iou is not money, it is only a promise to pay note. More importantly when you do pay its from money already in circullation.

The difference is that you can, legally, write an IOU for any amount you choose; banks are legally limited to writing IOUs for less than the amount they have on deposit.

???

 

[Finn McR]

Borrowing from the future is a good bet???

WTF?

Are the "borrow from the future" advocates here unaware that many Americans borrowed money against the future value of their homes, which were vastly overrated? Yeah, that has worked out extremely well... for the banks.

 

[webb5]

Which, as I understand it, is how Social Credit is supposed to work. The role of creating new money is assigned to the government. I'm a little hazy on the details, but IIRC, the government is supposed to pay new money out to the people in a dividend or something. I don't know whether it's really a viable system or not, as it's never actually been implemented. In this regard, the social credit people aren't quite as bad as the Austrian School, who think that the money supply should be constant and think a completely free market allowing prices and wages to fall will cope with deflation. I think with contracts for future goods at a set price, it would be nearly impossible to make a fixed money supply with falling prices work.

IMO, fractional reserve banking is the engine that drives all modern economies. It is not fraudulent at all. However, it does have an element of risk: If too many people default on loans, an economic crash can happen (as has happened recently with the US housing bubble, and as happened in the early '30's after the stock market crash). If the money supply is allowed to expand faster than the economy grows, inflation can result. It is the function of the Federal Reserve, and other central banks to try to manage the money supply so that neither of these things happen. Sometimes they aren't successful.

Social Credit does not use fractional reserve banking. Fractional reserve banking is the engine the banks use to create new money from nothing. It increases the money supply as debt. The prime reason the banks charge interest, is to reduce the money supply and to further increase the need to borrow. Social Credit when used wisely maintains an economy without inflation or deflation. and the interest reduces it.

 

[Sceptic-PK]

Borrowing from the future is a good bet???

WTF?

Are the "borrow from the future" advocates here unaware that many Americans borrowed money against the future value of their homes, which were vastly overrated? Yeah, that has worked out extremely well... for the banks.

So what? Capitalism is anarchic, no matter what model you think is best. You can't prevent people from losing money or making poor choices. There have been in excess of 100 US bank collapses since 2008, I would hardly deem that working extremely well "for the banks".

 

[timhau]

There have been in excess of 100 US bank collapses since 2008, I would hardly deem that working extremely well "for the banks".

Oh, but see, it has worked well for THE banks (wink wink, nudge nudge).

 

[Blue Mountain]

Borrowing from the future is a good bet???

WTF?

Are the "borrow from the future" advocates here unaware that many Americans borrowed money against the future value of their homes, which were vastly overrated?

Canadians didn't have that problem. Our housing market is still doing well, although I have heard some express concern that it's in a bubble too. I know I'm really happy my place is all paid for by now.

Yeah, that has worked out extremely well... for the banks.

True, to a degree ... not a single Canadian bank has failed in the recent economic turmoil. But I shudder to think of what might have happened if the Canadian regulators gave the banks everything they wanted in the 1990s and early 2000s.

Oh, Canada has a fractional reserve system too. How come we're not in a crisis?

 

[drkitten]

Canadians didn't have that problem. Our housing market is still doing well, although I have heard some express concern that it's in a bubble too. I know I'm really happy my place is all paid for by now.

True, to a degree ... not a single Canadian bank has failed in the recent economic turmoil. But I shudder to think of what might have happened if the Canadian regulators gave the banks everything they wanted in the 1990s and early 2000s.

Oh, Canada has a fractional reserve system too. How come we're not in a crisis?

Oh, you're in a crisis as well.

It's just that you're too polite as a group to mention it, so no one really knows about it. Including a lot of Canadians, I guess. Don't you know that one of the immediate results of fractional reserve banking is that people start eating babies? Haven't you noticed how high the infant death rate is in Canada?

(And how cheap veal is in the store?)

 

[psionl0]

It looks like Money Morning Australia (an investment magazine website) has found out what fractional reserve banking is all about and concluded that this is not a good thing.

In an article titled A Very Brief History of Australian Privatisations, editor Kris Sayce had this to say regarding the Commonwealth Bank:

. . .The Commonwealth Bank can create money from thin air which it can then lend to suckers who want to buy an overpriced house.

The last we looked, it isn’t yet possible for rail companies to create coal from thin air without a mining company first digging the stuff out of the ground.

And don’t forget the banks are in the kind of privileged position that no other business in Australia is in. And that’s the explicit guarantee from the government that it will underwrite all and any losses a bank is in danger of making.

Of course that ultimately won’t be possible without the massive devaluation of your wealth through inflation, but it’s accepted by the mainstream that that is what will happen and therefore banks are a good investment.

Make no mistake, the Commonwealth Bank was gifted a power that only it and other banks have, the ability to create its own assets from nothing.

Remember, it’s not a house or a business that is the asset on a bank’s balance sheet, it’s the loan against the house or business that’s the asset. Banks don’t actually create or build anything when they create an asset, they simply use a depositor’s savings as security and then create additional money which they credit to the borrower’s account.

Put simply, Customer A deposits $100,000 into the CBA. That’s an asset for the customer and a liability for the bank.

Then the CBA receives a loan application from Customer B for $90,000.

The CBA creates $90,000 which it deposits into Customer B’s account. That’s a liability for the customer and an asset for the bank.

$10,000 remains as equity in the bank. You can call it the bank’s reserves.

Yet both Customer A and B believe they are able to withdraw the full amount of cash in notes from their accounts – one from a deposit account, the other in a loan account – yet there’s only $100,000 of that money actually held in notes.

The bank is taking a punt that both customers won’t ask for the cash at the same time. In the world of banking that’s called banking. In any other business it’s called trading while insolvent.

So where does the remaining $90,000 come from? From thin air. The bank created it from nothing. It was able to create an asset for its balance sheet simply by making a book entry.

Now do you see why the banks are always so keen to offer you credit? Every time you accept an offer for a credit card or a home loan and draw down on it, that creates an asset for the bank.

It’s a good business. If you’re into counterfeiting and fraud that is. Ultimately – as you’ve seen over the last couple of years – the current financial system is unsustainable.

Yet the politicians and central bankers are determined to not only ensure it’s maintained, but they’re determined to return it back to where it was in 2008 before the bubble popped.

You don’t need me to tell you what the result of doing that will be.

Therefore, we’d be very wary about comparing the success of the Commonwealth Bank float to that of the QR float. The businesses, and how they make money are completely different.

The success or failure of one by no means ensures the success or failure of the other. . . .

 

[marplots]

It looks like Money Morning Australia (an investment magazine website) has found out what fractional reserve banking is all about and concluded that this is not a good thing.

I think I finally understand the reason why this bothers people. It's a confusion between money as a concept and money as actual, physical notes.

It would be the same if you thought that having more 2s on paper was any better than the concept of the digit 2. When I do math, I certainly 'create numbers out of thin air' as I need them. Digits handled this way do not surprise us and no one complains that I made too many 2s. They understand that 2 is just a way to measure other things.

Money, and dollar bills, are like this also. At one level, they are tactile and mean something -- a wad of cash in my pocket. But at another level, they are just an abstract concept, created and destroyed to keep track of the movement of value. Take the example from Australia and remove the bank. Have the person just loan out the money and then use the debt as an asset to sell to someone else. Keep it all conceptual and you'll see the same thing if you want to get 'physical cash' at some point. The bank has no special role here except as middle man.

You might also look at how stocks rise and fall in value, creating 'new money' as well as destroying it.

 

[webb5]

It must be stated here that money is only a tool; it is used as a means to exchange goods of value. Its value is only recognised by the accepted faith, the people have on money– without this, it is worthless. Money therefore has no real value. The real things of value are in the land and what we make of it. Everything around us, the land, trees, water ect, was created for our use, it is God’s creation.

Therefore if we use money as an exchange, it must be produced in correct quantities without cost. What man is physically able to produce, grow, build, and invent, must not be limited by lack of money but rather by the lack of resources. Trade need not be restricted by lack of money.


Below is a fictional story that we can relate to and learn from. Its about an island that came up with a solution, to the money problem.


In a remote island in the South Pacific, thousands of people could feed themselves, clothe them selves in fact supply everything they ever needed. The people lived in almost paradise and never went without. This was the case until a dark day arrived in their lives. It was discovered that almost two thirds of the island’s supply of shells (money) had disappeared and also it seems their chief banker. A crisis meeting was held with all the important chiefs in attendance. It was declared that the main supply of shells had disappeared which would put the economy in a perilous position. New shells were needed desperately or trading would come to a halt.

Bankers from Europe offered the islanders printed-paper (money). But this came at a great cost, Interest would be charged at a rate of ten percent and one third of the island’s assets were needed as insurance for the banker’s big risk. They were told this would bring them up to date with the modern world.

The islanders thought long and hard about this and almost agreed with the banks to borrow the printed-paper. Luckily a man from another island had seen this very thing happen to his own island. He told them that the banks now owned their island because they did not have the money to pay them back. They found too late that only the banks could supply this printed paper (money).

The banks forced them to give up their property and required that one third of the food they grew would now go to the banks for the next twenty years. There was much bloodshed lost over this until the united islands came in and ordered them to fulfill their agreements. The world islands bank offered them more money but this action made things worse (the interest was killing them!) The people no longer have a home, island or any possessions. They now owe more printed paper (money) than they did before.

The islanders took note of this and decided to revert back to bartering for six months until all the shells needed were collected. Although bartering was very cumbersome they thought it was a much better thing to do. A ton of wood for example was used as an exchange for six weeks supply of meat. After the shells were collected everything went back to normal.

The islanders in this story were self-sufficient and had every thing they could ever need. The shells they used for trade could easily of been replaced by rare feathers. They could also of printed their own debt-free money (If they had a printing press!) There was never any need to go into debt.

 

[Mashuna]

From your fictional story, I've learned that the chief banker was an idiot who ran off with a load of worthless shells.

 

[psionl0]

From your fictional story, I've learned that the chief banker was an idiot who ran off with a load of worthless shells.

Do you think the island's chief banker would have made off with the shells if the bankers from Europe hadn't offered him an inducement?

 

[drkitten]

Below is a fictional story that we can relate to and learn from.

Yes, but what we learn is that the author doesn't know much about banking, law, or public policy.

Bankers from Europe offered the islanders printed-paper (money). But this came at a great cost, Interest would be charged at a rate of ten percent and one third of the island’s assets were needed as insurance for the banker’s big risk. They were told this would bring them up to date with the modern world.

The islanders thought long and hard about this and almost agreed with the banks to borrow the printed-paper. Luckily a man from another island had seen this very thing happen to his own island. He told them that the banks now owned their island because they did not have the money to pay them back. They found too late that only the banks could supply this printed paper (money).

Evidently in antibank conspiracy fairy tale land, you're on the hook for your entire property when you pledge collateral for a loan.

Not just the amount of the collateral.

You default on your car loan, the banker doesn't just repossess your car, but it claims your house. And your neighbor's car. And your neighbor's house.

 

[drkitten]

Do you think the island's chief banker would have made off with the shells if the bankers from Europe hadn't offered him an inducement?

I don't know. Do you think Frodo would have gone to Mordor if Gandalf had offered him a ride on an eagle?

Part of what makes this particular fairy tale so uncompelling as an argument is that it's so unrealistic. It sounds to me like the islanders got rooked by a slick-talking salesman from the other island who lied to them about what the effects of creating a modern banking system would be. There's no explanation of how a patently impossible consequence is supposed to fall out of this story -- we're just supposed to take his word for it that this is what happened on the other island.

As far as I can tell, this is just like "don't wear short skirts or God will send you to hell," only without the plausibility.

 

[timhau]

It looks like Money Morning Australia (an investment magazine website) has found out what fractional reserve banking is all about and concluded that this is not a good thing.

I certainly wouldn't subscribe an investment magazine that has just recently figured out what fractional reserve banking is.

 

[psionl0]

I certainly wouldn't subscribe an investment magazine that has just recently figured out what fractional reserve banking is.

Investment analysts tend to be a rather conservative bunch. They frequently bemoan fiat currencies or the lack of a gold standard without recognizing the role that banks play in the overall money supply. (A bit like Ron Paul).

For an investment analyst to actually point out that banks are creating money . . . . .

 

[psionl0]

Evidently in antibank conspiracy fairy tale land, you're on the hook for your entire property when you pledge collateral for a loan.

A lot of third world nations are victims of this "antibank conspiracy fairy tale land".

 

[drkitten]

A lot of third world nations are victims of this "antibank conspiracy fairy tale land".

Yes, third world countries like Narnia, Gondor, Rohan, and Sans Serif.