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Banks create money, but it's less impressive than it sounds

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Re: Banks create money, but it's less impressive than it sounds

#21

Post by baobabKoodaa »

mehrdadn wrote: post #18

This is a fantastic page. I just have an issue with one of his points though: > That banks do not have any special powers in relation to money creation They most definitely do though: FDIC insured accounts have legal government backing—a random IOU from me can't achieve that, no matter how much anyone trusts me. Put another way, a bank deposit seems less like an "IOU" and more like a "WeOU"—"we (the bank or the gover…

Hey, author here. Your criticism is correct. Deposit insurance is a fundamental difference between bank IOUs and non-bank IOUs. So it's incorrect for me to say that banks have _no_ special powers (still not even close to central bank's power though).

Re: Banks create money, but it's less impressive than it sounds

#22

Post by jkhdigital »

mehrdadn wrote: post #18

This is a fantastic page. I just have an issue with one of his points though: > That banks do not have any special powers in relation to money creation They most definitely do though: FDIC insured accounts have legal government backing—a random IOU from me can't achieve that, no matter how much anyone trusts me. Put another way, a bank deposit seems less like an "IOU" and more like a "WeOU"—"we (the bank or the gover…

Exactly... not all IOUs are created equal. Any bank that is part of the Federal Reserve System can create US Dollars, the most liquid and trusted form of money in the world presently.

Re: Banks create money, but it's less impressive than it sounds

#23

Post by AmericanChopper »

whyhow wrote: post #20
AmericanChopper wrote: post #9

Earlier quoted context omitted.

The language used to describe fractional reserve is pretty misleading. Banks don't increase the total supply of money, all fraction reserve does is keep more of it in circulation. If a bank takes a $1,000,000 deposit one customer, and lends $850,000 of it to other customers, there isn't $1,850,000 worth of money all of a sudden. There is $850,000 worth of debt held by customers, and another customer with a $1,000,000…

So the depositor put $1,000,000 in the bank and the bank loans $850,000 to a small business so it can buy more inventory. The small business goes to the widget manufacturer and writes a check which the manufacturer deposits into the bank. So now the bank has 1,850,000 in deposits and 850,000 in loans. The bank takes the new deposits and loans out 85% of it ($723k) to another small business. This small business goes a…

Because doing it one time, or 10 times, or 1,000 times doesn't change anything about how it works. If everybody pays all their debts, it all adds back up to $1,000,000 in cash (plus interest for the bank(s)).

Re: Banks create money, but it's less impressive than it sounds

#24

Post by jkhdigital »

mgraczyk wrote: post #6
marcell wrote: post #5

> The main argument presented here is that banks do not have central bank-like special powers in relation to money creation; the process in which banks create money is entirely pedestrian. I think this is wrong in a subtle way. Regular banks have a reserve requirement that limits their ability to create money. They must hold a certain number of federal reserve notes to meet the reserve requirement. The Federal Reserv…

Reserve requirements haven't mattered in US banks for a long time. One way to think about it is that reserve requirements constrain bank behavior, but the optimal strategy for banks would be the same regardless of whether that requirement were removed. The requirement was removed in the US in March 2020 but has been a formality for most banks for a long time. https://www.federalreserve.gov/monetarypolicy/reservereq.h…

Right; the hard limitation on money creation is that banks exist in order to earn profits for shareholders, and there is only a finite pool of profitable lending opportunities at any given time. With no reserve requirement a bank could theoretically create unlimited amounts of money but it would eventually go bankrupt as it would take massive losses on bad loans.

Re: Banks create money, but it's less impressive than it sounds

#25

Post by AmericanChopper »

baobabKoodaa wrote: post #17
AmericanChopper wrote: post #15

Earlier quoted context omitted.

What's _actually_ in my bank account is a mixture of cash, other peoples debt, and other assets, that all adds up to the value listed when I log in to check the balance. Part of the service the bank is offering me is that at any time I request, they will exchange all of that for its' cash value if I want to make a withdrawal. This is the bit that people contrive when they make silly claims like "banks can make money…

If you go and read the article you will find that it agrees with everything you posted here, with the exception of your weird conclusion that "banks do not create money out of thin air". The article uses a simple example to illustrate that, using Eurozone M1 definition for money, loaning factually increases the amount of money which exists. Perhaps you are thinking of a different definition of money?

Because Eurozone M1 doesn't account for the debt that backs some of those balances. That's like suggesting you can increase your net worth by taking out a loan. You can increase the amount of money you have to spend right now by taking a loan, but you're not "creating net worth out of thin air".

Re: Banks create money, but it's less impressive than it sounds

#26

Post by [deleted] »

baobabKoodaa wrote: post #16
sukilot wrote: post #14

Earlier quoted context omitted.

Right, but people who get .ad that banks create "money" don't understand that "money" is not the same as "currency". Money is literally defined simply as "currency plus bank accounts" so obviously funding a bank account creates "money". Your post gets into the velocity and momentum of money, which is yet another concept.

No, there is no single, accepted definition of money. Money is not "literally defined as..." anything. For example, if you look at Wikipedia definitions for money, you will find multiple different definitions. The commonly used definitions seem to vary a lot by economic area.

[deleted]

Re: Banks create money, but it's less impressive than it sounds

#28

Post by [deleted] »

mehrdadn wrote: post #18

This is a fantastic page. I just have an issue with one of his points though: > That banks do not have any special powers in relation to money creation They most definitely do though: FDIC insured accounts have legal government backing—a random IOU from me can't achieve that, no matter how much anyone trusts me. Put another way, a bank deposit seems less like an "IOU" and more like a "WeOU"—"we (the bank or the gover…

[deleted]

Re: Banks create money, but it's less impressive than it sounds

#29

Post by jkhdigital »

baobabKoodaa wrote: post #16
sukilot wrote: post #14

Earlier quoted context omitted.

Right, but people who get .ad that banks create "money" don't understand that "money" is not the same as "currency". Money is literally defined simply as "currency plus bank accounts" so obviously funding a bank account creates "money". Your post gets into the velocity and momentum of money, which is yet another concept.

No, there is no single, accepted definition of money. Money is not "literally defined as..." anything. For example, if you look at Wikipedia definitions for money, you will find multiple different definitions. The commonly used definitions seem to vary a lot by economic area.

No, there is a definition: Money is a commonly accepted medium of exchange. The problem is not that there is no accepted definition of money, but rather that this definition actually encompasses a very broad class of assets, each of which has some interesting and unique characteristics that can be defined independently of the definition of money. Talking about "money" by itself is often not specific or helpful enough for the subject at hand. Mises does an excellent job of defining a taxonomy for money and money substitutes in his book The Theory of Money and Credit.

Re: Banks create money, but it's less impressive than it sounds

#30

Post by baobabKoodaa »

AmericanChopper wrote: post #25
baobabKoodaa wrote: post #17

Earlier quoted context omitted.

If you go and read the article you will find that it agrees with everything you posted here, with the exception of your weird conclusion that "banks do not create money out of thin air". The article uses a simple example to illustrate that, using Eurozone M1 definition for money, loaning factually increases the amount of money which exists. Perhaps you are thinking of a different definition of money?

Because Eurozone M1 doesn't account for the debt that backs some of those balances. That's like suggesting you can increase your net worth by taking out a loan. You can increase the amount of money you have to spend right now by taking a loan, but you're not "creating net worth out of thin air".

If you go and read the article, you will find that I use terms like "due to accounting conventions" or "economists decided to count these IOUs as money [but not some other IOUs]". Is there something in the article that you disagree with?
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