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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

#51

Post by eru »

wisty wrote: post #12
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…

> Banks don't increase the total supply of money, all fraction reserve does is keep more of it in circulation. It doesn't increase currency (M0). But is there 'money' in your bank account? They increase money by a slightly broader definition (accounts + currency). Even if you've got a narrower definition (and just want the physical paper to be defined as money, not entries in a database) then they don't increase the…

In earlier times in many jurisdictions banks could create bank notes, too. See eg https://www.alt-m.org/2015/07/29/there-was-no-place-like-can...

An advantage of that system was that banks did not lose reserves when customers withdrew money, ie converted deposits to cash.

(The banks lost reserves when those notes were eventually deposited with rival banks who demanded settlement in underlying reserves.)

Of course, even that system did not multiply the amount of reserves; you might call them M(-1), if you are so inclined.

Historically the underlying base money was gold, but you could imagine a system with private bank notes built on top of the federal reserve dollar just fine. You can even leave physical Fed cash in circulation, too.

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

#52

Post by eru »

AmericanChopper wrote: post #15
wisty wrote: post #12

Earlier quoted context omitted.

> Banks don't increase the total supply of money, all fraction reserve does is keep more of it in circulation. It doesn't increase currency (M0). But is there 'money' in your bank account? They increase money by a slightly broader definition (accounts + currency). Even if you've got a narrower definition (and just want the physical paper to be defined as money, not entries in a database) then they don't increase the…

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…

Well, what's actually in your bank account is only one thing: a special kind of bank debt.

That bank debt is backed by all the kinds of bank assets that you mention. Plus perhaps some government deposit insurance.

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

#53

Post by eru »

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…

There's not more base money, but more money-like assets.

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

#54

Post by eru »

baobabKoodaa wrote: post #11
stormbrew wrote: post #7

> These facts support the main argument of this article: that banks do not have any special powers in relation to money creation. Nothing in this blog post comes even close to supporting the idea that banks have no special money creating power. The hidden assumption is that this "iou power" is not regulated or enforced by government control over the money supply. That you can write a cheque and then not cash it, and…

We could quibble about the definition of "special power" all day. Sure, a bank is in a better position to create money than a poker site. And a poker site is in a better position than an individual person. But these are not fundamental differences, these are differences of degree. Fundamental difference is having a literal money printer, versus not having one (central bank's ability vs regular bank). When you issue I…

Well, legal barriers aside, Amazon could print their own currency and be in the same position as the Fed.

Though to make it absolutely the same position, Amazon's currency should not be tied to the dollar but freely floating.

Then there can be no run on Amazon's currency, just like there can be no run on the dollar. However, of course, both Amazon's currency and the dollar can lose in value compared to goods and services or other currencies.

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

#55

Post by onezerozeroone »

pdonis wrote: post #19
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…

> 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. Not all of a sudden, as in instantly, no, but there will be. See below. > There is $850,000 worth of debt held by customers, and another customer with a $1,000,000 balance Yes, but what do those other customers do with that $850,000 of debt? They either deposit it in…

The person that received the $850k loan spent it, so their balance is then $0 and the bank also has a corresponding entry for -$850k of debt that they are owed and can collect interest on.

The debt is an asset held by the bank until it is paid off, is sold, or is defaulted on.

Person A deposits $1M

Person A $1M, total deposits on hand = $1M

Person B takes $850k loan

Person A $1M, Person B $850k, Person B -$850k debt

Total deposits on hand is STILL only $1M. The combined balances are 1.85M but these are just entries that have no impact on what is actually in the bank's vault/account.

If A and B both ask for their entire balance at that moment the bank will have to go to the overnight window or some other facility to take a short-term loan that it will owe interest on and may need to provide collateral to receive.

In that case the bank's overall balance sheet would be $-850k of debt it owes someone. Because that debt isn't collateralized their rate will probably be higher. This is what led to things like the credit market freeze up that the Fed needed to step in to provide liquidity for. Banks usually borrow from each other not just the Fed, but when shit hits the fan banks might not be willing or able to loan to each other except at extremely high rates.

When the bank repays its loan (perhaps when Person C is paid by B and deposits the money into their account) the situation will unwind and we'll be back to the previous situation.

In real life it's much more complicated because the bank probably has many other types of assets like CLOs, CDOs, etc.

https://www.investopedia.com/ask/answers/040715/what-differe...

Sometimes the Fed will take assets as collateral for a loan and the bank is expected to repurchase it later at a slightly higher price a/k/a the Repo market

https://www.bankrate.com/banking/federal-reserve/why-the-fed...

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

#56

Post by baobabKoodaa »

thinkloop wrote: post #50
baobabKoodaa wrote: post #21

Earlier quoted context omitted.

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).

Hi author, excellent article. But I'm just not seeing the central premise that Werner is wrong in saying that banks are unique in their ability to create money. What Full Tilt Poker did was illegal, simply because they were not licensed as a bank. We do have a special class of institution in our society that is blessed with the ability to create money through fractional reserve that we call "banks". Do you mean regar…

Yes, I suppose I mean regardless of law. Although I wasn't looking at it like that, I was just looking at it from a practical perspective: "he is claiming that only banks create money - well here is a counterexample where a non bank made money".

The reason I attacked Werner's article is that he mystifies money creation and perpetuates the misconception that banks' ability to create money is similar to central banks' ability to create money (he does not directly say so, but a non expert reader is likely to gain this misunderstanding when he uses terms like "fairy dust" etc.).

In the article I attacked 2 specific claims of Werner. One was patently false. The other was correct due to a technicality only.

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

#57

Post by stormbrew »

baobabKoodaa wrote: post #11
stormbrew wrote: post #7

> These facts support the main argument of this article: that banks do not have any special powers in relation to money creation. Nothing in this blog post comes even close to supporting the idea that banks have no special money creating power. The hidden assumption is that this "iou power" is not regulated or enforced by government control over the money supply. That you can write a cheque and then not cash it, and…

We could quibble about the definition of "special power" all day. Sure, a bank is in a better position to create money than a poker site. And a poker site is in a better position than an individual person. But these are not fundamental differences, these are differences of degree. Fundamental difference is having a literal money printer, versus not having one (central bank's ability vs regular bank). When you issue I…

This is silly. Yes, there is a difference of degree and nature between A and B here. Are you saying that there is no similar gap between the banks and regular people in terms of their power to create money? Because that's patently nonsense.

And I mean, the vast majority of money in circulation does not come from the money printer or even the central bank's own ability to duplicate money, it comes from the multiplicative recirculation by banks.

The banks have been both legally empowered and de facto relied on to do this money creation on behalf of the government in ways that other people and organizations are not allowed to do.

Just witness the largely successful regulatory crackdown on cryptocurrency services, or the fact that "point exchange systems" like Xbox live points to to great lengths to insist that their points are not recoverable into dollars to avoid regulations as actual evidence that banks are not accidental money creators but an empowered subsystem of the process of making money exist.

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

#59

Post by renewiltord »

eru wrote: post #53
whyhow wrote: post #20

Earlier quoted context omitted.

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…

There's not more base money, but more money-like assets.

And AFAICS, the sum of this 'base money' + other expanding groups of money-like assets is where the M2, M3, etc. definitions of money go to.

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

#60

Post by rags2riches »

patrickthebold wrote: post #34
omazurov wrote: post #27

>Suppose you have $100 in cash... Now if you realize that that $100 is a mere IOU from the U.S. of A. you may get a feeling you are onto something...

IOU for what?

It's an IOU for 100 dollars. You can exchange it for other cash IOUs from the central bank. A bank can also exchange it for electronic central bank reserve IOUs.
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