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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

#121

Post by zajio1am »

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?

Base money (both cash and central bank reserves) is often emitted through short-term repo operations. If a bank wants some base money (e.g. to put some banknotes in ATMs), it sells central bank some (usually government) bonds with promise to repurchase it after a fixed time limit (e.g. 14 days, done in periodic rounds). That is essentially a lease agreement with different legal detais.

So it is essentially an IOU for bonds, just not redeemable in retail (by individuals) but in bulk (by commercial banks). If commercial bank wants 'redeem' some cash (for bonds), then it just acquire less cash in the next round of repo operations.

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

#122

Post by axilmar »

danybittel wrote: post #107

But the bank hasn't made any money?! It just wants back "more" than it "gave". Am I missing something? The one who is forced to "create" the money is the one who has to pay back the 1$ extra in interests (which previously did not exist). But he is not allowed to create any! So he has to create anything of value and sell that for money, so he can pay back the money and the interest. But that just moves it to the next…

Yes, it's a feedback loop.

If the value created from the loan covers the interest, then the whole thing is a net positive for the economy,

otherwise it's a net negative.

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

#123

Post by dalbasal »

II2II wrote: post #104

After starting to read this article, I had several random thoughts: * What makes this author's explanation credible? * Does anyone actually understand how money works, or are people trying to rationalize what we already have? * All that really matters (to me) is the value is relatively stable and it doesn't create a crazy imbalance of power. * Money does an okay job maintaining a stable value for some stuff (e.g. foo…

>* Does anyone actually understand how money works, or are people trying to rationalize what we already have?

I would say, no.. considering the divergence of expert opinions. Limited consensus have formed around high profile economists (eg Keynes, Friedman) but generally erodes as history throws up new examples that don't fit neatly into popular theories.

Monetarism is still the working understanding behind most central banking, but japanese staglation and later events (arguably including the current covid economy) have demoted it from "a theory of the truth about money" to "a method of doing central banking."

I do think that since pure fiat currency became the norm in the 70s, our understanding of money has improved. We are forced to conclude that "the truth about money" can only be found in financial systems, because there is nothing else anymore.

It's not really a question academics are trying to answer, atm. One reason is that trying to answer "what is money" is associated with all sorts of ideological quackery with a bad reputation. Another reason is that high prestige economics deals with a more pertinent question: "what should central banks and regulator do."

The economist who answers this question becomes the next JM Keynes or M Friedman. At the least, he becomes a central bank governor. This limits the field of search to stuff a central bank can do. Economic understandings are also generally curbed by what can be measured, and this also limits the field of search.

> * All that really matters (to me) is the value is relatively stable and it doesn't create a crazy imbalance of power.

> * Money does an okay job maintaining a stable value for some stuff (e.g. food), but an incredibly lousy job for other stuff (e.g. land).

These are not universally agreed to be products of monetary systems. Stability is, under the current theories used by central banks (mostly monetarism) but the others are explicitly "out of theory."

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

#124

Post by pjc50 »

Dylan16807 wrote: post #99
vmception wrote: post #83

Earlier quoted context omitted.

Some of my currently unpopular opinions: The universe of investible assets available for the central banks are small, they need your help in providing a service to them in the primary market (credit markets, corporate bonds). Direct issuances were always going to happen, if it wasn't the pandemic it would have been something else. Anything that slowed down China's growth would have resulted in the same outcome. There…

> Negative interest rates are therefore not controversial and can go much steeper than any central bank has experimented with. People would be willing to pay to keep their money. A bank can store money in the central bank, but it can also put cash in a vault. If the central bank has steep negative rates, why would they use it for much?

Cash vaulting is fairly expensive. And once everybody starts to do it, you see a different problem - it becomes hard to get hold of the physical cash in order to store it!

This used to manifest as "hoarding specie", but economies have also hit deflationary problems of hoarding physical cash. Not sure what that would look like in a world of widespread electronic payments. You'd probably have to pay a premium to get cash from an ATM. Banks would start making it easier to deposit small business cash and harder to obtain rolls of change. Eventually at high enough negative rates people would be paying an (electronic) premium on the face value - you give me a $10 bill and I paypal you $10.50?

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

#125

Post by pjc50 »

roenxi wrote: post #110
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).

How confident are you on that point? I don't have a reference on me right at this moment but I expect it is illegal for a non-bank entity to hand out IOUs at scale. People would be arrested. I'm thinking of things like https://en.wikipedia.org/wiki/Liberty_dollar_(private_curren... which ended in FBI raids.

That's what corporate bonds are. In the extreme, every as-yet-unpaid invoice on 30 or 90 terms creates a debt and "creates money".

Full Tilt Poker created a small closed e-money system which was seemingly legally fine; it was the gambling that got them raided, because only mob bosses in politically connected US states are allowed to profit from gambling and the US will go after gambling providers in other countries.

Liberty reserve were facilitating money laundering. This is the difficult bit - if you provide an electronic facility for easy transference of ownership of debts or e-money, the authorities want access to the paper trail.

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

#126

Post by adwn »

axilmar wrote: post #120

In my humble opinion, the article is too complex and the topic at hand could be explained in an easier way: -banks can create money when they issue a loan, because, if all things go well, the created money will create wealth. -banks cannot create money when they return money to depositors, if they don't have that money, because if they did the created money would not correspond to created wealth. I.e. fractional rese…

No. Money creation through fractional banking is neither directly related to, nor dependent on, wealth creation.

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

#127

Post by baobabKoodaa »

synnejye wrote: post #88

This article makes no sense? There is a fundamental difference between issuing a random "IOU" (like anyone can do) and an "IOU" which is universally accepted as payment (ie money - which banks do). I'm sure I could issue a OMGPWNIOU, but difference is, that no one will accept it as payment.

It's not black and white like some IOUs are accepted everywhere and some IOUs are accepted nowhere. For example, USD is not accepted as payment in Finland, where I live. In the article I gave a concrete example of non-bank IOUs which were effectively money. If you have an argument why the Full Tilt Poker IOUs should not be considered money, let me hear it.

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

#129

Post by [deleted] »

pjc50 wrote: post #125
roenxi wrote: post #110

Earlier quoted context omitted.

How confident are you on that point? I don't have a reference on me right at this moment but I expect it is illegal for a non-bank entity to hand out IOUs at scale. People would be arrested. I'm thinking of things like https://en.wikipedia.org/wiki/Liberty_dollar_(private_curren... which ended in FBI raids.

That's what corporate bonds are. In the extreme, every as-yet-unpaid invoice on 30 or 90 terms creates a debt and "creates money". Full Tilt Poker created a small closed e-money system which was seemingly legally fine; it was the gambling that got them raided, because only mob bosses in politically connected US states are allowed to profit from gambling and the US will go after gambling providers in other countries.…

[deleted]

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

#130

Post by globular-toast »

There's an organisation in the UK called Positive Money which has a lot of great information about this. See, for example: https://www.youtube.com/watch?v=Rd9Pf3Bqp20 They also have a series explaining how banking works: https://www.youtube.com/playlist?list=PLyl80QTKi0gPBcb32paMv... This is one of those things where learning it completely changed the way I saw the world.
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