7 ms·

Banks don't actually borrow the money. They create it. The fact that people don't understand and are completely unaware of this is THE problem with the banking

by Kinnard 11y ago

Banks don't actually borrow the money. They create it. The fact that people don't understand and are completely unaware of this is THE problem with the banking system: http://www.theguardian.com/commentisfree/2014/mar/18/truth-money-iou-bank-of-england-austerity http://www.theguardian.com/commentisfree/2014/mar/18/truth-m...

bduerst 11y ago
You're confusing private banks with central banks. I don't think anyone is surprised that the U.S. Fed reserve regulates the money supply in part by creating it.
- Kinnard 11y ago
  Nope. This is how money is created by both central and commercial banks. When commercial banks do it it's a loan. When the Federal Reserve for example does it they are buying a government bond. Same process. Alas, if only people knew.
  - bduerst 11y ago
    Buying assets (e.g. bonds) is one of the channels the Fed reserve uses to put new cash into circulation. Another channel is loaning the new money out, with interest, to private banks. Private banks aren't creating money, the central bank is. You've confused the two.
    - nhaehnle 11y ago
      The money that the central bank creates is central bank money/high-powered money/M0. The money that private banks create is the money in general circulation, i.e. M2. M2 is much bigger than M0.
      - bduerst 11y ago
        M2 is derived from M0, which is created by the central banks. The person was clearly under the impression that private banks were creating M0.
        nhaehnle 11y ago
        I don't know. It's easy to over-interpret what somebody intended to say. Which brings me to your own "M2 is derived from M0". There are certainly interpretations of that statement with which I would agree, but there are also interpretations which are seriously dubious. For example, the interpretation that "there is a causal mechanism from the quantity of M0 to the quantity of M2" is highly doubtful. The economists who actually study those things seem to come down mostly on the side of endogenous money, which says that the causality is the other way around: "changes in M2 drive changes in M0" - or rather, they did before interest rates went to the zero lower bound, at which point the two quantities became decoupled.
  - frankchn 11y ago
    If I borrow $100 from Bob (deposit), and turn around and immediately lend the same $100 to Charlie (loan), is that creating money? This is essentially what a commercial bank does, except on a much larger scale. If this is creating money, then anyone can create money, not just banks. The Federal Reserve, on the other hand, can create money from nothing and use that to buy government bonds, like they did with QE.
    - nightpool 11y ago
      Yes, you've increased the amount of money available to people to borrow (M2) by $100. it affects inflation, if not as much as M0 does iirc. (its been a while since I've taken econ, so i'm a little fuzzy on that)
      - frankchn 11y ago
        Yes, it would expand M2 money supply and affect inflation, but I don't think the scenario I painted was what Kinnard had in mind when he wrote "Banks don't actually borrow the money. They create it." To 'create money' under my scenario, you have to borrow it from someone else first.
    - erickt 11y ago
      You're not accounting for fractional reserve banking, where the banks only need to keep a certain amount of deposits on hand, and can loan the rest out to other people. For example, you deposit $100 into a bank. They keep, say, $20, and loan Erin $80 out to another person. This essentially creates money out of thin air since you still legally own that $100 dollars, and but now Erin has $80, bringing the total amount of money in our little economy to $180. This all works fine assuming you don't try to withdraw all $100 since they only have $20 on hand. Nor would it be good if Erin defaults on her debt. Or the bank collapses. This is what FDIC is there to protect, where the government will create new money in case things collapse.
      - weavie 11y ago
        Indeed. And what will Erin do with that money? She will give it to Tony in exchange for some service. What will Tony do? Pay that into his bank account. Which means the bank now has an extra $70 (assuming they keep a $10 reserve) that it can loan out, bringing the total amount of money in our economy to $250. Also that $80 that Erin borrows will need to be paid back with interest. Say the interest is $20. She pays back $100. The bank now has $120. That $20 that she paid back had to come from somewhere. Say she sold a blanket she knitted to Paul to make that extra $20. Where did Paul get that money from? He had to borrow it from the bank. And the cycle continues...
- wisty 11y ago
  Disclaimer, I'm not an economist, but I'll leave a brain dump anyway ... Everyone's a bit confused. Or talking at cross purposes. * Central banks create M0 (either paper currency, or electronic equivalents - original fiat money). (I had to say fiat, or some gold bug would complain that gold is the real money). * Banks borrow money, lend it out again, then when the money comes back to the banks they keep recyling it in an infinite cycle, creating M0/fr amount of broad money (M2?). * Then other infinite cycles create even broader money, but let's forget about that. A lot of people (especially bitcoin and gold proponents) forget is that the government can still create M0 if it's not just greenbacks (by lending out "imaginary" gold or bitcoins - as long as someone will take an IOU from the government in return for a little bit of interest). Banks can create M2, as long as someone will take their IOUs (with interest). You can ban lending, but since the critics of money usually lean Libertarian, that's not an argument you often get. What some post-keynesians and some economically literate marxists (and maybe MMTists, I don't actually know what they're on about) suggest is that the fraction can suddenly change. Boom - lowering fractional reserves, which means the total amount of broad money keeps increasing. Bust - banks try to lower fractional reserves, which makes the total amount of broad money contracts. The fraction is often treated as a constant, but if it suddenly changes (or the desired target suddenly changes), it can have a massive impact. Banks get very comfy lending out money with very low reserve rates (effectively the multiplier of money), because whenever there's a crisis the government will "print" M0, and hand it over. So as long as the banks don't act more irresponsibly than every other bank, they can't fail. "Macroprudential" reforms (telling banks to stop it when they lend to much, or risk fines / penalties) is becoming fashionable for this very reason, since telling banks they'll all go bankrupt is about as credible as a teacher yelling "If the class isn't quiet I'll expel the lot of you!". I like to consider the human side - in the asset bubble that occurs when M2 is rapidly growing, everyone wants to work hard and save hard, because otherwise they'll never get on the property ladder. That creates a boom, then a bust when they realise it's a Ponzi scheme. Economists who know better talk about high investment, then a crash in investment when the money suddenly dries up.
  - lifeisstillgood 11y ago
    So, a theory of regulatory practise might be to shoot a child every so often. Then the rest of the class would be quiet, certainly for a period of time. (See analogy above, do not assume I see this as good educational practise)
nicobn 11y ago
You do not understand central banking at all. Banks do not create money out of thin air: central banks do. Through loans to charter banks and bond purchases, the Federal Reserve creates (or destroys) money whenever the internal one day inter-bank loan market interest rate is above (or below) a certain guideline (the "interest rate"). On the other hand, if I deposit $100.00, the bank is allowed to loan a certain percentage of it to someone else. That is fractional reserve banking. Let's say the bank operates with a 2% reserve. I deposit $100.00, they loan $98.00 to Johnny. A naive understanding of the system would lead you to think that the bank "created" $98.00 because the sum of the balances of yours and Johnny's bank account is $198.00; it did not. If Johnny doesn't pay his loan back, they're out $98.00. Your deposit is a liability for the bank. The loan is an asset. So in this situation, the bank has $100.00 in liabilities, $98.00 in assets and $100.00 in reserve. When too many people don't pay their loans back, you have a bank run. Part of the reason the Federal Reserve system exists is to avoid this situation by allowing the banks to borrow from a lender of "last resort" if this were to happen.
- csomar 11y ago
  My understanding of fractional reserve banking, if they operate with a 10% reserve, they can loan up to $900 of the $100. So with 2% it's much more than that.
- nightpool 11y ago
  When you say money, you mean M0. When GP says money, they mean M2.
  - nicobn 11y ago
    Indeed. I think what I'm trying to clear up is that the "money" created by banks is not "free money". It is a carefully crafted game of musical chairs on the bank's balance sheet. Bottomline is, the loan is an asset and the deposit is a liability. Banks don't create M0.
    - jonasvp 11y ago
      No, but nobody cares about M0. It's M2 that creates demand in the marketplace. As soon as a bank fails, all that created M2 disappears from circulation and that's what crashes economies ("too big to fail"). In a full-reserve banking system (M0 = M2) nobody would care about crashing banks. > Bottomline is, the loan is an asset and the deposit is a liability. I used to be as skeptical as you about the full-reserve crowd but that point is actually what got me thinking: banks are the only players in the economy for whom giving out loans is a balance-sheet extension (what you're describing). They're worth more, the more loans they give out. For everybody else, giving out a loan doesn't change their net worth! They're just exchanging one asset (money) against another asset (an IOU from someone). In other words: banks are special and are not allowed to fail, because we let them create money.
nhaehnle 11y ago
Banks do borrow money from the central bank occasionally, though mostly they just sell government bonds to the central bank in exchange for money. The general thrust of what you're saying is correct, though: If you want to understand how money enters the circulation among the general public, you absolutely have to look at banks. The central bank and the government have almost nothing to do with it outside of their regulatory function.
yxhuvud 11y ago
The bank system create money, but individual banks borrow money all the time.
Kinnard 11y ago
The amount of confusion surrounding this post says it all. Very smart people are like dark age europeans debating health best practices. Why don't people know how the bedrock component, Money itself, of the economy works?

by Kinnard 11y ago

bduerst 11y ago

You're confusing private banks with central banks. I don't think anyone is surprised that the U.S. Fed reserve regulates the money supply in part by creating it.

Kinnard 11y ago
Nope. This is how money is created by both central and commercial banks. When commercial banks do it it's a loan. When the Federal Reserve for example does it they are buying a government bond. Same process. Alas, if only people knew.
- bduerst 11y ago
  Buying assets (e.g. bonds) is one of the channels the Fed reserve uses to put new cash into circulation. Another channel is loaning the new money out, with interest, to private banks. Private banks aren't creating money, the central bank is. You've confused the two.
  - nhaehnle 11y ago
    The money that the central bank creates is central bank money/high-powered money/M0. The money that private banks create is the money in general circulation, i.e. M2. M2 is much bigger than M0.
    - bduerst 11y ago
      M2 is derived from M0, which is created by the central banks. The person was clearly under the impression that private banks were creating M0.
      - nhaehnle 11y ago
        I don't know. It's easy to over-interpret what somebody intended to say. Which brings me to your own "M2 is derived from M0". There are certainly interpretations of that statement with which I would agree, but there are also interpretations which are seriously dubious. For example, the interpretation that "there is a causal mechanism from the quantity of M0 to the quantity of M2" is highly doubtful. The economists who actually study those things seem to come down mostly on the side of endogenous money, which says that the causality is the other way around: "changes in M2 drive changes in M0" - or rather, they did before interest rates went to the zero lower bound, at which point the two quantities became decoupled.
- frankchn 11y ago
  If I borrow $100 from Bob (deposit), and turn around and immediately lend the same $100 to Charlie (loan), is that creating money? This is essentially what a commercial bank does, except on a much larger scale. If this is creating money, then anyone can create money, not just banks. The Federal Reserve, on the other hand, can create money from nothing and use that to buy government bonds, like they did with QE.
  - nightpool 11y ago
    Yes, you've increased the amount of money available to people to borrow (M2) by $100. it affects inflation, if not as much as M0 does iirc. (its been a while since I've taken econ, so i'm a little fuzzy on that)
    - frankchn 11y ago
      Yes, it would expand M2 money supply and affect inflation, but I don't think the scenario I painted was what Kinnard had in mind when he wrote "Banks don't actually borrow the money. They create it." To 'create money' under my scenario, you have to borrow it from someone else first.
  - erickt 11y ago
    You're not accounting for fractional reserve banking, where the banks only need to keep a certain amount of deposits on hand, and can loan the rest out to other people. For example, you deposit $100 into a bank. They keep, say, $20, and loan Erin $80 out to another person. This essentially creates money out of thin air since you still legally own that $100 dollars, and but now Erin has $80, bringing the total amount of money in our little economy to $180. This all works fine assuming you don't try to withdraw all $100 since they only have $20 on hand. Nor would it be good if Erin defaults on her debt. Or the bank collapses. This is what FDIC is there to protect, where the government will create new money in case things collapse.
    - weavie 11y ago
      Indeed. And what will Erin do with that money? She will give it to Tony in exchange for some service. What will Tony do? Pay that into his bank account. Which means the bank now has an extra $70 (assuming they keep a $10 reserve) that it can loan out, bringing the total amount of money in our economy to $250. Also that $80 that Erin borrows will need to be paid back with interest. Say the interest is $20. She pays back $100. The bank now has $120. That $20 that she paid back had to come from somewhere. Say she sold a blanket she knitted to Paul to make that extra $20. Where did Paul get that money from? He had to borrow it from the bank. And the cycle continues...
wisty 11y ago
Disclaimer, I'm not an economist, but I'll leave a brain dump anyway ... Everyone's a bit confused. Or talking at cross purposes. * Central banks create M0 (either paper currency, or electronic equivalents - original fiat money). (I had to say fiat, or some gold bug would complain that gold is the real money). * Banks borrow money, lend it out again, then when the money comes back to the banks they keep recyling it in an infinite cycle, creating M0/fr amount of broad money (M2?). * Then other infinite cycles create even broader money, but let's forget about that. A lot of people (especially bitcoin and gold proponents) forget is that the government can still create M0 if it's not just greenbacks (by lending out "imaginary" gold or bitcoins - as long as someone will take an IOU from the government in return for a little bit of interest). Banks can create M2, as long as someone will take their IOUs (with interest). You can ban lending, but since the critics of money usually lean Libertarian, that's not an argument you often get. What some post-keynesians and some economically literate marxists (and maybe MMTists, I don't actually know what they're on about) suggest is that the fraction can suddenly change. Boom - lowering fractional reserves, which means the total amount of broad money keeps increasing. Bust - banks try to lower fractional reserves, which makes the total amount of broad money contracts. The fraction is often treated as a constant, but if it suddenly changes (or the desired target suddenly changes), it can have a massive impact. Banks get very comfy lending out money with very low reserve rates (effectively the multiplier of money), because whenever there's a crisis the government will "print" M0, and hand it over. So as long as the banks don't act more irresponsibly than every other bank, they can't fail. "Macroprudential" reforms (telling banks to stop it when they lend to much, or risk fines / penalties) is becoming fashionable for this very reason, since telling banks they'll all go bankrupt is about as credible as a teacher yelling "If the class isn't quiet I'll expel the lot of you!". I like to consider the human side - in the asset bubble that occurs when M2 is rapidly growing, everyone wants to work hard and save hard, because otherwise they'll never get on the property ladder. That creates a boom, then a bust when they realise it's a Ponzi scheme. Economists who know better talk about high investment, then a crash in investment when the money suddenly dries up.
- lifeisstillgood 11y ago
  So, a theory of regulatory practise might be to shoot a child every so often. Then the rest of the class would be quiet, certainly for a period of time. (See analogy above, do not assume I see this as good educational practise)

nicobn 11y ago

You do not understand central banking at all. Banks do not create money out of thin air: central banks do. Through loans to charter banks and bond purchases, the Federal Reserve creates (or destroys) money whenever the internal one day inter-bank loan market interest rate is above (or below) a certain guideline (the "interest rate"). On the other hand, if I deposit $100.00, the bank is allowed to loan a certain percentage of it to someone else. That is fractional reserve banking. Let's say the bank operates with a 2% reserve. I deposit $100.00, they loan $98.00 to Johnny. A naive understanding of the system would lead you to think that the bank "created" $98.00 because the sum of the balances of yours and Johnny's bank account is $198.00; it did not. If Johnny doesn't pay his loan back, they're out $98.00. Your deposit is a liability for the bank. The loan is an asset. So in this situation, the bank has $100.00 in liabilities, $98.00 in assets and $100.00 in reserve. When too many people don't pay their loans back, you have a bank run. Part of the reason the Federal Reserve system exists is to avoid this situation by allowing the banks to borrow from a lender of "last resort" if this were to happen.

csomar 11y ago
My understanding of fractional reserve banking, if they operate with a 10% reserve, they can loan up to $900 of the $100. So with 2% it's much more than that.
nightpool 11y ago
When you say money, you mean M0. When GP says money, they mean M2.
- nicobn 11y ago
  Indeed. I think what I'm trying to clear up is that the "money" created by banks is not "free money". It is a carefully crafted game of musical chairs on the bank's balance sheet. Bottomline is, the loan is an asset and the deposit is a liability. Banks don't create M0.
  - jonasvp 11y ago
    No, but nobody cares about M0. It's M2 that creates demand in the marketplace. As soon as a bank fails, all that created M2 disappears from circulation and that's what crashes economies ("too big to fail"). In a full-reserve banking system (M0 = M2) nobody would care about crashing banks. > Bottomline is, the loan is an asset and the deposit is a liability. I used to be as skeptical as you about the full-reserve crowd but that point is actually what got me thinking: banks are the only players in the economy for whom giving out loans is a balance-sheet extension (what you're describing). They're worth more, the more loans they give out. For everybody else, giving out a loan doesn't change their net worth! They're just exchanging one asset (money) against another asset (an IOU from someone). In other words: banks are special and are not allowed to fail, because we let them create money.

nhaehnle 11y ago

Banks do borrow money from the central bank occasionally, though mostly they just sell government bonds to the central bank in exchange for money. The general thrust of what you're saying is correct, though: If you want to understand how money enters the circulation among the general public, you absolutely have to look at banks. The central bank and the government have almost nothing to do with it outside of their regulatory function.

yxhuvud 11y ago

The bank system create money, but individual banks borrow money all the time.

Kinnard 11y ago

The amount of confusion surrounding this post says it all. Very smart people are like dark age europeans debating health best practices. Why don't people know how the bedrock component, Money itself, of the economy works?