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It is important to distinguish between what we call "creating money" which is really fraudulently introducing multiple claims on the same monetary unit at the s
by carsongross 11y ago
It is important to distinguish between what we call "creating money" which is really fraudulently introducing multiple claims on the same monetary unit at the same points of time (and which remain unexercised until a panic) vs. loaning money, which can be done perfectly safely so long as the money being loaned is available for the duration of the loan.
So, when a bank issues an honest loan for a million dollars for 10 years, it needs to have 1 million dollars pledged to it by savers for at least ten years (in the form of CDs or what have you.) This money may be spent in the economy and thereby returned to the bank as a deposit of some duration, which can be loaned against again safely, so long as it is reloaned under the same constraint: the bank must ensure that any loans made against the re-deposited money are done in a shorter term than the deposit is for. You can have very rapid loan growth in this manner, as time horizons expand during growth phases, and suffer none of the issues with multiple parties claiming the same monetary unit at the same time, commonly called bank runs.
Money can be safely "fractionally reserved" so long as intentional duration mismatch (which is really fraud) is not allowed. That's the core issue in the banking system. The production of the underlying money is a separate question, but I'm less and less convinced it matters all that much, as long as it isn't insane.
- mrb 11y ago"Money can be safely "fractionally reserved"" What you describe is the opposite of a fractional-reserve system. It is a full-reserve system.
- carsongross 11y agoThat is not correct, unless you consider demand-deposits and intentional duration mismatch fundamental aspect of a fractionally reserved system. If you follow that definition, then I concede the point, but I don't think it really matters to the fundamental argument. All demand deposits must be reserved at 100%, of course, but duration-constrained savings vehicles (e.g. CDs) can be loaned against safely, allowing credit to expand as time horizons do.
- mrb 11y agoAn "intentional duration mismatch" (as you call it) between a CD and a loan would indeed create a case of fractional reserves. But it is not "fundamental" as there are other events that can cause fractional reserve to occur. For example the CD and the loan could both be established for, say, 5 years, but if the loan recipient defaults after 5 years the bank would be missing the money to repay the CD depositor; so safety policies need to be established to avoid this, eg. never loan more than 90% of the deposits.
- carsongross 11y agoYes, that's correct: the bank would no doubt need to have some capital on hand to deal with defaults, and may of course choose to loan its own capital in an unconstrained manner. A prudent regulator would demand that a bank demonstrate at all times that it can satisfy its duration commitments and, as defaults creep in, insist that bank capital be used and/or raised to cover the shortcomings. Eventually a bank may go bankrupt (although this would be a much slower process than todays panics) and would need to be liquidated via the normal bankruptcy mechanisms. I would expect a healthy secondary market for CDs (or the like) to exist as well.
- PudgePacket 11y agoWhat happens if the bank lends 10 million as per the previous example, holding only 1 million, then the bank goes bust. Does that 9 million seemingly magic money stay with the borrower? I don't understand how it balances back again.
- deleted 11y ago[deleted]
- carsongross 11y agoI don't totally understand your question: the bank is typically slowly paid back on the loan and the loan is collateralized, so the nine million dollars don't puff out of existence at a single point any more dramatically than it currently would. The bank would have time to deal with the inevitable defaults due to the duration matching of deposits and loans. Obviously banks could still go bankrupt, but they would not be bankrupt by design, like they currently are.
- scotty79 11y ago> loaning money, which can be done perfectly safely so long as the money being loaned is available for the duration of the loan Or forever if the loan defaults. What's wrong with the system where only central bank issues loans and only commercial banks can take them?
- carsongross 11y agoI don't have strong feelings on your question. I would prefer to live in a country where individuals could save via CD-like instruments and earn a reasonable return, because I think it would better express the time preferences of society as a whole, rather than a centralized political entity, but its certainly not something I would force everyone to live under. My core point is that we should not allow the introduction of multiple claims on monetary units at a given point of time. This is simply fraud, even though it requires a bit of thinking (and un-thinking, if you have an econ background) to realize it. Intentional duration mismatch is fraud, and is no way to run a banking system.