21 ms·

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

• hinkley 6y ago
  Personal finance podcast clued me into this at some point. Every time a loan is used to pay for goods or services, some fraction of that goes back to “the bank” where 90% of it can be loaned out again. Best case, where all money is moved electronically and instantly, I keep seeing that 100 dollars go out and come back a little smaller over and over and over again. The tenth time I see it I can write a loan for about $30.
  • AmericanChopper 6y ago
    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 balance, which on the banks books will be represented by $150,000 or cash reserves and that $850,000 of debt. The thing that seems to confuse people is the abstraction mechanism by which the $1,000,000 depositor doesn't see any of the $850,000 debt, and the by which they can withdraw the $1,000,000 without being involved in any debt transactions themselves. Fractional reserve banking doesn't create money out of thin air, it's just a system that allows for deposits to be put to productive use. The alternative is that deposits are entirely withdraw from the economy completely until the depositor wants to use them, which would be the economic equivalent of hoarding all your money under the mattress. The rest of it also doesn't really "go to the bank", it's money that they must have on hand to service withdrawals, and absorb defaults and other losses.
    • wisty 6y ago
      > 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 amount, but they greatly amplify its effect by increasing the velocity of circulation (which you did mention). One little bit of money is being thrown around between owners much faster, which effectively magnifies its impact.
      • sukilot 6y ago
        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.
        • baobabKoodaa 6y ago
          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 6y ago
            [deleted]
          • jkhdigital 6y ago
            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.
          • QuesnayJr 6y ago
            I think it's better to say that the boundary of "money" is a bit vague, and things vary in their "moneyness". So sometimes a broad definition is more appropriate, and sometimes a narrow one is more appropriate.
      • AmericanChopper 6y ago
        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 out of thin air". You bank balance of $x does not translate to $x of cash (physical money or not, is irrelevant) on the banks ledger, waiting for you to withdraw it. It translates to $x worth of cash + assets held by the bank. They do it by keeping enough money laying around doing nothing, to service those withdrawals. If all of a sudden huge amount of customers started making huge withdrawals, they wouldn't be able to service them, because they wouldn't be able to liquidate those assets immediately. If banks were actually creating money out of thin air, this wouldn't be possible, because they'd just be able to create some money out of thin air to service them.
    • pdonis 6y ago
      > 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 another bank, or they use it to pay someone for something, and that someone deposits it in another bank, or... In short, virtually all of that $850,000 of "debt" ends up as $850,000 of additional bank deposits in other banks. And to those other banks, those deposits are simple deposits--there are no debts (yet) against them on the other banks' books. So there is nothing to stop the other banks from lending out as much of that $850,000 as they can again. Which means the other banks have just turned what was $850,000 of "debt" into $850,000 of new money. > Fractional reserve banking doesn't create money out of thin air Yes, it does. I just explained how. > it's just a system that allows for deposits to be put to productive use More precisely, it's a bad system for putting deposits to productive use, because it mismatches maturities and therefore leaves the entire financial system open to bank runs, which then have to be prevented by additional "protective" measures. Which will sooner or later fail, and fail all the more catastrophically because the protective measures enable financial institutions to hide the fact that bad investments are being made. The correct way to put deposits to productive use is to make them time deposits, not demand deposits. In other words, if you have a spare $1,000,000 that you have no good use for, you deposit it in some financial institution for a period of time, say a year, or 5 years, or 10 years, and that financial institution promises you some particular rate of return over that time in exchange for the use of your money to finance productive endeavors. Of course this is just another way of describing a bond, or a certificate of deposit, or a money market certificate, or whatever your financial institution chooses to call it. But suppose you buy, say, a 5 year bond with your $1,000,000, and then, a year later, you find you need the money? Well, that's what a bond market is for--so you can sell your bond, at a fair market rate, and get cash in exchange, while someone else has now invested their money for the remaining term of the bond. There is no need for the financial institution to treat your $1,000,000 deposit as a demand deposit, withdrawable at any time, while it is transforming maturities by investing that money in other productive endeavors that take time to mature, just to shield you from unavoidable uncertainty about the future. There is certainly no need to expose the entire financial system to possible collapse to do this. The only reason this wacky system persists is that people in power benefit from it, and ordinary people have gotten so used to it, since it has been around for so long, that they don't connect it with the occasional meltdowns that it causes.
    • whyhow 6y ago
      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 and uses it to pay its employees and they all deposit the money in the bank. Now the bank has $2.573m in deposits. The employees and the manufacturer can all withdraw the money at any time. So I struggle to see how this isn't creating money. The fractional reserve system lets the bank loan the same dollar out multiple times. How isn't this creating dollars? If the bank takes one dollar and loans 85 cents to you and 73 cents to me, isn't there more money?
      • AmericanChopper 6y ago
        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)).
        • whyhow 6y ago
          No it doesn't. In my example the bank loaned out $850k to the first small business and $723k to the second. That's $1,573,000. The bank started with $1million. It absolutely matters how many times the dollars come back to the bank because that is the pathway that lets the bank loan the same original dollar out multiple times.
          • AmericanChopper 6y ago
            I think you’re forgetting the bit where the business that took the $850,000 loan is left with $850,000 debt and $0 balance after they spend all of it. Every time it passes through the system the amount recirculated simply decreases by the reserve %. It all still adds up to the original amount (plus interest). In your example though, the bank has a different problem of offering unsecured loans, which could lead to some losses for them.
  • claydavisss 6y ago
    The current "fraction" in "fractional reserve" is zero.
• stormbrew 6y ago
  > 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 that a poker site can commit fraud, do not make banks unspecial. This is just a libertarian is/aught fallacy dressed up in a lot of words.
  • baobabKoodaa 6y ago
    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 IOUs with the backing of a literal money printer (as a central bank), those IOUs are fundamentally different from the IOUs issued by me/poker site/bank.
    • eru 6y ago
      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.
      • chii 6y ago
        so if amazon came to you to buy your house with amazon bucks, would you sell it? If you worked for amazon, would you accept amazon bucks as salary?
        • 6y ago
• mehrdadn 6y ago
  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 government) owe you". That seems like quite a fundamental difference, no? It seems to distinguish "fake" and "real" money (or banks).
  • baobabKoodaa 6y ago
    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).
    • thinkloop 6y ago
      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 regardless of law?
      • baobabKoodaa 6y ago
        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.
• omazurov 6y ago
  >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...
  • baobabKoodaa 6y ago
    A hundred dollar bill has not represented an IOU since giving up the gold standard.
    • magicsmoke 6y ago
      It represents not going to jail for failing to pay taxes. As a example of how much the value of fiat currency depends on taxation: https://www.irs.gov/taxtopics/tc420 https://www.irs.gov/taxtopics/tc420 Even if you barter without using any currency, the IRS wants a cut.
      • baobabKoodaa 6y ago
        That doesn't make it an IOU, though.
        • deleted 6y ago
          [deleted]
    • mcv 6y ago
      I was just thinking about this exact issue. Before abandoning the gold standard, money was basically an IOU for gold. Since abandoning the gold standard, it's clearly not an IOU anymore. It's just the value in itself. Why does it have that value? Only because we trust it. And honestly, that's really not so different than gold. Why would the gold standard work? What intrinsic value does gold have? Again it only has that value because we trust it. If we stopped caring about gold, maybe if asteroid mining were to quickly result in 10 times the amount of gold that's currently available, gold would quickly lose that trust; same as when a government started printing money with wild abandon. As long as governments are responsible about the money supply, money is just as good as gold. But only as long as they are.
• gumby 6y ago
  Every time you use your credit card you create money as instead of pulling $20 out of your pocket you still have it to spend. Of course you sterilize (cancel out) that creation when you pay the credit card bill.
  • count 6y ago
    When you use your credit card, the bank fronts your spending out of their cash reserves - no new money is created.
    • gumby 6y ago
      Though they were obtained at the discount window, as they are not circulating they have no impact on the functional money supply until you use them...at which point you still have that $20. But I am engaging in some hair splitting, I admit.
• jkhdigital 6y ago
  Money is defined as a commonly accepted medium of exchange. Yes, anyone can create IOUs which satisfy the abstract idealization of money as a "numeraire", but if these IOUs are not commonly accepted for commercial transactions then they aren't money. This is an empirical definition, which is perhaps less useful for theoretical arguments. Banks which participate in a central banking scheme (such as the Federal Reserve System) have a license to create IOUs which are authenticated by the government which sponsors that central bank. In other words, such banks can create IOUs that are backed by the full trust and credit of the government, not merely their own trust and credit as a business enterprise. I'm not sure I would characterize this as "impressive", but it is most certainly a privileged and unique position over the rest of us.
• ipython 6y ago
  I found this video very informative - an effective eli5 about how the economy works with an emphasis on debt: https://m.youtube.com/watch?v=PHe0bXAIuk0 https://m.youtube.com/watch?v=PHe0bXAIuk0
• 7373737373 6y ago
  'Richard Dawkins said in an offhand comment in The Selfish Gene that “Money is a formal token of delayed reciprocal altruism.”' (from: https://nakamotoinstitute.org/reciprocal-altruism-in-the-theory-of-money/ https://nakamotoinstitute.org/reciprocal-altruism-in-the-the...) I was just thinking about the immutability debate in the Ethereum blockchain world, where the community split due to a difference of opinion/interests on whether their system of money should allow a transaction reversal due to unintended effects of a certain contracts code on the state of the system (https://en.wikipedia.org/wiki/The_DAO_(organization) https://en.wikipedia.org/wiki/The_DAO_(organization)). Those who were in the "code is law"/"immutability despite errors/malicious behavior" faction insisted that no change should take place, resulting in the loss of money/decreased action (state change) potential for the original holders affected by the unintended state change. The more popular/valuable (by market cap) system of money (ETH) was the one where this change took place, though this was a one-time event. The state of the system was since not adjusted to reverse effects of hacks, accidental transfers/state changes of smaller impact (still millions of dollars equivalent). Reversible systems need adjudicators which determine if a reversal should take place, and since this is a complex, subjective consensus issue, they pretty much must be humans, resulting in unpredictable and possibly unstable sociopolitical processes. Fiat money derives its value through its utility (widespread acceptance in the exchange for goods) and its contractual enforcement ability provided by a states monopoly on violence (resulting in working contract law) and as the primary means of paying taxes. An (unbacked) IOU has less value than central bank (digital or cash) money, because whether it results in delayed reciprocity is more uncertain (credit default risk, bank runs). In the same way, more irreversible money/settlement systems (like cash https://en.wikipedia.org/wiki/Real-time_gross_settlement https://en.wikipedia.org/wiki/Real-time_gross_settlement) carry less of this type of uncertainty and risk but more of others (legal, last resort to violence to enforce state/or even consenus change, large losses due to mistakes).
  • Zamicol 6y ago
    Ethereum and Defi products are now creating money as well through lending. Lock some amount of ETH up, get some amount of stable dollars out, which inflates the total amount of money in the system.
• vmception 6y ago
  I've done extremely well obtaining goods and services by operating under my unpopular perceptions of the world, including how banks make money and the purpose of money and currency. My unpopular perceptions have consensus with the people that matter (banks, lawyers, accountants, regulators, courts) but they just won't get very far on web forums if you try to tell people something that doesn't match their understanding. The primary cognitive dissonance with other people comes from tying morality to prosperity. Or put simply "some people deserve money and when that criteria is not satisfied it is controversial", but what they really mean is that "someone should have the ability to have goods and services more than others", with the money itself only being a reductive surrogate to make that happen. The further you abstract yourself away from that, the easier it becomes to operate and see opportunities, or how to exchange time for more food and shelter in a more efficient way. How to have enough resources that the money itself looses additional utility, no different than how an abundance of oxygen looses its utility while a known upcoming absence of oxygen will redirect all of your thoughts and resources into making sure that doesn't happen. Yes, it should not be a mystery how banks can create money.
  • 838hhh 6y ago
    Do you have a blog?
  • sethjgore 6y ago
    Would love to know more about your unpopular opinions. Too many people think the same way about money.
    • vmception 6y ago
      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 is no transparency in direct issuances, you just need to appear or structure your offering as credit worthy. There are no consequences. Some people are ready for this specific outcome, if you think you can steward money better (or just want a lot of it for whatever reason), you should structure an offering for this. Central Bank direct and primary market operations are going to continue as their universe of investible assets is small, their monetary policy is not able to achieve the behaviors of market participants that they want as it requires associated fiscal policy changes from legislature and results. Central bank's stated goals for their monetary policy is disingenuous as they do not care about inflation targets or GDP numbers, but they do factor them in. They are just tools to alter and manage the yield curve as they just buy bonds from their friends at a profit. Yield curve based monetary policy doesn't work to its stated goals due to a fundamental misunderstanding of what people want. Dropping yield curves don't cause as much growth in the real economy because people just don't want to give random entrepreneurs their money. People are willing to pay to not do that. 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. Fed and Central Bank balance sheets should not be seen as a threat or overhang to the markets, as it doesn't need to sell credit assets, it just holds them to maturity. It and other sovereign wealth funds have an infinite time horizon. Conspiracies about central banks and their ownership structure are irrelevant. Orphaned entities like trusts are common structures. There is a lack of transparency in some areas either way. Don't just pay attention to the Fed, ECB and BOJ. There are plenty of Central Banks on the periphery of the EU who must react and expand their universe of investible assets before or after the ECB/Fed. In smaller markets you can have a lot of influence as an individual. As in, you can get the ear of a regulator or the upper echelon, or even the stewards of a central bank, just by having a good idea and understanding their needs, interests and psychology. Compared to attempting to earn a pedigree you weren't born into. The Swiss National Bank is amazing for Swiss people, but it should probably be considered a national security threat to the US markets. Since it is not, it is more likely that the SNB is part of a coordinated stock market growth arrangement with the US, as their stock purchases of individual companies with newly created CHF is not something the Fed is authorized to do, yet. I wish more central banks were publicly traded like the SNB. Liquidity of the currency shows the tolerance of distribution. Think of inflation like corporate stock dilution, if the market is liquid then you can create more without undermining confidence in that market. Think of government currency like shares of a country/economic union. People are uncomfortable with the idea of analogies that show the similarities between private organizations and states formed to serve the people. Hyperinflation is not as big of a threat when all major currencies are doing it at the same time. Coordinated inflation masks hyperinflation of any individual currency as their value relative to each other stays similar while the supply of all of them is increasing. The price of individual consumptive goods can still increase dramatically, but the price of the currency and confidence in the currency is not shaken, so the credit markets remain resilient. Countries outside of the economic union who have freely adopted the currency have much bigger issues to reconcile. Market signals are missing in the real estate market. A few hundred thousand playing with historically low interest debt (due to central bank activity) is a distraction, real estate agents and mortgage underwriters getting "so much business" should not be trusted, indeed this is all they see. Several million people defaulting is a bigger and looming issue.
• marcell 6y ago
  > 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 Reserve can create federal reserve notes.
  • baobabKoodaa 6y ago
    Even if there was no reserve requirements, or other regulation to limit money creation by banks, a regular bank still would not have powers similar to the central bank. Imagine a fraudulent banker who keeps adding billions to his own account. Suppose no-one notices. The banker starts to buy mansions and islands with this made-up money. Every time his bank transfers money to other banks (to buy those mansions), the bank loses some reserves. At some point the bank has no reserves left. Even if the reserve requirement was 0, having no reserves would mean that you could no longer transfer money to other banks.
  • eru 6y ago
    Not all countries have minimum reserve requirements. Eg if memory serves right, Canada didn't have them. And Scotland also didn't have them during their free banking episode. What the Scottish banks had instead where crazy high equity cushions (like 1/3 of assets, instead of the about 8% common these days). But not because of any law, but because customers insisted. Equity cushions are much more important in protecting depositors than reserves.
  • mgraczyk 6y ago
    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.htm https://www.federalreserve.gov/monetarypolicy/reservereq.htm
• pan69 6y ago
  This is a video of Richard Werner (an economist the article refers to) in action: https://www.youtube.com/watch?v=EC0G7pY4wRE https://www.youtube.com/watch?v=EC0G7pY4wRE
• sandGorgon 6y ago
  Is this the US way of defining assets & liabilities? In india, all deposits are considered liabilities (since you need to pay the customer interest on it). All loans are considered assets (since you make money on them)
  • bobthepanda 6y ago
    TFA says the same. Rather what's considered assets are the book value of the loan and the cash the bank actually has on hand.
    • sandGorgon 6y ago
      Cash at hand is generally also not considered an asset. Because you're paying interest on it. It's usually raised using deposits. Unless I'm missing something
• riffraff 6y ago
  > Welcome to fractional reserve banking! I don't think that is fractional reserve banking. FRB is the system where a bank is required to have a reserve of X% before it can issue money, while in the current system the banks first emits money and then (in the US) it attempts to get a reserve[0] for that (and in the EU, it doesn't either, tho there are liquidity requirements). [0] https://en.wikipedia.org/wiki/Reserve_requirement https://en.wikipedia.org/wiki/Reserve_requirement
  • jbverschoor 6y ago
    Doesn’t really matter, as the requirements were set to 0% recently
  • kgwgk 6y ago
    So you think this is not fractional reserve banking because instead of having the fractional reserve of X% beforehand they get the fractional reserve of X% right afterwards?
    • dwd 6y ago
      According to Steve Keen[1] based on research by Kydland & Prescott[2] it's up to a year before the fractional reserve catches up. [1] https://www.deflation.com/Articles/The-Roving-Cavaliers-of-Credit https://www.deflation.com/Articles/The-Roving-Cavaliers-of-C... [2] https://researchdatabase.minneapolisfed.org/concern/parent/b2773v855/file_sets/0p096701c https://researchdatabase.minneapolisfed.org/concern/parent/b...
      • kgwgk 6y ago
        Thanks for the reference. Edit: I've just briefly skimmed it [1], but "The creation of credit money should happen after the creation of government money." would be true if the system was working at capacity. The fractional reserve requirements are not really a limiting factor, the banking system in aggregate is operating well below that limit if I remember correctly. [1] The 2012 article, for a few seconds; I didn't look at the 30-year-old paper beyond noticing the date in the cover
• asgard1024 6y ago
  The way I like to explain this is to start from an intensional definition of money as "something that has no value by itself but can be potentially exchanged for something of that value". And total amount of money in economy is the total amount of these things at a given point in time. So when somebody creates an IOU trusted enough so it could be resold, they have effectively created "money" according to the above definition, because now that IOU can be traded _independently_ of the thing it was originally exchanged for. I think what confuses lot of people about this is that creation of money is a 3-sided transaction, and we are conditioned to think of a market economy as a sequences of 2-sided transactions. Also, what I find very funny, some libertarians want to impose government to only create money backed by a commodity, like a gold standard. Yet their fundamental axiom is to allow any two parties to enter (almost) any contract, in particular, allow them to create and resell IOUs. However, if the government has to enforce any contract that two parties can come up with, this is already giving too much freedom for the money to be created regardless of the actual commodities in existence, and regardless what the government does.
  • chii 6y ago
    To me, commodity money (gold/silver) is only required when the trust in the gov't enforcement of money creation doesn't exist. and this isn't the case (yet) with the USA - despite the rampant increase in money supply. Unlike other hyper-inflating economies such as Venezuela, the USA gov't isn't printing money to meet it's obligations, but instead turning illiquid assets (such as bonds and treasuries) into liquid assets (cash), that can then be used to grease more commerce and transactions. I don't believe this can cause hyper-inflation that many fear (and thus turn to buy gold/commodities), because the money is backed by debt, which has to still be paid pack.
• justinzollars 6y ago
  I recommend reading "The creature from Jekyll Island". This book opened my eyes up to the question "what is money?" and it's especially relevant today, given we are living through the largest wealth transfer in human history. But it also talks about how smaller banks work, and this notion of IOUs, credit and loans.
  • FinanceAnon 6y ago
    From wikipedia, about the author: 'He is an HIV/AIDS denialist, supports the 9/11 Truth movement, and supports a specific John F. Kennedy assassination conspiracy theory.[2] He also believes that the Biblical Noah's Ark is located at the Durupınar site in Turkey.[6]'. I would recommend learning from different sources.
    • bproven 6y ago
      I agree. And the book does off into crazy land about the 1/2 through to the end of the book. BUT I think the first part is actually a pretty good approachable explanation of the Federal Reserve and how our money works.
    • justinzollars 6y ago
      That's an Ad hominem attack by Media Matters and doesn't effect my strong recommendation that this book explains the banking system and how the federal reserve functions.
• athrun 6y ago
  I found this paper from the Bank of England very enlightening when it comes to the actual mechanisms of money creation and their limits. The paper is short and concise enough and the diagrams are very helpful to the uninitiated. Money Creation in the Modern Economy: https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...
  • anticristi 6y ago
    Thanks for sharing! Would be cool to make it even more accessible. Something that can be shared virally via WhatsApp by my aunt. :D
• nly 6y ago
  Fun fact: Bank of England bank notes, denominated in £ sterling, still have printed on them: "I promise to pay the bearer on demand the sum of <value> pounds" Signed by the Chief Cashier of the BoE
  • jacobush 6y ago
    The UK is like that, banks have their own notes, still.
    • pjc50 6y ago
      The BoE ones are the "real" government-issued ones. The interesting ones are the genuinely private ones by the Scottish and Northern Irish banks. Including my favourite ever, the Northern Bank portrait-format space shuttle: http://www.polymernotes.com/northireland.html http://www.polymernotes.com/northireland.html The current legal basis is the Banknotes (Scotland) Act 1845: https://www.scotbanks.org.uk/history/banknote-history.html https://www.scotbanks.org.uk/history/banknote-history.html
      • phaemon 6y ago
        Of course, in 2004 Northern Bank was acquired by Denmark-based Danske Group. So now, you have Northern Irish banknotes, which are UK pounds (GBP), with Dankse Bank written on them! https://danskebank.co.uk/about-us/bank-notes/ten-pound-note https://danskebank.co.uk/about-us/bank-notes/ten-pound-note
• csomar 6y ago
  It's not the wild west, though. The Central Bank do know how much these banks are issuing; and also differentiate between the different kinds of money. And not only banks issue money, other financial institutions do also issue some kind of money. From Wikipedia (https://en.wikipedia.org/wiki/Money_supply https://en.wikipedia.org/wiki/Money_supply) - M0: In some countries, such as the United Kingdom, M0 includes bank reserves, so M0 is referred to as the monetary base, or narrow money.[20] - MB: is referred to as the monetary base or total currency.[17] This is the base from which other forms of money (like checking deposits, listed below) are created and is traditionally the most liquid measure of the money supply.[21] - M1: Bank reserves are not included in M1. - M2: Represents M1 and "close substitutes" for M1.[22] M2 is a broader classification of money than M1. M2 is a key economic indicator used to forecast inflation.[23] - M3: M2 plus large and long-term deposits. Since 2006, M3 is no longer published by the US central bank.[24] However, there are still estimates produced by various private institutions. - MZM: Money with zero maturity. It measures the supply of financial assets redeemable at par on demand. Velocity of MZM is historically a relatively accurate predictor of inflation.[25][26][27] You can see the M0, M1 and M2 money supplies at Trading Economics: https://tradingeconomics.com/united-states/money-supply-m2 https://tradingeconomics.com/united-states/money-supply-m2 By the way, you can issue money too. Let's say you buy a computer for $1.000 and promise the seller that you are going to pay him $1.050 by next year. You just issued $1.050 of M2. Counter-intuitively, this money supply system is helping developed countries control inflation. In some developing countries, inflation is harder to control because people are issuing money on their own.
• axegon_ 6y ago
  What... An... Awesome... BLOG! We need more of those!!!!!
• gridlockd 6y ago
  "There’s a lot to unpack here. First, Werner claims that banks are special due to their ability to create money out of thin air. Second, Werner claims that the first claim is proven conclusively with empirical evidence. Werner’s second claim is patently false, because the ”evidence” he presents in his paper only describes banks’ ability to create money out of thin air — he presents no evidence for non-bank entities’ inability to create money out of thin air. Thus, he presents no evidence that banks possess an ability non-banks do not possess. And yet, he claims to have done the opposite." This is awful semantic gaming to "prove" that a false claim was made. If the definition of "money" is fuzzy and there are different kinds of money, if "bank IOUs" and "private IOUs" are materially and legally different from one another, then the strongest interpretation of Werner's words must be taken: He is talking about the sets of money that do not include IOUs from random private entities. Clearly, banks are special in this regard and the amount of bank-created money on the money supply is enormous, whereas the impact of private IOUs is so minor that we can disregard it.
  • baobabKoodaa 6y ago
    It sounds like you are referring to "claim one", not "claim two". I noted in the article that Werner is (only) technically correct on claim 1, essentially due to the reasons you described. Claim two is about presenting empirical evidence for claim one. You might think that empirical evidence is not needed. That's fine. It still was not presented, so claiming to have presented it was a false statement.
    • gridlockd 6y ago
      You ask for empirical evidence that "private entities have the inability to create money out of thin air", but this rests on a definition of "money". You brought up the example of a private IOU (the Poker Site). If we remove the distinction between private IOUs and bank IOUs, indeed you would have an example of a private entity creating money out of thin air, for a more loose definition of money. However, as we established, removing this distinction is unwarranted, bank IOUs are treated quite differently both legally and materially. If we maintain the distinction between private IOUs and bank IOUs, then your example becomes simply irrelevant. Any IOUs that may be issued by private entities that are materially and legally different from bank IOUs have no bearing on Werner's claims. I believe the empirical evidence for private non-bank entities not being able to create bank IOUs is that they're not banks. Am I missing something?
• cryptica 6y ago
  >> A bank loan is merely an exchange of 2 IOUs Wow. This is a flat out lie. Banks operate on a fractional reserve system and they are allowed to loan out more money than they have. It's not just about swapping an IOU between a depositor and a borrower. With the recent COVID-19 regulations, banks don't need any reserves at all anymore. The Fed had been constantly lowering the reserve requirement over the years, effectively causing an infinite but controlled supply of money to enter the economy with financial firms being the biggest beneficiaries.
  • baobabKoodaa 6y ago
    The "money" created by the bank in the process of loaning money _is_ an IOU, so all this stuff that you talked about does not invalidate the description that "taking a loan is an exchange of 2 IOUs". If you disagree with something in the article, please be more specific what you disagree with.
• H8crilA 6y ago
  > For example, when you make a bank transfer to another bank, the bank can not simply send over money created by itself. Uhh, yes it can. That's what LIBOR is (supposed) to represent - short term unsecured lending between major banks. I.e. they can agree that the sending bank is now slightly more indebted to the receiving bank. It depends on what the involved banks agree on. And because such things are based on trust they do blow up sometimes. For example during the panic in March there was a pretty wide gap between FRA rates (unsecured lending) and OIS rates (secured lending). FRA was quite a bit higher. Edit: let me just add that this does not invalidate the rest of the article.
  • baobabKoodaa 6y ago
    Thanks for this feedback. I have now updated the article substantially. The new version covers the possibility of banks lending money to each other as opposed to settling a transaction with cash/reserve deposits. Diffs: https://github.com/baobabKoodaa/blog/commit/c2f7fef53d621accee110f3b40510c15e9cdc061 https://github.com/baobabKoodaa/blog/commit/c2f7fef53d621acc...
    • H8crilA 6y ago
      Sure! The various types of money usually have interest rates associated with them, and those rates tell you about the relationships between the types of money. For example there is an interest rate differential between the central bank money and the US treasuries (which are equivalent to USD money for most people most of the time), captured by the repo rate minus IOER. This differential blew up quite recently (in 2019), showing a temporary divergence between tbills and "real money". In the past, before central banks, each region of the US had their own money, and merchants had conversion tables. They would literally tell you that, for example, Boston money is worth for me only 80 cents on the dollar. Much like today we quote prices on bonds. Robert Shiller has some really good finance lectures on YouTube. The one about central banking: https://m.youtube.com/watch?v=_SpIaGTq0u8 https://m.youtube.com/watch?v=_SpIaGTq0u8
• synnejye 6y ago
  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.
  • baobabKoodaa 6y ago
    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.
    • nstj 6y ago
      Full Tilt Poker didn't operate like a bank from what you described as they "had slowly siphoned off almost all player funds over the course of multiple years, leaving only a small fraction in reserve". In this case they were like a _Ponzi Scheme_ and not like a fractional reserve bank as they had _no assets_ to redeem the claims of their depositors with. Pokerstars (from what you've described) was operating in a manner similar to a fractional reserve bank.
      • baobabKoodaa 6y ago
        Pokerstars was not operating like a fractional reserve bank, because it had segregated player funds to separate bank accounts. As in, it didn't have a "fraction" of reserves for the money players saw in their accounts, it had "full" reserves. It didn't have to go out and sell illiquid assets in order to pay players. It already had the money at hand. If you want to characterize Full Tilt Poker's operation as a ponzi scheme, I have no problem with that. Full Tilt Poker was operating as a fractional reserve bank, and in addition to this it was siphoning assets of the bank to its owners.
• FinanceAnon 6y ago
  In the first example, is it possible to repay all the debt? The bank has $100 cash and $11 promised. Customers have $10 cash and $100 promised. Assuming the person with $100 withdraws the money and wants to share it with the other person to pay off his loan, they end up with $99, but they started with $100. If they started at $0 they would be at -$1. How is this resolved in a real banking system?
  • andrewaylett 6y ago
    The customers started with $100 and the bank started with $0. By the end, the customers have between them paid the bank $1 for their services.
• habosa 6y ago
  There is a fantastic book that covers this topic called "The End of Alchemy" by Mervyn King who was Governor of the Bank of England during the 2007 crisis: https://www.goodreads.com/book/show/30231791-the-end-of-alchemy https://www.goodreads.com/book/show/30231791-the-end-of-alch... It explains how banks work today in a patient and and accessible way that helps you really "get" it.
• dalbasal 6y ago
  I think "fundamental" is a treacherous concept for explaining money creation. Both this article and the stuff Atte is responding to end up with "X is merely Y" explanations. The (arguable, but widely accepted) reality of macroeconomic and monetary dynamics is that it is not merely microeconomics. A layer of emergence separates the two. It's true that what banks do is not fundamentally different to what full tilt poker did. Even the "bank run" parallels the many bank runs in history, and associated monetary collapse. You can find other parallels too. My favourite is employees. Say you have no money. You hire 10 people clean pools, with salaries due at the end of the month. They work. You get paid. If you get paid enough, you can pay salaries on time and make profit. This is the same principle as monetary stimulus, where a government makes loans to stimulate economic activity. We do call that money creation, but it's not fundamentally different to what every employee does. IRL, a poker site or pool cleaning business will (almost) always hit a point of reversal. Expansion becomes deflationary rather than inflationary. Further growth requires capital, rather than generating it. The business models that don't do reach levels where their money creation starts to have macro-scale effects. These tend to join the financial sector (eg, the stock market), where they are regulated in some fashion to curb monetary inflations and deflations. What makes banks qualitatively different is stability. They can do this long term, continuously increasing scale, without bank runs. Quantity is a quality of its own. If banks expand mortgage lending, real estate will inflate... either with higher prices or with more building. This isn't money that was redirected from one sector to another. It's new money. This is why monetary policy isn't just central banking. It's regulators. The regulator controls this sort of activity (eg mortgage lending) in order to regulate the supply of money.
• italicbold 6y ago
  The modern banking system does not use fractional reserve lending. Highly recommend this video to understand and this channel in general: https://youtu.be/K3lP3BhvnSo https://youtu.be/K3lP3BhvnSo Skip to 1:14.
  • deleted 6y ago
    [deleted]
• UmbraeImperator 6y ago
  Would the same principle work for non national currency ? I am thinking specifically of Bitcoin. Say a bank would accept deposit and issue loan in Bitcoin. We apply the same example as in the article. Someone deposit 100BTC. Another person takes a loan of 10BTC and owns the bank 11BTC. (that would be much bigger value than $100, but the principle is the same) Would the total number of Bitcoin be higher than before those transactions ? That would break the hard limit on the total number of Bitcoin. My understanding was that hard limit was a key feature of Bitcoin.
  • icebraining 6y ago
    As the article said, deposits are just IOUs. You can definitively have IOUs denominated in BTC. The number of Bitcoins in the ledger/blockchain would not increase, but if you asked everyone how many Bitcoins they owned and summed it all, it would have increased. To use the standard terms, the hard limit on the number of BTC in the ledger/blockchain is M1. You can have an increase in M2/M3 without an increase in M1.
• II2II 6y ago
  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. food), but an incredibly lousy job for other stuff (e.g. land). That got me to thinking about a game I was recently playing and frustration with it's two in-game currencies, neither of which have anything to do with external transactions (such as obtaining DLC). One of those currencies could fluctuate in value based upon supply and demand (actually, how much you were trying to sell). Now that leaves me wondering if the game developers discovered that it was impossible to balance the game with a single currency (i.e. avoid an imbalance of power through the fluctuating value of currency). In other words, did art avoid emulating reality because the premise of reality is fundamentally flawed?
  • dalbasal 6y ago
    >* 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."
• danybittel 6y ago
  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 poor fellow. Doesn't this create a feedback loop?
  • baobabKoodaa 6y ago
    > But the bank hasn't made any money?! It just wants back "more" than it "gave". Am I missing something? Let's take the example where the bank loans out $10 and wants back $11. The money created in this example is not $1 (when the loan is eventually paid back and the bank makes $1 profit), it's $10 (when the loan is initially given out). Let's imagine that the bank does not want to make a profit and only wants back $10. Even in this example the bank is creating $10. If you sum up how much money everybody has, people have $10 more money the moment the loan is given out.
  • stanleydrew 6y ago
    Yes, I think. The feedback loop is the economy.
  • x87678r 6y ago
    It wants the extra dollar, just like any other company in the economy, its working to earn it. It also doesn't always get the dollar, or even the principle. Lots of people borrow the $10 and only repay $5.
  • axilmar 6y ago
    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.
  • yxhuvud 6y ago
    It is also a feedback loop where many of the steps are used to invest in the economy and create more value. So as long as the investments pay off it is a virtuous feedback loop.
• aronpye 6y ago
  The article doesn’t adequately cover the role of central banks in fractional reserve banking. Back in the days of the gold standard you used to be able to redeem a set weight of physical gold from the central bank for a dollar / pound of paper cash or minted coin. This conversion ratio was set by the central bank and acted as a final brake on inflation. When the gold standard was abolished and the dollar and pound became free floating fiat currency, it only became worth something because the government says it is. The “I promise to pay the bearer x pounds/ dollars” is just a hangover from the gold standard days when you could redeem money for gold directly from the central bank rather than through a private gold dealer. Now you can only redeem an equivalent amount of fiat currency at the central bank if day your dollar / pound note becomes damaged. Banks can create deposits / reserves at the central bank out of nothing, they just have to promise to pay the central bank back at a later date, plus an equivalent amount of interest equal to the central bank set interest rate. This is how the central bank regulates the interest rate in the economy. If a bank charges another bank a higher level of interest for lending than the central bank, that bank can just go to the central bank instead and get charged the lower central bank interest rate. This acts as a brake on maximum inter-bank interest rates and ultimately what interest rates are charged by end consumers. The same is true for cash deposits, the central bank acts a floor / minimum interest rate for deposits as the central bank will pay interest at the central bank interest rate for deposits held at the central bank.
  • TheBobinator 6y ago
    Loaning money drives inflation; when a loan check is created, it spends just like cash, except the banks, behind the scene's, trade the loan checks so everyone has enough cash on hand to appear solvent. Inflation drives interest rates; interest consists of the rate of inflation plus risk and margin, no bank is going to make a loan at less the rate of inflation. This self-regultes the rate of loans; the first people to take out loans gets them cheaper than late comers and have more favorable pricing. Business loans drive companies to leverage capital by taking out loans using their business as collaterol in order to capture market share (and rarely, creating new markets or shrinking existing ones through technological change). If they do not do this, they will be driven out of business. Net on net, because the markets are not expanding at pace with interest, prices rise. I like to think of this as the accumulation of cumulative interest; effectively when every business in a supply chain has to pass its labor and material through a bank loan, the end product becomes much more expensive than production cost. Cumulative interest acts as a tax on the velocity of capital, and when that stagnates, business revenues drop and companies\people begin to play a game of musical chairs of solvency. What this is supposed to do, in theory, is kill off rotten businesses and ownership, and provide a capital market to ensure the economy can continue expanding and when you have commonwealth companies; companies that pay majority profits to employee's and put employee welfare and interests first; this works because employee's invest in the company during downturns to reap profits in upturns. In practice, in every downturn, wages stagnate because businesses shed labor and do not have to compete for labor during the upturn. Governments are motivated to assure labor shortages are solved because paying staff more because they demand it never improves profitability of a business and is always a serious detriment. Because wages stagnate and do not recover, the profits from upturns are captured by ownership and investorship. This cycle, historically, is not new, and tends to repeat until the people become so impoverished they lose their concept of self repect and dignity and actually think burning things and killing people are effective means to solving their problems which tends to break down systems of government and force governemnts to devolve to basal forms such as tyrranies, dictatorships or autocracies out of necessity. E.G. Many western countries have negative fertility rates despite being the most technologically advanced societies in recorded history, and the way governments are assuring labor shortages do not occur is through replacement-level immigration which further radicalizes politics (it provides people making arguments about genocide with a lot of convincing empricial evidence in favor of their argument).
• x87678r 6y ago
  These descriptions are way too complicated. If I have a check account with $0 balance and you have the same we have no money. If I write a check for $100 and you deposit it suddenly you have money - created from thin air.
• axilmar 6y ago
  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 reserve banking exists because what can be created with money, i.e. the actual wealth, can come after money is created, and not before: first money is created out of thin air, then that is used to pay people, which create wealth. The old system with the gold standard was limited because it depended on the amount of gold that existed.
  • adwn 6y ago
    No. Money creation through fractional banking is neither directly related to, nor dependent on, wealth creation.
• known 6y ago
  US dollar is the national currency of Ecuador https://en.wikipedia.org/wiki/Currency_of_Ecuador https://en.wikipedia.org/wiki/Currency_of_Ecuador OPEC sells Oil exclusively in US dollars https://en.wikipedia.org/wiki/Petrocurrency https://en.wikipedia.org/wiki/Petrocurrency
• globular-toast 6y ago
  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 https://www.youtube.com/watch?v=Rd9Pf3Bqp20 They also have a series explaining how banking works: https://www.youtube.com/playlist?list=PLyl80QTKi0gPBcb32paMvXxcq7UUeJskV https://www.youtube.com/playlist?list=PLyl80QTKi0gPBcb32paMv... This is one of those things where learning it completely changed the way I saw the world.
• jonplackett 6y ago
  I’d recommend ‘Money As Debt’ if you’re interested in this subject. It’s done as a cartoon but makes it really easy to understand why the world works like this and what the big problems are with it. Namely that if money is created only when you lend it to people, but they have to pay back what you created + interest, there is never enough money to pay all debts back. So bankruptcy is built into the system. It’s like musical chairs. It has to happen.
  • zoul 6y ago
    Does it? Can’t we just expand the amount of money available forever?
    • jonplackett 6y ago
      Well, the credit crunch would suggest not. But, probably more importantly, that relies on an ever increasing economy, which relies on ever increasing use of natural resources, which = earth is screwed.
  • rags2riches 6y ago
    Paying back all debt would mean there was no more money! What would that even look like? It was years since I saw 'Money as Debt' but I remember it as quite flawed in its arguments. Let's say there's a silly town with a single evil bank. The good people borrow a hundred dollars in total. Horror! The evil bank is now owed one hundred and ten dollars. This can never be repayed, there is not enough money! Except the good janitor at the bank has his wage of ten dollars credited to his account by the bank for the value created by his labour. He pays the grocer, the landlord and so on and now the silly town people can pay all their loans, should they ever want to. And then the old grocer dies and his estate defaults on its debts. And it turns out the bank overvalued his house. The banks is now down ten dollars on its loan assets. But the bank still has its liabilities to the other good town people the grocer paid when he took out the loan. Suddenly the town can pay back all their debts and still have ten dollars left owed to them by the bank! The evil bankers are foiled. 'Money as Debt' goes to all this trouble to explain that money is debt. Then we are supposed to be shocked by the fact that debt can be created by no more than signing a paper! It's stupid.
• daneel_w 6y ago
  "There are two ways to conquer and enslave a nation. One is by the sword. The other is by debt." Debt created by a bank through a loan can never truly be repaid. The debt is just passed on to another place in society, and the society as a whole remains forever indebted to the bank. Sinister in its very essence and a form of true evil.
• nstj 6y ago
  In general this is a half decent way of explaining how fractional reserve banking is presented in econ 101 text books. This is very different to how commercial banks operate in the real world. Reading the piece however is a reasonable exercise for people to understand how a bank may not retain the same amount of liquidity as their deposits may demand.
• x87678r 6y ago
  > If you have an argument why these IOUs should not be considered money, I would love to hear it. Otherwise, let’s conclude that non-bank corporations can sometimes create money out of thin air. It comes down to the definition of money. Yes non-financial intermediaries are very similar to banks and "create money" but money is defined as the amounts on bank's balance sheets so by definition non-financial intermediaries cannot create "money", but they are doing something very similar. Also Nonintermediated debt is probably a better example. If you own a CD from a AAA corporate its effectively money but technically isn't.
  • anticristi 6y ago
    For my own clarification, are financial instruments "money"? I think common people, like me, have a hard time to distinguish money from cash and cash-equivalents. A bond from an AAA corporate might not be money, but it's so liquid that it's as good as cash to me. :D
    • x87678r 6y ago
      No one can agree exactly what money is so that's why you see a bunch of arguments like this. A stock market billionaire who has a small mortgage on one of their properties has no money - he owes money. You can see different countries have different definitions. https://en.wikipedia.org/wiki/Money_supply#Definitions_of_%22money%22 https://en.wikipedia.org/wiki/Money_supply#Definitions_of_%2...
    • SpicyLemonZest 6y ago
      They're not. There are actually multiple different definitions of "money" in use, because it's complicated to define exactly what distinguishes money from a financial instrument, but corporate bonds aren't included in any definition I'm aware of.
• known 6y ago
  As of August 5, 2020, there was $1.95 trillion worth of Federal Reserve notes in circulation https://www.federalreserve.gov/faqs/currency_12773.htm https://www.federalreserve.gov/faqs/currency_12773.htm
• known 6y ago
  The devil is in details https://en.wikipedia.org/wiki/Money_supply https://en.wikipedia.org/wiki/Money_supply
• scottmsul 6y ago
  This article misrepresents just how much of the economy it's made up of these IOUs. If you deposit $100 and there's a 10% reserve requirement, that doesn't mean the bank can loan out $90. Rather, they can loan out $1000 since the $100 is 10% of that.
  • baobabKoodaa 6y ago
    The article did not make any claims about how much the money supply can expand within a specific regulatory environment (such as the 10% reserve requirement you mentioned). I felt like that was outside the scope and would not be possible to present with a simple example.
• PeterStuer 6y ago
  Alice is a customer of ABank Bob is a customer of BBank. Alice asks ABank for a $100 loan at 10% interest to buy some fidgets from Bob Bob asks BBank a $100 at 10% interest to buy some doodads from Alice ABank creates a $100 credit line for Alice, and creates an asset of $110 future revenue payments. BBank creates a $100 credit line for Bob, and creates an asset of $110 future revenue payments. Bob and Alice make their deals each paying with their respective debit cards. ABank and BBank settle their transactions with a net 0 transfer. Alice and Bob both repay $100 to their outstanding loan. Both ABank and BBank now own $10 in future revenue from Alice and Bob respectively. You can argue that 'technically' ABank and BBank didn't 'create' the money, they merely created the legally backed first row claim to that money that will be created.
• zimablue 6y ago
  There's another paper by Richard W that I happened to read yesterday which seems to contradict this article and is not refuted or addressed in it, basically that a combination of accouting practices and "client money rules" distinguish bank loans from "random IOUs", basically anyone can issue an IOU but anyone other than a bank has to draw down their accounting assets when they disburse it, and undisbursed IOUs are not spendable. https://www.sciencedirect.com/science/article/pii/S1057521914001434 https://www.sciencedirect.com/science/article/pii/S105752191...
  • amgreg 6y ago
    I think what the author would take issue with is this notion of “has to.” His point is that non-bank corporations can empirically create money (ie people will treat the IOUs as money), even if they may not be legally permitted to do so.
    • zimablue 6y ago
      I think it's splitting a very meaningless hair in a way that's totally misleading to say that "anyone can create money", when you mean "anyone can theoretically create money, they'll just land in jail fairly quickly" It's like saying that nation-states don't have a monopoly of force, because I can shoot my neighbour, or that I support abortion but I think you should be jailed afterwards. Only banks can create money without getting locked up in jail. That's the important point, and this article adds or takes nothing, other than a very weird dodge with the justification that somehow legality isn't a primary consideration. It's as interesting as saying you don't have to pay your taxes, (small print: because you can choose to go to jail instead).
• godelzilla 6y ago
  >One might argue that the regulatory environment monopolizes money creation to banks, and that creating money as a non-bank is illegal. This might be true, but it does not prevent non-banks from creating money. Just like criminalizing murder does not prevent people from murdering each other. It would be silly to claim that something does not happen just because it is illegal. One might argue that states can create wars, execute people, etc., and that killing people as a non-state is illegal. This might be true, but it does not prevent non-states from killing people. It would be silly to claim that something does not happen just because it is illegal. :/
• MrXOR 6y ago
  Excellent article. Yesterday, I read about the role of banks, I found two quotes: “Banking was conceived in iniquity and was born in sin. The Bankers own the earth. Take it away from them, but leave them the power to create deposits, and with the flick of the pen they will create enough deposits to buy it back again. However, take it away from them, and all the great fortunes like mine will disappear and they ought to disappear, for this would be a happier and better world to live in. But, if you wish to remain the slaves of Bankers and pay the cost of your own slavery, let them continue to create deposits.” [1] “Give me control of a nation's money and I care not who makes the laws.” [2] [1] http://libertytree.ca/quotes/Josiah.Stamp.Quote.69BB http://libertytree.ca/quotes/Josiah.Stamp.Quote.69BB [2] http://libertytree.ca/quotes/Mayer.Amschel.Rothschild.Quote.8BED http://libertytree.ca/quotes/Mayer.Amschel.Rothschild.Quote....
• deleted 6y ago
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