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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

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.
  - baobabKoodaa 6y ago
    If you go and read the article you will find that it agrees with everything you posted here, with the exception of your weird conclusion that "banks do not create money out of thin air". The article uses a simple example to illustrate that, using Eurozone M1 definition for money, loaning factually increases the amount of money which exists. Perhaps you are thinking of a different definition of money?
    - AmericanChopper 6y ago
      Because Eurozone M1 doesn't account for the debt that backs some of those balances. That's like suggesting you can increase your net worth by taking out a loan. You can increase the amount of money you have to spend right now by taking a loan, but you're not "creating net worth out of thin air".
      - baobabKoodaa 6y ago
        If you go and read the article, you will find that I use terms like "due to accounting conventions" or "economists decided to count these IOUs as money [but not some other IOUs]". Is there something in the article that you disagree with?
- eru 6y ago
  In earlier times in many jurisdictions banks could create bank notes, too. See eg https://www.alt-m.org/2015/07/29/there-was-no-place-like-canada/ https://www.alt-m.org/2015/07/29/there-was-no-place-like-can... An advantage of that system was that banks did not lose reserves when customers withdrew money, ie converted deposits to cash. (The banks lost reserves when those notes were eventually deposited with rival banks who demanded settlement in underlying reserves.) Of course, even that system did not multiply the amount of reserves; you might call them M(-1), if you are so inclined. Historically the underlying base money was gold, but you could imagine a system with private bank notes built on top of the federal reserve dollar just fine. You can even leave physical Fed cash in circulation, too.
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.

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.
- baobabKoodaa 6y ago
  If you go and read the article you will find that it agrees with everything you posted here, with the exception of your weird conclusion that "banks do not create money out of thin air". The article uses a simple example to illustrate that, using Eurozone M1 definition for money, loaning factually increases the amount of money which exists. Perhaps you are thinking of a different definition of money?
  - AmericanChopper 6y ago
    Because Eurozone M1 doesn't account for the debt that backs some of those balances. That's like suggesting you can increase your net worth by taking out a loan. You can increase the amount of money you have to spend right now by taking a loan, but you're not "creating net worth out of thin air".
    - baobabKoodaa 6y ago
      If you go and read the article, you will find that I use terms like "due to accounting conventions" or "economists decided to count these IOUs as money [but not some other IOUs]". Is there something in the article that you disagree with?
eru 6y ago
In earlier times in many jurisdictions banks could create bank notes, too. See eg https://www.alt-m.org/2015/07/29/there-was-no-place-like-canada/ https://www.alt-m.org/2015/07/29/there-was-no-place-like-can... An advantage of that system was that banks did not lose reserves when customers withdrew money, ie converted deposits to cash. (The banks lost reserves when those notes were eventually deposited with rival banks who demanded settlement in underlying reserves.) Of course, even that system did not multiply the amount of reserves; you might call them M(-1), if you are so inclined. Historically the underlying base money was gold, but you could imagine a system with private bank notes built on top of the federal reserve dollar just fine. You can even leave physical Fed cash in circulation, too.

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.