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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 m

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.
    - anticristi 6y ago
      Hi author. Excellent write-up and nice food for my brain! Although "technically" I agree with your article, banks have a legal definition, legal power and legal responsibility. That makes them special and gives them the legal power to create money -- not without limits, though. Banks can -- subject to some rules -- borrow money from the central bank, which will create said money for them. With repo rates hovering zero and all processing happening electronically, "out of thin air" is not really that far from reality. :) I would argue that if I issue you an IOU, that is not real money: I do not hold a banking license, I do not keep track of all IOUs, I have no audit to pass once-a-year. In fact, I might drink away your deposited cash next day. :) The Full Tilt Poker example is relevant, but I would argue that that is illegal banking: It happens, but it really shouldn't. Wirecard is the other extreme: They were a bank (legally) and created money against the rules (I'm a bit oversimplifying). I guess the common person needs to be educated about legal powers: For example, what makes this house special that I own it? A large enough hammer can open the door, as easily as my keys. In fact, if I sublet it, I might not even have the keys! Ownership, as money, are legal constructs that only hold value if they are properly enforced. Of course, enforcement is easier the more society accepts the construct.
- cryptica 6y ago
  This article is misleading. Banks do ultimately create money. Even if you ignore the details and complexity of how this works, the empirical evidence is clear: - How do you explain that the M2 money supply is always going up? Where is all that new money entering into the system? Government contracts funded by government bonds? If that was the case, government contractors would be getting very wealthy and everyone would be working for them (directly or indirectly)... - How do you explain the recent, significant, almost instantaneous jump in stock prices of major tech companies after the Fed printed and injected trillions of new dollars into the economy? Did these corporations all suddenly score huge government contracts from the bonds which the government created? Seems more like investors and company insiders used loan money from banks to do stock buybacks or increase their positions. - Under the model suggested by the article, how does one explain why there are so many millionaires are in the real estate industry? If you assume the opposite argument that banks are able to print money (directly or indirectly), the number of millionaires makes perfect sense since everyone buys houses using 'loans' from banks; so it's natural that all this free money from banks would constantly inflate real estate prices; each new generation of citizens would inflate the prices of the properties which were bought by the previous generation with increasingly larger loans from newly printed credit from their banks. What is claimed by the article does not match the evidence, even the people have wised up to this scheme which is why Bitcoin and cryptocurrencies have been able to hold their value.
  - baobabKoodaa 6y ago
    Yes, banks do create money. This is said in the article multiple times, if you would like to read it.
    - zimablue 6y ago
      The key question or claim is not whether banks create money but whether the way in which they are able to do it is unique. "creating money" is ambiguous to be nearly meaningless, "creating money in a way that noone else is able to" is a lot less ambiguous
      - 6y ago
- roenxi 6y ago
  How confident are you on that point? I don't have a reference on me right at this moment but I expect it is illegal for a non-bank entity to hand out IOUs at scale. People would be arrested. I'm thinking of things like https://en.wikipedia.org/wiki/Liberty_dollar_(private_currency) https://en.wikipedia.org/wiki/Liberty_dollar_(private_curren... which ended in FBI raids.
  - baobabKoodaa 6y ago
    It might be illegal, but it happens, and the article includes one very concrete example of that.
    - roenxi 6y ago
      So I suppose I put it to you that there is something special about the IOUs created by banks - they are legally allowed to used. Even if everyone agreed to use your IOU from the article the tax office is going to have quite a bit to say on the subject and probably start launching audits. And if the IOU start getting traction they are likely to trigger police raids and maybe a legislative response (look at how Facebook dropped their Libra for example). That seems substantially different from the IOUs the banks can create. I wouldn't use bank-issued IOUs if I thought I had a choice. I'm pretty sure I'm forced to by government policy.
      - baobabKoodaa 6y ago
        > So I suppose I put it to you that there is something special about the IOUs created by banks - they are legally allowed to used. IANAL, but the IOUs created by Full Tilt Poker were also legal to use. When the government eventually pressed charges in the debacle, no charges were pressed against regular players of the poker site, including those who used these IOUs for small economic activity. If using these IOUs would have been illegal, then surely the government would have pressed at least some charges after spending years investigating the case? But anyway, even if _using_ the IOUs was not illegal, creating them like a fractional reserve bank surely was illegal. So you definitely have a point that the regulatory environment creates a special status for the legal tender of the country.
- zajio1am 6y ago
  > Deposit insurance is a fundamental difference between bank IOUs and non-bank IOUs. Yes, but that is relatively recent development. Bank money (and IOU-based money creation) is much older than deposit insurance.
- baobabKoodaa 6y ago
  I have now updated the article substantially. Deposit insurance is now covered in more depth. Diffs: https://github.com/baobabKoodaa/blog/commit/c2f7fef53d621accee110f3b40510c15e9cdc061 https://github.com/baobabKoodaa/blog/commit/c2f7fef53d621acc...
jkhdigital 6y ago
Exactly... not all IOUs are created equal. Any bank that is part of the Federal Reserve System can create US Dollars, the most liquid and trusted form of money in the world presently.
- jmtulloss 6y ago
  It comes with the downside of being highly regulated. I have no idea if the weights and balances are correct, but it makes sense at the surface level that if you are risking the government’s money, you have to do it on their terms.
  - ClumsyPilot 6y ago
    So heavilly regulates you can hand out mortgages to people who can't afferd them, then turn around and package those loans intonCDOs, and mislead investors as to their liquidity. Then suffer no consequences when global economy crashes.
deleted 6y ago
[deleted]
dragandj 6y ago
I agree with you, but as a non-expert in the matter, I have to add that banks are heavily regulated in that regard and have to deposits certain reserves to central banks (depending on the country) for that privilege. It's not that they operate differently than LLCs while having the privilege of insurance. They pay a price for that privilege, and we can argue whether that price is too low or not.
irln 6y ago
> Deposit insurance is a fundamental difference between bank IOUs and non-bank IOUs. Deposit insurance is a fundamental difference but it's not the main difference. Individuals and most non-banks don't have access to Federal Reserve accounts and therefore access to reserves. The main distinction between a bank and a non-bank is the ability to create IOUs ultimately backed by reserves (whether they have sufficient amounts or not) which can only be created by the FR (and in this context) to back a bad IOU. Whether the new reserves go directly to backing up the IOU or indirectly via added liquidity is irrelevant. A bank can create a misguided IOU that defaults, which if too big to fail, is a liability that the FR and thus all holders of the IOUs, cash, and reserves must bear.
- baobabKoodaa 6y ago
  This is not entirely accurate. Suppose a fraudulent bank decided to credit my account with a trillion dollars. The federal reserve would not honor this IOU with actual dollars. This is in stark contrast to federal reserve's ability to create a trillion dollars. They could create an actual trillion dollars and give it to a corrupt politician. A regular bank does not possess this ability.
  - irln 6y ago
    What does a fraudulent bank have to do with the fact that the FR is the ultimate backstop to loans (IOUs) created by a bank...a "power" you claim is the same as a non-bank created IOU or a an individual IOU? Further not sure how your example refutes my previous reply's accuracy, regardless, if a bank makes a bunch of fraudulent loans adding up to a Trillion dollars and it isn't discovered until those loans are cross-collateralized sufficiently to cause systemic risk, you can bet the FR will back those loans. Finally, given a bit of time a single Trillion dollar loan may not seem as large as it does now. :)
    - baobabKoodaa 6y ago
      > What does a fraudulent bank have to do with the fact that the FR is the ultimate backstop to loans (IOUs) created by a bank...a "power" you claim is the same as a non-bank created IOU or a an individual IOU? I'm not claiming it's the same. I'm saying these are differences of degree (my IOU vs bank's IOU), whereas the difference between central bank IOU and bank IOU is fundamental. We have several historic examples of central banks ruining entire economies by printing excessive amounts of money causing hyperinflation. Do you have a single example of a regular bank printing so much money that it causes hyperinflation? No. Why is that, if it's so easy for a regular bank to print a trillion dollars of fraudulent money without anyone noticing?
anticristi 6y ago
I love the IOU vs WeOU differentiation. Banks need to have licenses and adhere to strict regulations, which are checked at least yearly by auditors. (Joke: Unless you are a German bank, in which case you get checked only once-a-decade.) That is what makes banks special: They have legal backing, but also legal responsibility. Side note regarding non-bank IOU: I found the idea of having a payment card from my grocery store very appealing. If they run out-of-cash, they can repay me in food, which I'm pretty happy to take at any time. However, that is not how it works in 2020. The grocery entity and the banking entity need to be separated, and have different licenses.
- yxhuvud 6y ago
  > The grocery entity and the banking entity need to be separated Quite a few of the grocery chain cards here in Sweden have accounts backed by chain-owned banks. So at least here, the separation is not all that great.
  - anticristi 6y ago
    They share branding and sometimes ownership, but the entities are separated. ICA Gruppen has ICA Banken as a bank subsidiary. COOP outsourced banking to EnterCard, etc.
brandmeyer 6y ago
Quite true. Its also why we should find it deeply concerning when a tech company starts taking on some of the powers of a bank without any of the responsibilities of a bank. Facebook's digital currency system is one recent example. Paypal's behavior is a much longer-running example.
alasdair_ 6y ago
Seems like a great scam. Create a bank, go through the many many steps to obtain FDIC backing, pay out enormous loans to insiders, have a run on the bank, then everyone is made whole again while the fraudster skips town. I understand that this is basically insurance fraud, but the money is gone long before the fraud occurs and the government must pay out, unlike a single insurer.
- sunshinerag 6y ago
  I think it would not be shocking anymore to know that you discovered the operating model of the bank. Business as Usual.

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.
  - anticristi 6y ago
    Hi author. Excellent write-up and nice food for my brain! Although "technically" I agree with your article, banks have a legal definition, legal power and legal responsibility. That makes them special and gives them the legal power to create money -- not without limits, though. Banks can -- subject to some rules -- borrow money from the central bank, which will create said money for them. With repo rates hovering zero and all processing happening electronically, "out of thin air" is not really that far from reality. :) I would argue that if I issue you an IOU, that is not real money: I do not hold a banking license, I do not keep track of all IOUs, I have no audit to pass once-a-year. In fact, I might drink away your deposited cash next day. :) The Full Tilt Poker example is relevant, but I would argue that that is illegal banking: It happens, but it really shouldn't. Wirecard is the other extreme: They were a bank (legally) and created money against the rules (I'm a bit oversimplifying). I guess the common person needs to be educated about legal powers: For example, what makes this house special that I own it? A large enough hammer can open the door, as easily as my keys. In fact, if I sublet it, I might not even have the keys! Ownership, as money, are legal constructs that only hold value if they are properly enforced. Of course, enforcement is easier the more society accepts the construct.
cryptica 6y ago
This article is misleading. Banks do ultimately create money. Even if you ignore the details and complexity of how this works, the empirical evidence is clear: - How do you explain that the M2 money supply is always going up? Where is all that new money entering into the system? Government contracts funded by government bonds? If that was the case, government contractors would be getting very wealthy and everyone would be working for them (directly or indirectly)... - How do you explain the recent, significant, almost instantaneous jump in stock prices of major tech companies after the Fed printed and injected trillions of new dollars into the economy? Did these corporations all suddenly score huge government contracts from the bonds which the government created? Seems more like investors and company insiders used loan money from banks to do stock buybacks or increase their positions. - Under the model suggested by the article, how does one explain why there are so many millionaires are in the real estate industry? If you assume the opposite argument that banks are able to print money (directly or indirectly), the number of millionaires makes perfect sense since everyone buys houses using 'loans' from banks; so it's natural that all this free money from banks would constantly inflate real estate prices; each new generation of citizens would inflate the prices of the properties which were bought by the previous generation with increasingly larger loans from newly printed credit from their banks. What is claimed by the article does not match the evidence, even the people have wised up to this scheme which is why Bitcoin and cryptocurrencies have been able to hold their value.
- baobabKoodaa 6y ago
  Yes, banks do create money. This is said in the article multiple times, if you would like to read it.
  - zimablue 6y ago
    The key question or claim is not whether banks create money but whether the way in which they are able to do it is unique. "creating money" is ambiguous to be nearly meaningless, "creating money in a way that noone else is able to" is a lot less ambiguous
    - 6y ago
roenxi 6y ago
How confident are you on that point? I don't have a reference on me right at this moment but I expect it is illegal for a non-bank entity to hand out IOUs at scale. People would be arrested. I'm thinking of things like https://en.wikipedia.org/wiki/Liberty_dollar_(private_currency) https://en.wikipedia.org/wiki/Liberty_dollar_(private_curren... which ended in FBI raids.
- baobabKoodaa 6y ago
  It might be illegal, but it happens, and the article includes one very concrete example of that.
  - roenxi 6y ago
    So I suppose I put it to you that there is something special about the IOUs created by banks - they are legally allowed to used. Even if everyone agreed to use your IOU from the article the tax office is going to have quite a bit to say on the subject and probably start launching audits. And if the IOU start getting traction they are likely to trigger police raids and maybe a legislative response (look at how Facebook dropped their Libra for example). That seems substantially different from the IOUs the banks can create. I wouldn't use bank-issued IOUs if I thought I had a choice. I'm pretty sure I'm forced to by government policy.
    - baobabKoodaa 6y ago
      > So I suppose I put it to you that there is something special about the IOUs created by banks - they are legally allowed to used. IANAL, but the IOUs created by Full Tilt Poker were also legal to use. When the government eventually pressed charges in the debacle, no charges were pressed against regular players of the poker site, including those who used these IOUs for small economic activity. If using these IOUs would have been illegal, then surely the government would have pressed at least some charges after spending years investigating the case? But anyway, even if _using_ the IOUs was not illegal, creating them like a fractional reserve bank surely was illegal. So you definitely have a point that the regulatory environment creates a special status for the legal tender of the country.
zajio1am 6y ago
> Deposit insurance is a fundamental difference between bank IOUs and non-bank IOUs. Yes, but that is relatively recent development. Bank money (and IOU-based money creation) is much older than deposit insurance.
baobabKoodaa 6y ago
I have now updated the article substantially. Deposit insurance is now covered in more depth. Diffs: https://github.com/baobabKoodaa/blog/commit/c2f7fef53d621accee110f3b40510c15e9cdc061 https://github.com/baobabKoodaa/blog/commit/c2f7fef53d621acc...

jkhdigital 6y ago

Exactly... not all IOUs are created equal. Any bank that is part of the Federal Reserve System can create US Dollars, the most liquid and trusted form of money in the world presently.

jmtulloss 6y ago
It comes with the downside of being highly regulated. I have no idea if the weights and balances are correct, but it makes sense at the surface level that if you are risking the government’s money, you have to do it on their terms.
- ClumsyPilot 6y ago
  So heavilly regulates you can hand out mortgages to people who can't afferd them, then turn around and package those loans intonCDOs, and mislead investors as to their liquidity. Then suffer no consequences when global economy crashes.

deleted 6y ago

[deleted]

dragandj 6y ago

I agree with you, but as a non-expert in the matter, I have to add that banks are heavily regulated in that regard and have to deposits certain reserves to central banks (depending on the country) for that privilege. It's not that they operate differently than LLCs while having the privilege of insurance. They pay a price for that privilege, and we can argue whether that price is too low or not.

irln 6y ago

> Deposit insurance is a fundamental difference between bank IOUs and non-bank IOUs. Deposit insurance is a fundamental difference but it's not the main difference. Individuals and most non-banks don't have access to Federal Reserve accounts and therefore access to reserves. The main distinction between a bank and a non-bank is the ability to create IOUs ultimately backed by reserves (whether they have sufficient amounts or not) which can only be created by the FR (and in this context) to back a bad IOU. Whether the new reserves go directly to backing up the IOU or indirectly via added liquidity is irrelevant. A bank can create a misguided IOU that defaults, which if too big to fail, is a liability that the FR and thus all holders of the IOUs, cash, and reserves must bear.

baobabKoodaa 6y ago
This is not entirely accurate. Suppose a fraudulent bank decided to credit my account with a trillion dollars. The federal reserve would not honor this IOU with actual dollars. This is in stark contrast to federal reserve's ability to create a trillion dollars. They could create an actual trillion dollars and give it to a corrupt politician. A regular bank does not possess this ability.
- irln 6y ago
  What does a fraudulent bank have to do with the fact that the FR is the ultimate backstop to loans (IOUs) created by a bank...a "power" you claim is the same as a non-bank created IOU or a an individual IOU? Further not sure how your example refutes my previous reply's accuracy, regardless, if a bank makes a bunch of fraudulent loans adding up to a Trillion dollars and it isn't discovered until those loans are cross-collateralized sufficiently to cause systemic risk, you can bet the FR will back those loans. Finally, given a bit of time a single Trillion dollar loan may not seem as large as it does now. :)
  - baobabKoodaa 6y ago
    > What does a fraudulent bank have to do with the fact that the FR is the ultimate backstop to loans (IOUs) created by a bank...a "power" you claim is the same as a non-bank created IOU or a an individual IOU? I'm not claiming it's the same. I'm saying these are differences of degree (my IOU vs bank's IOU), whereas the difference between central bank IOU and bank IOU is fundamental. We have several historic examples of central banks ruining entire economies by printing excessive amounts of money causing hyperinflation. Do you have a single example of a regular bank printing so much money that it causes hyperinflation? No. Why is that, if it's so easy for a regular bank to print a trillion dollars of fraudulent money without anyone noticing?

anticristi 6y ago

I love the IOU vs WeOU differentiation. Banks need to have licenses and adhere to strict regulations, which are checked at least yearly by auditors. (Joke: Unless you are a German bank, in which case you get checked only once-a-decade.) That is what makes banks special: They have legal backing, but also legal responsibility. Side note regarding non-bank IOU: I found the idea of having a payment card from my grocery store very appealing. If they run out-of-cash, they can repay me in food, which I'm pretty happy to take at any time. However, that is not how it works in 2020. The grocery entity and the banking entity need to be separated, and have different licenses.

yxhuvud 6y ago
> The grocery entity and the banking entity need to be separated Quite a few of the grocery chain cards here in Sweden have accounts backed by chain-owned banks. So at least here, the separation is not all that great.
- anticristi 6y ago
  They share branding and sometimes ownership, but the entities are separated. ICA Gruppen has ICA Banken as a bank subsidiary. COOP outsourced banking to EnterCard, etc.

brandmeyer 6y ago

Quite true. Its also why we should find it deeply concerning when a tech company starts taking on some of the powers of a bank without any of the responsibilities of a bank. Facebook's digital currency system is one recent example. Paypal's behavior is a much longer-running example.

alasdair_ 6y ago

Seems like a great scam. Create a bank, go through the many many steps to obtain FDIC backing, pay out enormous loans to insiders, have a run on the bank, then everyone is made whole again while the fraudster skips town. I understand that this is basically insurance fraud, but the money is gone long before the fraud occurs and the government must pay out, unlike a single insurer.

sunshinerag 6y ago
I think it would not be shocking anymore to know that you discovered the operating model of the bank. Business as Usual.