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This article is bad, and contains several falsehoods, but the worst one is about fractional reserve banking: > banks are able to issue out far more digital chi

This article is bad, and contains several falsehoods, but the worst one is about fractional reserve banking: > banks are able to issue out far more digital chips than they have in a state money ‘behind the counter’ > Imagine a person arriving a casino with no money but requesting chips nevertheless - this is pretty much what happens when someone approaches a bank and asks for a loan. This is just completely wrong - banks only loan out money they have. If you go to a bank and get a loan the bank didn't just edit a database entry - they had that money. Banks loaning out money they don't have is extremely illegal. The reason that banks ""create"" money is because when you loan money it ""duplicates"" it. You don't have to go through a bank to see this in action: Alice loans Bob $20 and then Bob goes and loans $20 to Charlie. The world now has $40 "more" in it, and remains that way until the loan is settled. Banks just do this process with your money and pay you interest for the privilege. This is the reason that banks are sometimes required to keep some percentage of their money in reserve (and thus where the name fractional reserve banking comes from), because otherwise the same money could be loaned out forever and the maximum money supply would be infinite. ======= EDIT: Because everybody seems to be ready to link the same Bank of England paper. Yes, this is an simplified and slightly incorrect model of how it works in real life. In reality, this process is asynchronous: the government gives banks permission to loan out the money _now_ and figure out the backing cash later. They don't have to keep track of who's money is loaned out to who as long as the balance sheet works out at the end of the day, and some percentage of assets are kept in liquid form (I believe it's something like 4%-5% in the US). In the end, the point is the same: the government controls the creation of money, even if banks are the agents by which they do so. The analogy the author has of a casino just going into debt by creating chips out of thin air is inaccurate and extremely misleading. If everybody were to claim their chips, the casino would go bankrupt. If everybody were to simultaneously pay off their loans and withdraw their money from the banks, the banks would be fine (and have the interest payments they collected left over).

lifty 4y ago
Loan creation doesn’t work like that for many many years. These days banks don’t even have a reserve requirement. They just create the money and balance the books later. Edit: to make my point clearer, banks don’t need your deposits to create new money. They just do.
- cmeacham98 4y ago
  > Loan creation doesn’t work like that for many many years. These days banks don’t even have a reserve requirement. They just create the money and balance the books later. I glossed over it because it isn't really relevant to my point, but yes, the reserve requirement in the US is currently zero: https://www.federalreserve.gov/monetarypolicy/reservereq.htm https://www.federalreserve.gov/monetarypolicy/reservereq.htm > Edit: to make my point clearer, banks don’t need your deposits to create new money. They just do. This is not true. Like I said, banks only lend out money they have. The only way banks "create" money is because the same money can be lent out multiple times (Bank lends out Person A's money to Person B; Person B deposits their money at a bank; Bank lends out Person B's money to Person C; etc)
  - cjmb 4y ago
    and what would then happen if a bank were -- somehow -- induced to make more of those loans, which, as you describe "duplicate" or "create" money a number of times up to the number of loans made? and how would the world look if that same bank then decided to stop making so many loans? would there be a difference in the total money "created"/"duplicated" between those two worlds? you can quibble with language ("Many people get ensnared in a series of linguistic traps when they talk about bank accounts." - quoting the article) but I think you'll find the OP and other commenters here have a sufficiently reasonable model of what is happening under the hood in the modern banking system. I suspect if you view the OP charitably and accept that he does understand what's going on and is describing the relative difference between these two hypothetical scenarios I gave above as "more or less money creation"...the essay becomes less "bad".
  - lifty 4y ago
    You are wrong. Banks don’t need deposits to create loans/money. They crate the money, out of thin air, as the conspiracy theorists like to say it, and they pay the central bank interest on it. That’s it. Start with this paper from the BoE if you want to learn more: 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-...
onlyrealcuzzo 4y ago
Not really. The bank has money, it lends it to you, and then shortly after it bundles that loan up into an MBS and sells it to the Fed (for a profit). Repeat step 1. The Fed - for the last 15 years - usually "expanded its balance sheet" to buy MBSes.
- deleted 4y ago
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- deleted 4y ago
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williamcotton 4y ago
> Alice loans Bob $20 and then Bob goes and loans $20 to Charlie. The world now has $40 "more" in it, and remains that way until the loan is settled. Alice has $30 to spend. Bob and Charlie each have $10. After the loans you described Alice and Bob have $10 and Charlie has $30. That’s the same.
- lesuorac 4y ago
  There's only $50 physical dollars sure. But if they take all of their money out of the bank then Alice has $30, Charlie has $30 and Bob has $30 which adds up to $90 (aka $40 more). Charlie and Bob still owe $40 combined but the point is not the net amount of dollars change its that the assets/liabilities increased by $40.
  - williamcotton 4y ago
    There is no bank in his description.
    - lesuorac 4y ago
      w/e, `sed 's/banks/Bob and Charlie/'`. Do you not get what he was getting at with the extra $40? https://en.wikipedia.org/wiki/Money_multiplier https://en.wikipedia.org/wiki/Money_multiplier
      - williamcotton 4y ago
        I understand how debits and credits work in fractional reserve banking and how money is created in such a system. I don’t understand whatever OP was describing.
  - williamcotton 4y ago
    Now that I have more time… Alice has: $10 and Bob’s IOUs for $20 Bob has: $10 and Charlie’s IOUs for $20 Charlie has: $30 Will Alice take Charlie’s IOUs for $20 from Bob to settle? Will Target take Charlie’s IOUs for $20 from Bob in exchange for socks and underwear? The answer is no. Charlie’s IOUs and Bob’s IOUs are like Lloyd’s Samsonite briefcase filled with scraps of paper in Dumb and Dumber. Worthless. However, if Alice deposited $20 in a bank and is issued a debit card for that bank, and then if Bob went to another bank and was loaned $20 and issued a debit card for that other bank, and then Charlie went to yet a third bank and did the same… Alice, Bob and Charlie have: $10 cash and $20 on their debit cards. Bob and Charlie also owe the bank money… but in the meantime all three can go to Target and buy $20 worth of socks and underwear and still have $10 in cash. If Alice, Bob and Charlie have a positive balance in their checking accounts, ACH will ultimately (via hand waving) handle settlement between Target’s bank and Alice, Bob and Charlie’s banks. When Alice deposited $20 at the bank one real and two accounting things happened: the bank put the $20 bill in their safe and debited $20 to their cash assets and credited $20 to Alice’s checking account, a liability on the banks books. This is called double-entry accounting. The same double-entry happens with a loan: Bob’s IOUs are a kinda risky asset but they are still balanced with $20 credited to Bob’s checking account. The system works for a few reasons, but mainly because everyone trusts each other’s banks and our banks trust each other. The Federal government instills a lot of trust and stability to the whole system. Banks can trade in cash, bank IOUs, and Target, Alice, Bob and Charlie IOUs and that enables quite a bit of commercial activity.
motohagiography 4y ago
The maximum money supply is infinite, and the marginal value of dollars approaching an infinite number is zero, and every levered loan, derivative contract, and rehypothecated asset creates new hot money out of risk. Banks pre-2008 were loaning out 30x the cash they had on hand. That is what creates the money. The loan creates it. This is not loaning out money they in fact have at all, it's pure risk compensated for by the rate of interest. The rest about fractional reserve is mostly accurate, but that fraction of reserve they keep and lever up 10-50x, and then charge fees, interest and commissions back on - together these make the bank a dynamical system whose failure mode requires exogenous recapitalization. Banks are just government backed hedge funds with airs. The challenge with the article is that if you stop believing in the integrity and base reality of fiat (layer 1 capital), apprehending the consequences of what else has (or doesn't have) meaning is a bit much to ask of most people who work really hard just to align to their norms and are very personally invested in them. Cryptocurrencies were a forcing function on a critical theory of money, and that's more radical than mere 20th century radicals were willing to go, imo.
milderworkacc 4y ago
> This is just completely wrong - banks only loan out money they have. If you go to a bank and get a loan the bank didn't just edit a database entry - they had that money. Banks loaning out money they don't have is extremely illegal. I'm afraid to say that this is completely wrong. Commercial banks do in fact create money via lending! The 101 textbook explanation offered here is at best outdated and at worst misleadingly perpetuates a myth that simply must die. The Bank of England's note on money creation in the modern economy [0] is the place to start - and more or less reflects the explanation in the article. [0] https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/money-creation-in-the-modern-economy https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/m...
- lesuorac 4y ago
  Page 19 seems to show that the newly generated money has to be backed by somebody's deposit and not just minted though. Like for any situation that doesn't involve you taking a loan from a bank to use that money at the bank the BoE paper calls out that the bank needs to get deposits from where you're sending the loan. So, you buy a house using say Chase and the seller has Wells Fargo then Chase "mints" say 1M the money for your loan but then solicits 1M of deposits from Wells Fargo. like why does it matter if the 1m for your loan came from Chase depositors or Wells Fargo depositors? The point is that it's backed 1:1 by cash that came from a person which BoE example shows.
  - throwawaymaths 4y ago
    > the newly generated money has to be backed by somebody's deposit Ok. Suppose I am a bank, and pg deposits $10. Then I lend to you, lesourac $9. This $9 is "backed" by pg's deposit. But I, the bank, only hold $1, and you, lesourac, hold $9. In your head, you hold $9. In pg's head, he has $10 of assets. There are $19 of imagined assets running around, even though the "real" assets are only $10. It's all good until pg pulls his $10 sooner than I expected, or if you, lesourac declare bankruptcy and default on your loan, and unable to pay back those $9. This is why bankruptcies are deflationary. We could have a safer banking system if loans were from individual to individual, possibly mediated by a bank, and the lender fully accepted the risk of default.
thewanderer1983 4y ago
I don't mean to be rude. I really like Hacker news. It's a great place to get a wide range of interesting posts with a technology focus, and great talking points from people who have specialization within these areas. It reminds me of the early days of slashdot and even digg. However, it frequently falls short when it moves into areas outside of this. Especially when it's finance or fintech related fields. I think too many people here are well regarded in their tech field and think whatever thoughts they have on areas outside their lane is wisdom, even if they haven't spent much thinking of or gaining much knowledge in said field.
anigbrowl 4y ago
> You don't have to go through a bank to see this in action: Alice loans Bob $20 and then Bob goes and loans $20 to Charlie. The world now has $40 "more" in it, and remains that way until the loan is settled. The world now has $40 debt in it, it still only has $20 of spending power. Suppose both Alice and Bob sell their debt to Donna, sight unseen (ie only the amount is known). Bob still owes $20, but now to Donna, effectively canceling out the $20 he received for Charlie's note.
halpmeh 4y ago
In your example, there is still $20 in the economy after Bob lends Charlie $20. Alice has $20. She loans it to Bob. Alice has $20 in assets (the loan), Bob has $20 in assets (the money) and $20 in liabilities (the loan). The net amount is still $20. If Bob loans Charlie his $20, the net is still $20. Banks do create money via lending, but the money creation comes from the interest charged. For example, if Bob lends Charlie $20 for a year and charges 10% interest to Charlie, he'll have $22 after one year. Where did the $2 come from?
- HWR_14 4y ago
  > Where did the $2 come from? Charlie
  - halpmeh 4y ago
    Yes, the money came from Charlie. But at the beginning, there was only $20 in circulation. After the loan is repaid, there is $22. Money was created from the loan.
    - deleted 4y ago
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    - tsukikage 4y ago
      The bank didn't create anything, though. It got the money from Charlie. If it wasn't in circulation before, Charlie must have created it. Off to prison with him.
      - halpmeh 4y ago
        The bank did create the money. There is an element of cash flow to all of this. Charlie takes the loan, uses it to start a business, perhaps by buying something from Bob. Bob uses the money to pay back Alice. Alice then buys something from Charlie, allowing Charlie to repay his loan. The economy is basically a big flywheel.
MrPatan 4y ago
Boy do I hate that BoE paper.
- bondarchuk 4y ago
  What exactly is wrong with it? Is it really unequivocally dead wrong, or is there some subtle point of contention I'm missing? I'm having a hard time trusting MrPatan and cmeacham98 over the Bank of England.
thelamest 4y ago
It’s not a closed system or a zero sum game. The average loan has positive expected value in terms of new, real goods and services being created – so it can be accompanied with an increase in nominal amount of money. The casino analogy falters here, because gambling is associated with, at best, only intangible entertainment value creation, and at worst, value destruction. Banks are somewhat free to create money, because they enable making new real value, and carry much of the risk for bad calls.

lifty 4y ago

Loan creation doesn’t work like that for many many years. These days banks don’t even have a reserve requirement. They just create the money and balance the books later. Edit: to make my point clearer, banks don’t need your deposits to create new money. They just do.

cmeacham98 4y ago
> Loan creation doesn’t work like that for many many years. These days banks don’t even have a reserve requirement. They just create the money and balance the books later. I glossed over it because it isn't really relevant to my point, but yes, the reserve requirement in the US is currently zero: https://www.federalreserve.gov/monetarypolicy/reservereq.htm https://www.federalreserve.gov/monetarypolicy/reservereq.htm > Edit: to make my point clearer, banks don’t need your deposits to create new money. They just do. This is not true. Like I said, banks only lend out money they have. The only way banks "create" money is because the same money can be lent out multiple times (Bank lends out Person A's money to Person B; Person B deposits their money at a bank; Bank lends out Person B's money to Person C; etc)
- cjmb 4y ago
  and what would then happen if a bank were -- somehow -- induced to make more of those loans, which, as you describe "duplicate" or "create" money a number of times up to the number of loans made? and how would the world look if that same bank then decided to stop making so many loans? would there be a difference in the total money "created"/"duplicated" between those two worlds? you can quibble with language ("Many people get ensnared in a series of linguistic traps when they talk about bank accounts." - quoting the article) but I think you'll find the OP and other commenters here have a sufficiently reasonable model of what is happening under the hood in the modern banking system. I suspect if you view the OP charitably and accept that he does understand what's going on and is describing the relative difference between these two hypothetical scenarios I gave above as "more or less money creation"...the essay becomes less "bad".
- lifty 4y ago
  You are wrong. Banks don’t need deposits to create loans/money. They crate the money, out of thin air, as the conspiracy theorists like to say it, and they pay the central bank interest on it. That’s it. Start with this paper from the BoE if you want to learn more: 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-...

onlyrealcuzzo 4y ago

Not really. The bank has money, it lends it to you, and then shortly after it bundles that loan up into an MBS and sells it to the Fed (for a profit). Repeat step 1. The Fed - for the last 15 years - usually "expanded its balance sheet" to buy MBSes.

deleted 4y ago
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deleted 4y ago
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williamcotton 4y ago

> Alice loans Bob $20 and then Bob goes and loans $20 to Charlie. The world now has $40 "more" in it, and remains that way until the loan is settled. Alice has $30 to spend. Bob and Charlie each have $10. After the loans you described Alice and Bob have $10 and Charlie has $30. That’s the same.

lesuorac 4y ago
There's only $50 physical dollars sure. But if they take all of their money out of the bank then Alice has $30, Charlie has $30 and Bob has $30 which adds up to $90 (aka $40 more). Charlie and Bob still owe $40 combined but the point is not the net amount of dollars change its that the assets/liabilities increased by $40.
- williamcotton 4y ago
  There is no bank in his description.
  - lesuorac 4y ago
    w/e, `sed 's/banks/Bob and Charlie/'`. Do you not get what he was getting at with the extra $40? https://en.wikipedia.org/wiki/Money_multiplier https://en.wikipedia.org/wiki/Money_multiplier
    - williamcotton 4y ago
      I understand how debits and credits work in fractional reserve banking and how money is created in such a system. I don’t understand whatever OP was describing.
- williamcotton 4y ago
  Now that I have more time… Alice has: $10 and Bob’s IOUs for $20 Bob has: $10 and Charlie’s IOUs for $20 Charlie has: $30 Will Alice take Charlie’s IOUs for $20 from Bob to settle? Will Target take Charlie’s IOUs for $20 from Bob in exchange for socks and underwear? The answer is no. Charlie’s IOUs and Bob’s IOUs are like Lloyd’s Samsonite briefcase filled with scraps of paper in Dumb and Dumber. Worthless. However, if Alice deposited $20 in a bank and is issued a debit card for that bank, and then if Bob went to another bank and was loaned $20 and issued a debit card for that other bank, and then Charlie went to yet a third bank and did the same… Alice, Bob and Charlie have: $10 cash and $20 on their debit cards. Bob and Charlie also owe the bank money… but in the meantime all three can go to Target and buy $20 worth of socks and underwear and still have $10 in cash. If Alice, Bob and Charlie have a positive balance in their checking accounts, ACH will ultimately (via hand waving) handle settlement between Target’s bank and Alice, Bob and Charlie’s banks. When Alice deposited $20 at the bank one real and two accounting things happened: the bank put the $20 bill in their safe and debited $20 to their cash assets and credited $20 to Alice’s checking account, a liability on the banks books. This is called double-entry accounting. The same double-entry happens with a loan: Bob’s IOUs are a kinda risky asset but they are still balanced with $20 credited to Bob’s checking account. The system works for a few reasons, but mainly because everyone trusts each other’s banks and our banks trust each other. The Federal government instills a lot of trust and stability to the whole system. Banks can trade in cash, bank IOUs, and Target, Alice, Bob and Charlie IOUs and that enables quite a bit of commercial activity.

motohagiography 4y ago

The maximum money supply is infinite, and the marginal value of dollars approaching an infinite number is zero, and every levered loan, derivative contract, and rehypothecated asset creates new hot money out of risk. Banks pre-2008 were loaning out 30x the cash they had on hand. That is what creates the money. The loan creates it. This is not loaning out money they in fact have at all, it's pure risk compensated for by the rate of interest. The rest about fractional reserve is mostly accurate, but that fraction of reserve they keep and lever up 10-50x, and then charge fees, interest and commissions back on - together these make the bank a dynamical system whose failure mode requires exogenous recapitalization. Banks are just government backed hedge funds with airs. The challenge with the article is that if you stop believing in the integrity and base reality of fiat (layer 1 capital), apprehending the consequences of what else has (or doesn't have) meaning is a bit much to ask of most people who work really hard just to align to their norms and are very personally invested in them. Cryptocurrencies were a forcing function on a critical theory of money, and that's more radical than mere 20th century radicals were willing to go, imo.

milderworkacc 4y ago

> This is just completely wrong - banks only loan out money they have. If you go to a bank and get a loan the bank didn't just edit a database entry - they had that money. Banks loaning out money they don't have is extremely illegal. I'm afraid to say that this is completely wrong. Commercial banks do in fact create money via lending! The 101 textbook explanation offered here is at best outdated and at worst misleadingly perpetuates a myth that simply must die. The Bank of England's note on money creation in the modern economy [0] is the place to start - and more or less reflects the explanation in the article. [0] https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/money-creation-in-the-modern-economy https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/m...

lesuorac 4y ago
Page 19 seems to show that the newly generated money has to be backed by somebody's deposit and not just minted though. Like for any situation that doesn't involve you taking a loan from a bank to use that money at the bank the BoE paper calls out that the bank needs to get deposits from where you're sending the loan. So, you buy a house using say Chase and the seller has Wells Fargo then Chase "mints" say 1M the money for your loan but then solicits 1M of deposits from Wells Fargo. like why does it matter if the 1m for your loan came from Chase depositors or Wells Fargo depositors? The point is that it's backed 1:1 by cash that came from a person which BoE example shows.
- throwawaymaths 4y ago
  > the newly generated money has to be backed by somebody's deposit Ok. Suppose I am a bank, and pg deposits $10. Then I lend to you, lesourac $9. This $9 is "backed" by pg's deposit. But I, the bank, only hold $1, and you, lesourac, hold $9. In your head, you hold $9. In pg's head, he has $10 of assets. There are $19 of imagined assets running around, even though the "real" assets are only $10. It's all good until pg pulls his $10 sooner than I expected, or if you, lesourac declare bankruptcy and default on your loan, and unable to pay back those $9. This is why bankruptcies are deflationary. We could have a safer banking system if loans were from individual to individual, possibly mediated by a bank, and the lender fully accepted the risk of default.

thewanderer1983 4y ago

I don't mean to be rude. I really like Hacker news. It's a great place to get a wide range of interesting posts with a technology focus, and great talking points from people who have specialization within these areas. It reminds me of the early days of slashdot and even digg. However, it frequently falls short when it moves into areas outside of this. Especially when it's finance or fintech related fields. I think too many people here are well regarded in their tech field and think whatever thoughts they have on areas outside their lane is wisdom, even if they haven't spent much thinking of or gaining much knowledge in said field.

anigbrowl 4y ago

> You don't have to go through a bank to see this in action: Alice loans Bob $20 and then Bob goes and loans $20 to Charlie. The world now has $40 "more" in it, and remains that way until the loan is settled. The world now has $40 debt in it, it still only has $20 of spending power. Suppose both Alice and Bob sell their debt to Donna, sight unseen (ie only the amount is known). Bob still owes $20, but now to Donna, effectively canceling out the $20 he received for Charlie's note.

halpmeh 4y ago

In your example, there is still $20 in the economy after Bob lends Charlie $20. Alice has $20. She loans it to Bob. Alice has $20 in assets (the loan), Bob has $20 in assets (the money) and $20 in liabilities (the loan). The net amount is still $20. If Bob loans Charlie his $20, the net is still $20. Banks do create money via lending, but the money creation comes from the interest charged. For example, if Bob lends Charlie $20 for a year and charges 10% interest to Charlie, he'll have $22 after one year. Where did the $2 come from?

HWR_14 4y ago
> Where did the $2 come from? Charlie
- halpmeh 4y ago
  Yes, the money came from Charlie. But at the beginning, there was only $20 in circulation. After the loan is repaid, there is $22. Money was created from the loan.
  - deleted 4y ago
    [deleted]
  - tsukikage 4y ago
    The bank didn't create anything, though. It got the money from Charlie. If it wasn't in circulation before, Charlie must have created it. Off to prison with him.
    - halpmeh 4y ago
      The bank did create the money. There is an element of cash flow to all of this. Charlie takes the loan, uses it to start a business, perhaps by buying something from Bob. Bob uses the money to pay back Alice. Alice then buys something from Charlie, allowing Charlie to repay his loan. The economy is basically a big flywheel.

MrPatan 4y ago

Boy do I hate that BoE paper.

bondarchuk 4y ago
What exactly is wrong with it? Is it really unequivocally dead wrong, or is there some subtle point of contention I'm missing? I'm having a hard time trusting MrPatan and cmeacham98 over the Bank of England.

thelamest 4y ago

It’s not a closed system or a zero sum game. The average loan has positive expected value in terms of new, real goods and services being created – so it can be accompanied with an increase in nominal amount of money. The casino analogy falters here, because gambling is associated with, at best, only intangible entertainment value creation, and at worst, value destruction. Banks are somewhat free to create money, because they enable making new real value, and carry much of the risk for bad calls.