16 ms·

Money creation in the modern economy (2014) [pdf]

231 points by sytelus 4y ago

amalgamated_inc 4y ago
Relevant: https://fedupgame.com https://fedupgame.com
ericls 4y ago
Might need a 2014 in the title?
- booleandilemma 4y ago
  And [pdf]!
whatever1 4y ago
All economy is fragile because it is based on perception. The value of a company, of an asset, security, labor, whatever is completely subjective. Yes frequently valuations sound realistic because some people have gambled a ton of money on them (e.g. Tesla is Trillion Dollar Company, or a software engineer’s labor is worth 10 times the labor of a teacher ), but at the end of the day it’s a completely arbitrary valuation. I am really surprised that the system works at all.
- User23 4y ago
  The value of fiat is subjective until the IRS knocks at your door and then suddenly it has the very objective value of keeping you out of prison. Taxes drive money.
  - eru 4y ago
    That's only a small portion. Perhaps a bootstrap at most. Most of the value comes from network effects.
    - imtringued 4y ago
      And those network effects can be marketed in the form of a liquidity premium which is paid to the saboteurs of the money system in the form of an artificially high interest rate and now we have invented capitalism...
      - eru 4y ago
        Saboteurs?
- chrispeel 4y ago
  It's imagination and turtles all the way down. Welcome to humanity
- worik 4y ago
  > All economy is fragile because it is based on perception. There are several ways of looking at it. Rather than "based on perception" I prefer "based on relationships" The economy is a network of relationships concerning material goods and services (is one definition). One of the mistakes a lot of dry economists make is to forget that. As Maggie (in)famously said: "There is no such thing as society there, are just individuals". Wrong This was illustrated in the Asian Financial Crises in the late '90s. Thailand and Malaysia were badly effected. Thailand, that has hardly been colonised, did better than Malaysia (according to Joe Stiglitz) because the ancient communal ties still existed and people, hence the economy, could fall back on them when the money system collapsed. In Malaysia those ties had been broken by colonisation and there was more misery.
- jrm4 4y ago
  Why? That's all money ever was. Gotta remember, money literally has never been objectively anything. It feels like it should be because there are numbers involved, but it's always been wildly subjective.
  - brutusborn 4y ago
    Many societies used money with inherent value, maybe even most societies. Are gold and silver objectively nothing? Sure, high trust societies used IOUs successfully, but modern society is not high trust so we have traditionally used things with inherent value for trade, and any IOU-based money needs to be ultra-regulated to function well (which always ends in failure). Notice how people escaping a collapsing country can always spend their saved gold, but as soon as society has a crisis, hyperinflation destroys fiat currency. That’s because the first case is a currency with inherent value, and the other is an IOU from a society that doesn’t exist anymore. Thinking all money has never been objectively anything is a mistake.
    - awesome_dude 4y ago
      Gold, especially, only has one valuable property, which is why I believe it was used as a representative "money" - it's an inert metal. It doesn't degrade, ever, not for thousands of years. The amount of gold in a blob can change/be diluted, but touchstones revolutionised that - people could easily discover what the percentage of real gold was in a given blob. We haven't used gold for currency in centuries, because it's not actually very good as a currency. Why not? Because the amount of gold in circulation doesn't reflect the size of the economy. It's value sharply drops when a new discovery is made. And it's value tracks upwards between discoveries because the economies are growing (when economies collapse the local value of the gold drops too)
      - eru 4y ago
        Your understanding of the classic gold standard is flawed. First, in the long run the value of gold had been rather stable. That's because the supply of gold isn't random: it takes effort to mine gold. If the gold price is higher than usual for a longer time, people will put more effort into mining. (More formally: even more marginal mines will be worked.) Similar for periods of low gold prices. Of course, these adjustments happen over long time periods only. Second, in anything but a very naive gold standard the amount of gold in circulation doesn't need to reflect the size of the economy. At least not directly. Gold was mostly a unit of account, but people seldom exchanged physical gold coins. Which fractional reserve banking, there's no simple relation between the amount of money in an economy and the amount of gold, even if every note is redeemable in gold on demand. During its free banking era, Scotland was famous for having both a very strong and stable banking sector (one of the reasons it manage to mostly catch up with the England during the Industrial Revolution), and also scarcely any gold in the country. In Scotland during that time, typical banks held about 2% of their as assets as gold reserves, the rest was invested in the real economy. However, they also had much thicker equity cushions than was is common today: about 30% instead of 8%. That's equivalent to saying that Scottish banks were much less leveraged.
- abigail95 4y ago
  If it were arbitrary, it would be random. It's not, you can build a consistent model that applies to a microbusiness as well as it applies to Tesla. Should a farm that can feed 100 people be worth more than one that can feed 20? That's not an arbitrary distinction. How about a farm that will feed 100 people in 10 years vs one that feeds 100 now but is eroding? Also software engineering is only 1.4x teaching.
- deleted 4y ago
  [deleted]
- hsn915 4y ago
  > I am really surprised that the system works at all. I hold the same view, but IMO it's proof that we don't actually understand how the system works. Whatever mental model of it we're holding is probably a mere caricature of the actual thing. If it wasn't, we'd understand exactly how and why it works, and we'd be able to take advantage of it. Just like the philosophers/nerds who are not successful with women and often punt that women are a mystery.
  - isitmadeofglass 4y ago
    [dead]
- dools 4y ago
  > All economy is fragile because it is based on perception. Not really, it’s based on laws, specifically taxation.
  - bradwood 4y ago
    Taxation is what defines fiscal policy, which is only half the story. You need to take both fiscal and monetary policy into account to get a full picture of the economy as a whole.
- yxhuvud 4y ago
  Everything you say about the economy can also be said about the civil society as a whole.
chrispeel 4y ago
2014 thread: https://news.ycombinator.com/item?id=28473807 https://news.ycombinator.com/item?id=28473807
- aeharding 4y ago
  2021 thread, 2014 report.
TekMol 4y ago
Can everybody create money? If Alice and Bob agree that Alice owes Bob $100, Bob will have show this $100 in his books and pay taxes on it. Does this mean Alice and Bob have created $100? Are there other players, who can create money that is "more real" than the $100 Alice and Bob created?
- jljljl 4y ago
  Correct. It doesn't have to be a bank or central bank: lot's of other entities create money through lending -- Insurance companies, pawn shops, hedge funds all do it. This it's what's known commonly referred to as shadow banking (https://en.wikipedia.org/wiki/Shadow_banking_system https://en.wikipedia.org/wiki/Shadow_banking_system)
  - brutusborn 4y ago
    Unless the pawn shop has an account at the Fed the result is zero sum: no money is ‘created’ because deposits balance credits. The other commenter explains it well - you need the privilege of a central bank account to create money.
    - simple-thoughts 4y ago
      That’s incorrect, as the original article explains. Absent QE (which the BOE explains in this article can result in both creation and destruction of money, depending on complex factors) money is usually created and destroyed without any influence from central authorities. You can read the article for a detailed explanation, but the simple version is that the financial sector as a whole can increase/decrease the entire balance sheet together. Yes assets and liabilities are balanced, but if the size of the balance sheet grows then there are more liabilities and this more money.
      - brutusborn 4y ago
        I’m not saying the central authorities create money, I’m saying they confer the privilege to do so. Minor players do not truly create money in this way because they are isolated from the financial sector as a whole. They don’t get to play at the big boys table, so their contribution is zero sum.
spraveenitpro 4y ago
[dead]
lsiq 4y ago
Banks create the money supply (~97% of it). A bank "loan" is not a legally a loan at all but a new security that is created and purchased by the bank. Furthermore, the money for that purchase does not come from any other account or "fed reserves" it is literally instantiated in the account. This "credit creation" theory of the money supply is what the article is about and was empirically proven by the work of Richard Werner. This is a very important level of understanding, and one that is obfuscated by the central banks. Once understood, it is self-evident that banks are wholly responsible for asset bubbles. Banks, especially large banks, create loans mostly for existing asset purchases, and not for new productive investment. Of course, they do this in part because those assets work as collateral. What happens when this behavior is aggregated in the whole system is essentially wealthy people jumping over each other to secure an amount of loans approaching infinity to acquire FINITE real estate and SEMI-FINITE stock. You can see how that ratio will repeatedly create asset price inflation which inevitably implodes along with the banks who issued the loans. The only solution is for the regulator, in this case the central banks, to issue guidance for the banks to create credit for only new productive investments, whether that be new housing, factories, machinery, or firms, because those are not inflationary and increase the size of the GDP pie. If done, the economy would grow at a high clip with low inflation. The current system of credit creation for leveraged buyouts ad infinitum of a slow growing economic pie, has only one logical outcome....
- egnenytg 4y ago
  [flagged]
  - JumpCrisscross 4y ago
    > only solution is to get back to sound money Gold buggery, now crypto, is an old scam. In truth, sound money has never existed. And it cannot exist. Value is a subjective measure on reality. Transporting that across time requires work. Expecting to get that transport for free is the perpetual-motion problem of finance.
    - Consultant32452 4y ago
awesome_dude 4y ago
I've never understood the complaint. Once upon a time the central bank would load up trains and armoured trucks with hard currency that they would send to the bank. The bank would then loan that out for stuff (houses, cars, whatever). The banks realised pretty early on that they could loan out more than they had in physical cash because people didn't need the currency they needed the bank cheque. At the end of the day the banks would reconcile with one another and the central banks. Now, because there's even less need for hard currency in our economies, the central banks can (effectively) email to banks how much that they can have to use for loans. Accounting rules limit the banks on how much they can loan out. Nothing has changed from when the hard currency was shipped around countries, except that it's done with a telephone.
- JumpCrisscross 4y ago
  > Once upon a time the central bank would load up trains and armoured trucks with hard currency that they would send to the bank Free banking precedes central banking.
  - awesome_dude 4y ago
    Lots of things precede central banking - that doesn't change how the system now is still essentially the same as when hard currency was shipped out and about
    - JumpCrisscross 4y ago
      > when hard currency was shipped out and about When was this? When Caesar borrowed to finance his civil war, do you think he physically collected talents?
  - eru 4y ago
    And crucially: what used to be called 'free banking' in 19th century America wasn't really 'free banking' like they practiced in more laissez faire places like Scotland or Canada.
JumpCrisscross 4y ago
This is a low-quality comment section. I strongly recommend reading the source, which is one of the best sources of how money works on the internet.
- eru 4y ago
  Alas, discussion of money and especially money creation online tends to be of uniformly low quality. (To be fair, even many economists have a fairly nebulous understanding.) What's somewhat ironic is that the some of the actual 'Austrian' economists like George Selgin have a pretty good handle on the topic, but 'Internet Austrians' invariable are some of the worst misunderstanders.
- omnicognate 4y ago
  Yes. The amazing thing about this topic is how confidently otherwise intelligent people routinely spout utter bullshit about it. It's particularly ironic (but completely unsurprising) to see people flaunting their misconceptioms in response to an extremely clear explanation of how it actually works from one of the most authoritative sources possible. Please, if you think you know something on this topic and haven't read this pdf, just try and forget what you think you know and read it. (Of course, now somebody will explain to me why the Bank of England doesn't actually know how money creation works, or is deliberately lying about it for some reason, and on it goes.)
  - paganel 4y ago
    > to an extremely clear explanation of how it actually works from one of the most authoritative sources possible. If I'm not mistaken late into the 2000s authoritative sources like the Bank of England were still not completely on board with the idea that commercial banks themselves are in the process of actual money creation, a process explained described/explained by Schumpeter (I guess amongst many others) ever since back in the 1940s. So a little bit of "not following the authoritative sources" on this one is understandable, as those authoritative sources themselves are pretty new to the idea.
    - 4y ago
OscarCunningham 4y ago
How money is created depends on how you define 'money': 1) If money is (cash) + (accounts at the central bank), then only the central bank can create it. 2) If money is (cash held outside banks) + (accounts at private banks), then it's created when private banks make loans. However I think the main point is that saying 'private banks create money' makes it sound like they're getting something for nothing, when in fact this isn't true. Because (2) doesn't include cash held by a bank as 'money' you can't say a bank is losing money when it loans out some cash. But it's still losing an asset worth the same amount. Personally I think (2) is a silly definition for most discussions. Bank robber: Give me the money! Bank teller: We don't have any money, only cash. But it will become money if I give it to you.
- JumpCrisscross 4y ago
  > (2) is a silly definition for most discussions This is commercial bank money. (The first is central bank money.) The latter is the only definition appropriate for most discussions. Nobody says Apple has no money because they don't have an account at the Federal Reserve.
  - OscarCunningham 4y ago
    People say that Warren Buffet has lots of money, but I wouldn't call shares money either. EDIT: I'd say that in common parlence bank accounts are called 'money' because they're a claim on money (1) that the bank has to pay out on demand. But if you're calculating an aggregate then you shouldn't include both the claim and the thing it's a claim on.
    - JumpCrisscross 4y ago
      > if you're calculating an aggregate then you shouldn't include both the claim and the thing it's a claim on It's all claims. We count both. But other than for international finance, high-powered money is irrelevant.
    - lottin 4y ago
      > if you're calculating an aggregate then you shouldn't include both the claim and the thing it's a claim on This is why M1, which includes bank deposits, does not include bank reserves.
dools 4y ago
It was the comment section of Graeber’s Guardian article written in response to this paper which first lead me to MMT. EDIT: since I see the discovery of MMT as the most important information I have ever learned, I think it’s a good idea to mention it in this comment section also, in case someone else discovers it as a result and thus learns the most important information they will ever learn.
MrPatan 4y ago
What do people get out of this paper? That banks can create as much money as they want, without limit? Or that, even if the bank has a hard limit to how much they can loan out to the amount they hold in reserves in the central bank, what counts as money being created into the wider economy is the act of making a new loan for a customer? One is way more boring, technical and unsurprising than the other.
- imtringued 4y ago
  Money creation is limited by the productive investments that the banks can find and if it is overly pessimistic it will not lend even to productive investments. Sound money advocates think that money for loans should be limited by the availability of "prudent savers".
- lottin 4y ago
  Banks can create deposits but creating deposits that aren't backed with reserves entails a risk of insolvency. Thus the amount of deposits banks can create is ultimately limited by the reserves that they hold. The demand for credit also affects the amount of deposits that are created in practice.
- throw0101c 4y ago
  > Or that, even if the bank has a hard limit to how much they can loan out to the amount they hold in reserves in the central bank Reserves haven't been a limit for a while: * https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1905625 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1905625 * https://rationalreminder.ca/podcast/132 https://rationalreminder.ca/podcast/132 Some countries haven't had reserve limits for decades: * https://en.wikipedia.org/wiki/Reserve_requirement#Canada https://en.wikipedia.org/wiki/Reserve_requirement#Canada
  - danielmarkbruce 4y ago
    They all have capital requirements.
- ryloric 4y ago
danielschonfeld 4y ago
This article tries to gently update the public’s 1930s worldview in teaching us that bank reserve don’t matter anymore and haven’t for a long while and to a lesser degree their respective central banks don’t either. What matters is balance sheet capacity and how constrained it is or isn’t (Hint: it’s very constrained since 2008).
nazgul17 4y ago
What are some good articles like this that introduce general concepts for a general of educated audience?
- garyclarke27 4y ago
  I wrote a blog post which is pretty good - even if I say so myself (it’s had great feedback) I agree with the fundamentals of this article but I fill in some missing pieces. https://www.onedb.online/blog/what_is_money https://www.onedb.online/blog/what_is_money
  - oli5679 4y ago
    Your article is really interesting. I was wondering what you think about the type of maths Krugman does here [1]? “ This willingness of foreigners to hold American cash means, in effect, that the world has lent the U.S. a substantial amount of money — maybe on the order of $1 trillion — at zero interest. That’s not a big deal when interest rates are as low as they are now, but in the past it has been worth more — maybe as much as 0.25 percent of G.D.P.” What is the mechanism where being global reserve currency leads to greater benefits than what Paul calculated? 1. https://archive.ph/Zpp0a https://archive.ph/Zpp0a
- spiralx 4y ago
  They've got a companion piece on money in general if you liked this one: https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-in-the-modern-economy-an-introduction.pdf https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...
college_physics 4y ago
How money works should really be elementary school level education. Using games and simple setups that replicate the essence if not the details. The fact that there is such widespread financial illiteracy is a key reason society is so dysfunctional.
- kderbyma 4y ago
  I would hazard a guess that it has been intentionally muddied, made confusing, opaque, and left til the last minute for a reason.....interest rates and credit scores.
  - college_physics 4y ago
    I don't think its intentional (the overlords?) but it is an unjustifiable gap for any society that considers itself democratic. Its not just the broad unwashed masses. Essentially outside a tiny number of central banking economists the rest of the world has still "flat Earth" level understanding of how monetary systems work, the role of private banks and, crucially, what alternatives there might be and pros/cons. Efforts for financial literacy, to the extend they exist, are inadequate and incomplete, essentially manuals for smoothing financial product consumption, not background knowledge on how and why these systems are setup. Its a fixable gap. Compared to the amount of complexity of material people are exposed to at different school levels, this stuff is really not that difficult.
    - danielmarkbruce 4y ago
      People have a flat earth understanding of many topics because they are complex and take a lot of work to understand. It would be nice if everyone understood the basics of human biology and health care - but it's incredibly complex. I'm a health care flat earther.... I might always be. Understanding the legal system would likely be more helpful to most than the financial system. But again, takes lot of work to get there. For most people, this stuff doesn't matter.
      - 4y ago
scotty79 4y ago
How much of "core money" lives as physical banknotes and how much is just electronic account balance of accounts that central bank has for private banks?
- ryloric 4y ago
  It's a elastic system, there's no fixed proportions like that and that is by design. What you call core money are Federal Reserve Notes(FRN), the other component that you call account balance is called Federal Reserve Credit(FRC), together they make up what's called Monetary Base or base money. Think of monetary base as level one fundamental money. FRN is not better or more "real" than FRC in in any way or vice versa, they're both exactly the same and controlled by the Fed. How much cash is in circulation changes depending on what the public wants, if they demand more cash then Fed decreases credit balance of banks and sends hard cash to their branches to satisfy the demand. If the opposite happens where the banks are holding too much cash, they deposit it back to Fed and fed increases their balance and reduces cash in circulation. In reality though, FRN is miniscule compared to FRC because the vast majority of transactions are settled digitally. Hard to believe now, but in 1913 one of the primary reasons for the Fed's creation was to provide an "elastic currency", which is provide notes to member banks when their customers demand 'hard cash'. The primary concern back then was if a bank failed to furnish cash when it's depositors asked for it, there was a real risk of a bank run driven by panic, even if the bank was in good shape.
  - scotty79 4y ago
    Thank you for a very clear explanation. > In reality though, FRN is miniscule compared to FRC because the vast majority of transactions are settled digitally. I thought so. I'm just curious what is the usual FRN/(FRN+FRC) ratio.
    - ryloric 4y ago
      I think it's like 0.2-ish iirc. I remember during covid stimulus fed's assets were about 8Tn, and cash was about 1.5 Tn or something. Also worth noting vast portions of that cash is held outside America and not really 'circulated' like cash in your pocket is.
bArray 4y ago
I was literally reading this article just 4 hours before it was submitted to HN. It's a little concerning when my 'unique' search from 2014 isn't even unique. Some questions I am trying to answer: 1. What are the minimal reserves held by BoE (as %) and what do they currently hold. The same question for all the banks they have a contract with. 2. What is breakdown of the reserves? I.e. Foreign currency, gold, etc. 3. How have these numbers changed over time.
- mmarq 4y ago
  https://googlethatforyou.com?q=bank%20of%20englang%20balance%20sheet https://googlethatforyou.com?q=bank%20of%20englang%20balance...
  - bArray 4y ago
    Thanks, but that only answers part of my question. I also want to see what the ratio is for contracted banks, it's no good if they outsource poor reserve ratios.
pier25 4y ago
So banks create money when lending? So banks get "infinitely" rich as long as people need to borrow money? And what's stopping anyone from opening a bank a do the same?
- luxcem 4y ago
  When someone repays their loan, the money does not go into the bank's accounts, it is destroyed. Only interest are effectively added to the bank credit. The bank does not get infinitely rich, because interests are used to pay bank employees, taxes, shareholders. It can get infinitely rich the same way any other company that makes profits can. What's stopping anyone from opening a bank is laws and regulations, you have to get a banking license from the government.
drbeast 4y ago
[dead]
_448 4y ago
Recently I watched this interesting video on how money is created: https://www.youtube.com/watch?v=iFDe5kUUyT0 https://www.youtube.com/watch?v=iFDe5kUUyT0
deleted 4y ago
[deleted]
danielmarkbruce 4y ago
This article is pretty bad. In theory, in aggregate, it's sort of right. But it doesn't track the flow of what happens after that loan is made, it doesn't discuss how credit spends just like money (ie, anyone can create "money" depending on how you define it), and it doesn't discuss capital requirements (either from a reg perspective or a practical risk management perspective) other than a passing note. People/companies don't borrow money and then leave it in the bank which lent them the money. The money typically gets wired somewhere, and then the bank which "created money" has to actually have the money in their account with the central bank or have assets to give another bank so they'll give some of their central bank reserves. So, their description is true for a hot minute, then lacking. A bank can't just keep lending and lending. As for limits on lending, both for a specific bank and in aggregate - they don't discuss capital requirements or anything about Basel III... It's mentioned in passing with a reference to another paper, as though it's a minor detail. It isn't. The limit on lending could be the limit they lay out... but in practice the capital requirements mean that the amount of lending is severely constrained, both in quantity and the types of loans and the types of customers. Just look at a balance sheet of an actual bank... (like https://www.sec.gov/ix?doc=/Archives/edgar/data/72971/000007297122000205/wfc-20220930.htm https://www.sec.gov/ix?doc=/Archives/edgar/data/72971/000007... , page 62). Using the BOE paper you'd assume there are banks levered 1000-1. There are not.

231 points by sytelus 4y ago

amalgamated_inc 4y ago

Relevant: https://fedupgame.com https://fedupgame.com

ericls 4y ago

Might need a 2014 in the title?

booleandilemma 4y ago
And [pdf]!

whatever1 4y ago

All economy is fragile because it is based on perception. The value of a company, of an asset, security, labor, whatever is completely subjective. Yes frequently valuations sound realistic because some people have gambled a ton of money on them (e.g. Tesla is Trillion Dollar Company, or a software engineer’s labor is worth 10 times the labor of a teacher ), but at the end of the day it’s a completely arbitrary valuation. I am really surprised that the system works at all.

User23 4y ago
The value of fiat is subjective until the IRS knocks at your door and then suddenly it has the very objective value of keeping you out of prison. Taxes drive money.
- eru 4y ago
  That's only a small portion. Perhaps a bootstrap at most. Most of the value comes from network effects.
  - imtringued 4y ago
    And those network effects can be marketed in the form of a liquidity premium which is paid to the saboteurs of the money system in the form of an artificially high interest rate and now we have invented capitalism...
    - eru 4y ago
      Saboteurs?
chrispeel 4y ago
It's imagination and turtles all the way down. Welcome to humanity
worik 4y ago
> All economy is fragile because it is based on perception. There are several ways of looking at it. Rather than "based on perception" I prefer "based on relationships" The economy is a network of relationships concerning material goods and services (is one definition). One of the mistakes a lot of dry economists make is to forget that. As Maggie (in)famously said: "There is no such thing as society there, are just individuals". Wrong This was illustrated in the Asian Financial Crises in the late '90s. Thailand and Malaysia were badly effected. Thailand, that has hardly been colonised, did better than Malaysia (according to Joe Stiglitz) because the ancient communal ties still existed and people, hence the economy, could fall back on them when the money system collapsed. In Malaysia those ties had been broken by colonisation and there was more misery.
jrm4 4y ago
Why? That's all money ever was. Gotta remember, money literally has never been objectively anything. It feels like it should be because there are numbers involved, but it's always been wildly subjective.
- brutusborn 4y ago
  Many societies used money with inherent value, maybe even most societies. Are gold and silver objectively nothing? Sure, high trust societies used IOUs successfully, but modern society is not high trust so we have traditionally used things with inherent value for trade, and any IOU-based money needs to be ultra-regulated to function well (which always ends in failure). Notice how people escaping a collapsing country can always spend their saved gold, but as soon as society has a crisis, hyperinflation destroys fiat currency. That’s because the first case is a currency with inherent value, and the other is an IOU from a society that doesn’t exist anymore. Thinking all money has never been objectively anything is a mistake.
  - awesome_dude 4y ago
    Gold, especially, only has one valuable property, which is why I believe it was used as a representative "money" - it's an inert metal. It doesn't degrade, ever, not for thousands of years. The amount of gold in a blob can change/be diluted, but touchstones revolutionised that - people could easily discover what the percentage of real gold was in a given blob. We haven't used gold for currency in centuries, because it's not actually very good as a currency. Why not? Because the amount of gold in circulation doesn't reflect the size of the economy. It's value sharply drops when a new discovery is made. And it's value tracks upwards between discoveries because the economies are growing (when economies collapse the local value of the gold drops too)
    - eru 4y ago
      Your understanding of the classic gold standard is flawed. First, in the long run the value of gold had been rather stable. That's because the supply of gold isn't random: it takes effort to mine gold. If the gold price is higher than usual for a longer time, people will put more effort into mining. (More formally: even more marginal mines will be worked.) Similar for periods of low gold prices. Of course, these adjustments happen over long time periods only. Second, in anything but a very naive gold standard the amount of gold in circulation doesn't need to reflect the size of the economy. At least not directly. Gold was mostly a unit of account, but people seldom exchanged physical gold coins. Which fractional reserve banking, there's no simple relation between the amount of money in an economy and the amount of gold, even if every note is redeemable in gold on demand. During its free banking era, Scotland was famous for having both a very strong and stable banking sector (one of the reasons it manage to mostly catch up with the England during the Industrial Revolution), and also scarcely any gold in the country. In Scotland during that time, typical banks held about 2% of their as assets as gold reserves, the rest was invested in the real economy. However, they also had much thicker equity cushions than was is common today: about 30% instead of 8%. That's equivalent to saying that Scottish banks were much less leveraged.
abigail95 4y ago
If it were arbitrary, it would be random. It's not, you can build a consistent model that applies to a microbusiness as well as it applies to Tesla. Should a farm that can feed 100 people be worth more than one that can feed 20? That's not an arbitrary distinction. How about a farm that will feed 100 people in 10 years vs one that feeds 100 now but is eroding? Also software engineering is only 1.4x teaching.
deleted 4y ago
[deleted]
hsn915 4y ago
> I am really surprised that the system works at all. I hold the same view, but IMO it's proof that we don't actually understand how the system works. Whatever mental model of it we're holding is probably a mere caricature of the actual thing. If it wasn't, we'd understand exactly how and why it works, and we'd be able to take advantage of it. Just like the philosophers/nerds who are not successful with women and often punt that women are a mystery.
- isitmadeofglass 4y ago
  [dead]
dools 4y ago
> All economy is fragile because it is based on perception. Not really, it’s based on laws, specifically taxation.
- bradwood 4y ago
  Taxation is what defines fiscal policy, which is only half the story. You need to take both fiscal and monetary policy into account to get a full picture of the economy as a whole.
yxhuvud 4y ago
Everything you say about the economy can also be said about the civil society as a whole.

chrispeel 4y ago

2014 thread: https://news.ycombinator.com/item?id=28473807 https://news.ycombinator.com/item?id=28473807

aeharding 4y ago
2021 thread, 2014 report.

TekMol 4y ago

Can everybody create money? If Alice and Bob agree that Alice owes Bob $100, Bob will have show this $100 in his books and pay taxes on it. Does this mean Alice and Bob have created $100? Are there other players, who can create money that is "more real" than the $100 Alice and Bob created?

jljljl 4y ago
Correct. It doesn't have to be a bank or central bank: lot's of other entities create money through lending -- Insurance companies, pawn shops, hedge funds all do it. This it's what's known commonly referred to as shadow banking (https://en.wikipedia.org/wiki/Shadow_banking_system https://en.wikipedia.org/wiki/Shadow_banking_system)
- brutusborn 4y ago
  Unless the pawn shop has an account at the Fed the result is zero sum: no money is ‘created’ because deposits balance credits. The other commenter explains it well - you need the privilege of a central bank account to create money.
  - simple-thoughts 4y ago
    That’s incorrect, as the original article explains. Absent QE (which the BOE explains in this article can result in both creation and destruction of money, depending on complex factors) money is usually created and destroyed without any influence from central authorities. You can read the article for a detailed explanation, but the simple version is that the financial sector as a whole can increase/decrease the entire balance sheet together. Yes assets and liabilities are balanced, but if the size of the balance sheet grows then there are more liabilities and this more money.
    - brutusborn 4y ago
      I’m not saying the central authorities create money, I’m saying they confer the privilege to do so. Minor players do not truly create money in this way because they are isolated from the financial sector as a whole. They don’t get to play at the big boys table, so their contribution is zero sum.

spraveenitpro 4y ago

[dead]

lsiq 4y ago

Banks create the money supply (~97% of it). A bank "loan" is not a legally a loan at all but a new security that is created and purchased by the bank. Furthermore, the money for that purchase does not come from any other account or "fed reserves" it is literally instantiated in the account. This "credit creation" theory of the money supply is what the article is about and was empirically proven by the work of Richard Werner. This is a very important level of understanding, and one that is obfuscated by the central banks. Once understood, it is self-evident that banks are wholly responsible for asset bubbles. Banks, especially large banks, create loans mostly for existing asset purchases, and not for new productive investment. Of course, they do this in part because those assets work as collateral. What happens when this behavior is aggregated in the whole system is essentially wealthy people jumping over each other to secure an amount of loans approaching infinity to acquire FINITE real estate and SEMI-FINITE stock. You can see how that ratio will repeatedly create asset price inflation which inevitably implodes along with the banks who issued the loans. The only solution is for the regulator, in this case the central banks, to issue guidance for the banks to create credit for only new productive investments, whether that be new housing, factories, machinery, or firms, because those are not inflationary and increase the size of the GDP pie. If done, the economy would grow at a high clip with low inflation. The current system of credit creation for leveraged buyouts ad infinitum of a slow growing economic pie, has only one logical outcome....

egnenytg 4y ago
[flagged]
- JumpCrisscross 4y ago
  > only solution is to get back to sound money Gold buggery, now crypto, is an old scam. In truth, sound money has never existed. And it cannot exist. Value is a subjective measure on reality. Transporting that across time requires work. Expecting to get that transport for free is the perpetual-motion problem of finance.
  - Consultant32452 4y ago

awesome_dude 4y ago

I've never understood the complaint. Once upon a time the central bank would load up trains and armoured trucks with hard currency that they would send to the bank. The bank would then loan that out for stuff (houses, cars, whatever). The banks realised pretty early on that they could loan out more than they had in physical cash because people didn't need the currency they needed the bank cheque. At the end of the day the banks would reconcile with one another and the central banks. Now, because there's even less need for hard currency in our economies, the central banks can (effectively) email to banks how much that they can have to use for loans. Accounting rules limit the banks on how much they can loan out. Nothing has changed from when the hard currency was shipped around countries, except that it's done with a telephone.

JumpCrisscross 4y ago
> Once upon a time the central bank would load up trains and armoured trucks with hard currency that they would send to the bank Free banking precedes central banking.
- awesome_dude 4y ago
  Lots of things precede central banking - that doesn't change how the system now is still essentially the same as when hard currency was shipped out and about
  - JumpCrisscross 4y ago
    > when hard currency was shipped out and about When was this? When Caesar borrowed to finance his civil war, do you think he physically collected talents?
- eru 4y ago
  And crucially: what used to be called 'free banking' in 19th century America wasn't really 'free banking' like they practiced in more laissez faire places like Scotland or Canada.

JumpCrisscross 4y ago

This is a low-quality comment section. I strongly recommend reading the source, which is one of the best sources of how money works on the internet.

eru 4y ago
Alas, discussion of money and especially money creation online tends to be of uniformly low quality. (To be fair, even many economists have a fairly nebulous understanding.) What's somewhat ironic is that the some of the actual 'Austrian' economists like George Selgin have a pretty good handle on the topic, but 'Internet Austrians' invariable are some of the worst misunderstanders.
omnicognate 4y ago
Yes. The amazing thing about this topic is how confidently otherwise intelligent people routinely spout utter bullshit about it. It's particularly ironic (but completely unsurprising) to see people flaunting their misconceptioms in response to an extremely clear explanation of how it actually works from one of the most authoritative sources possible. Please, if you think you know something on this topic and haven't read this pdf, just try and forget what you think you know and read it. (Of course, now somebody will explain to me why the Bank of England doesn't actually know how money creation works, or is deliberately lying about it for some reason, and on it goes.)
- paganel 4y ago
  > to an extremely clear explanation of how it actually works from one of the most authoritative sources possible. If I'm not mistaken late into the 2000s authoritative sources like the Bank of England were still not completely on board with the idea that commercial banks themselves are in the process of actual money creation, a process explained described/explained by Schumpeter (I guess amongst many others) ever since back in the 1940s. So a little bit of "not following the authoritative sources" on this one is understandable, as those authoritative sources themselves are pretty new to the idea.
  - 4y ago

OscarCunningham 4y ago

How money is created depends on how you define 'money': 1) If money is (cash) + (accounts at the central bank), then only the central bank can create it. 2) If money is (cash held outside banks) + (accounts at private banks), then it's created when private banks make loans. However I think the main point is that saying 'private banks create money' makes it sound like they're getting something for nothing, when in fact this isn't true. Because (2) doesn't include cash held by a bank as 'money' you can't say a bank is losing money when it loans out some cash. But it's still losing an asset worth the same amount. Personally I think (2) is a silly definition for most discussions. Bank robber: Give me the money! Bank teller: We don't have any money, only cash. But it will become money if I give it to you.

JumpCrisscross 4y ago
> (2) is a silly definition for most discussions This is commercial bank money. (The first is central bank money.) The latter is the only definition appropriate for most discussions. Nobody says Apple has no money because they don't have an account at the Federal Reserve.
- OscarCunningham 4y ago
  People say that Warren Buffet has lots of money, but I wouldn't call shares money either. EDIT: I'd say that in common parlence bank accounts are called 'money' because they're a claim on money (1) that the bank has to pay out on demand. But if you're calculating an aggregate then you shouldn't include both the claim and the thing it's a claim on.
  - JumpCrisscross 4y ago
    > if you're calculating an aggregate then you shouldn't include both the claim and the thing it's a claim on It's all claims. We count both. But other than for international finance, high-powered money is irrelevant.
  - lottin 4y ago
    > if you're calculating an aggregate then you shouldn't include both the claim and the thing it's a claim on This is why M1, which includes bank deposits, does not include bank reserves.

dools 4y ago

It was the comment section of Graeber’s Guardian article written in response to this paper which first lead me to MMT. EDIT: since I see the discovery of MMT as the most important information I have ever learned, I think it’s a good idea to mention it in this comment section also, in case someone else discovers it as a result and thus learns the most important information they will ever learn.

MrPatan 4y ago

What do people get out of this paper? That banks can create as much money as they want, without limit? Or that, even if the bank has a hard limit to how much they can loan out to the amount they hold in reserves in the central bank, what counts as money being created into the wider economy is the act of making a new loan for a customer? One is way more boring, technical and unsurprising than the other.

imtringued 4y ago
Money creation is limited by the productive investments that the banks can find and if it is overly pessimistic it will not lend even to productive investments. Sound money advocates think that money for loans should be limited by the availability of "prudent savers".
lottin 4y ago
Banks can create deposits but creating deposits that aren't backed with reserves entails a risk of insolvency. Thus the amount of deposits banks can create is ultimately limited by the reserves that they hold. The demand for credit also affects the amount of deposits that are created in practice.
throw0101c 4y ago
> Or that, even if the bank has a hard limit to how much they can loan out to the amount they hold in reserves in the central bank Reserves haven't been a limit for a while: * https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1905625 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1905625 * https://rationalreminder.ca/podcast/132 https://rationalreminder.ca/podcast/132 Some countries haven't had reserve limits for decades: * https://en.wikipedia.org/wiki/Reserve_requirement#Canada https://en.wikipedia.org/wiki/Reserve_requirement#Canada
- danielmarkbruce 4y ago
  They all have capital requirements.
ryloric 4y ago

danielschonfeld 4y ago

This article tries to gently update the public’s 1930s worldview in teaching us that bank reserve don’t matter anymore and haven’t for a long while and to a lesser degree their respective central banks don’t either. What matters is balance sheet capacity and how constrained it is or isn’t (Hint: it’s very constrained since 2008).

nazgul17 4y ago

What are some good articles like this that introduce general concepts for a general of educated audience?

garyclarke27 4y ago
I wrote a blog post which is pretty good - even if I say so myself (it’s had great feedback) I agree with the fundamentals of this article but I fill in some missing pieces. https://www.onedb.online/blog/what_is_money https://www.onedb.online/blog/what_is_money
- oli5679 4y ago
  Your article is really interesting. I was wondering what you think about the type of maths Krugman does here [1]? “ This willingness of foreigners to hold American cash means, in effect, that the world has lent the U.S. a substantial amount of money — maybe on the order of $1 trillion — at zero interest. That’s not a big deal when interest rates are as low as they are now, but in the past it has been worth more — maybe as much as 0.25 percent of G.D.P.” What is the mechanism where being global reserve currency leads to greater benefits than what Paul calculated? 1. https://archive.ph/Zpp0a https://archive.ph/Zpp0a
spiralx 4y ago
They've got a companion piece on money in general if you liked this one: https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-in-the-modern-economy-an-introduction.pdf https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...

college_physics 4y ago

How money works should really be elementary school level education. Using games and simple setups that replicate the essence if not the details. The fact that there is such widespread financial illiteracy is a key reason society is so dysfunctional.

kderbyma 4y ago
I would hazard a guess that it has been intentionally muddied, made confusing, opaque, and left til the last minute for a reason.....interest rates and credit scores.
- college_physics 4y ago
  I don't think its intentional (the overlords?) but it is an unjustifiable gap for any society that considers itself democratic. Its not just the broad unwashed masses. Essentially outside a tiny number of central banking economists the rest of the world has still "flat Earth" level understanding of how monetary systems work, the role of private banks and, crucially, what alternatives there might be and pros/cons. Efforts for financial literacy, to the extend they exist, are inadequate and incomplete, essentially manuals for smoothing financial product consumption, not background knowledge on how and why these systems are setup. Its a fixable gap. Compared to the amount of complexity of material people are exposed to at different school levels, this stuff is really not that difficult.
  - danielmarkbruce 4y ago
    People have a flat earth understanding of many topics because they are complex and take a lot of work to understand. It would be nice if everyone understood the basics of human biology and health care - but it's incredibly complex. I'm a health care flat earther.... I might always be. Understanding the legal system would likely be more helpful to most than the financial system. But again, takes lot of work to get there. For most people, this stuff doesn't matter.
    - 4y ago

scotty79 4y ago

How much of "core money" lives as physical banknotes and how much is just electronic account balance of accounts that central bank has for private banks?

ryloric 4y ago
It's a elastic system, there's no fixed proportions like that and that is by design. What you call core money are Federal Reserve Notes(FRN), the other component that you call account balance is called Federal Reserve Credit(FRC), together they make up what's called Monetary Base or base money. Think of monetary base as level one fundamental money. FRN is not better or more "real" than FRC in in any way or vice versa, they're both exactly the same and controlled by the Fed. How much cash is in circulation changes depending on what the public wants, if they demand more cash then Fed decreases credit balance of banks and sends hard cash to their branches to satisfy the demand. If the opposite happens where the banks are holding too much cash, they deposit it back to Fed and fed increases their balance and reduces cash in circulation. In reality though, FRN is miniscule compared to FRC because the vast majority of transactions are settled digitally. Hard to believe now, but in 1913 one of the primary reasons for the Fed's creation was to provide an "elastic currency", which is provide notes to member banks when their customers demand 'hard cash'. The primary concern back then was if a bank failed to furnish cash when it's depositors asked for it, there was a real risk of a bank run driven by panic, even if the bank was in good shape.
- scotty79 4y ago
  Thank you for a very clear explanation. > In reality though, FRN is miniscule compared to FRC because the vast majority of transactions are settled digitally. I thought so. I'm just curious what is the usual FRN/(FRN+FRC) ratio.
  - ryloric 4y ago
    I think it's like 0.2-ish iirc. I remember during covid stimulus fed's assets were about 8Tn, and cash was about 1.5 Tn or something. Also worth noting vast portions of that cash is held outside America and not really 'circulated' like cash in your pocket is.

bArray 4y ago

I was literally reading this article just 4 hours before it was submitted to HN. It's a little concerning when my 'unique' search from 2014 isn't even unique. Some questions I am trying to answer: 1. What are the minimal reserves held by BoE (as %) and what do they currently hold. The same question for all the banks they have a contract with. 2. What is breakdown of the reserves? I.e. Foreign currency, gold, etc. 3. How have these numbers changed over time.

mmarq 4y ago
https://googlethatforyou.com?q=bank%20of%20englang%20balance%20sheet https://googlethatforyou.com?q=bank%20of%20englang%20balance...
- bArray 4y ago
  Thanks, but that only answers part of my question. I also want to see what the ratio is for contracted banks, it's no good if they outsource poor reserve ratios.

pier25 4y ago

So banks create money when lending? So banks get "infinitely" rich as long as people need to borrow money? And what's stopping anyone from opening a bank a do the same?

luxcem 4y ago
When someone repays their loan, the money does not go into the bank's accounts, it is destroyed. Only interest are effectively added to the bank credit. The bank does not get infinitely rich, because interests are used to pay bank employees, taxes, shareholders. It can get infinitely rich the same way any other company that makes profits can. What's stopping anyone from opening a bank is laws and regulations, you have to get a banking license from the government.

drbeast 4y ago

[dead]

_448 4y ago

Recently I watched this interesting video on how money is created: https://www.youtube.com/watch?v=iFDe5kUUyT0 https://www.youtube.com/watch?v=iFDe5kUUyT0

deleted 4y ago

[deleted]

danielmarkbruce 4y ago

This article is pretty bad. In theory, in aggregate, it's sort of right. But it doesn't track the flow of what happens after that loan is made, it doesn't discuss how credit spends just like money (ie, anyone can create "money" depending on how you define it), and it doesn't discuss capital requirements (either from a reg perspective or a practical risk management perspective) other than a passing note. People/companies don't borrow money and then leave it in the bank which lent them the money. The money typically gets wired somewhere, and then the bank which "created money" has to actually have the money in their account with the central bank or have assets to give another bank so they'll give some of their central bank reserves. So, their description is true for a hot minute, then lacking. A bank can't just keep lending and lending. As for limits on lending, both for a specific bank and in aggregate - they don't discuss capital requirements or anything about Basel III... It's mentioned in passing with a reference to another paper, as though it's a minor detail. It isn't. The limit on lending could be the limit they lay out... but in practice the capital requirements mean that the amount of lending is severely constrained, both in quantity and the types of loans and the types of customers. Just look at a balance sheet of an actual bank... (like https://www.sec.gov/ix?doc=/Archives/edgar/data/72971/000007297122000205/wfc-20220930.htm https://www.sec.gov/ix?doc=/Archives/edgar/data/72971/000007... , page 62). Using the BOE paper you'd assume there are banks levered 1000-1. There are not.