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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
by 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 agoUnless 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 agoThat’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 agoI’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.
- simple-thoughts 4y agoThis starts to get outside the scope of the article, but it is not true that USD central authorities fully or even majority control the money supply through regulation. You can create a bank in UAE or many other jurisdictions with a local license that allows you to deal in USD completely outside the jurisdiction of US enforcement agencies. Even within the jurisdiction of US agencies, there is a shadow banking ecosystem that is poorly understood and highly illegible. Most USD are not created within the jurisdiction of US authorities because USD is an international trade and reserve currency.
- jljljl 4y agoBanks are regulated and restricted, but any entity who lends money would technically create money. Individuals are rarely at a size where they can do this, but hedge funds and insurance companies are.
- jljljl 4y agoI'm not sure this is correct -- a bank could create money by issuing loans without needing a central bank account. The central bank account provides banks with extra liquidity, but it isn't required to create deposits.
- brutusborn 4y agoWhen a bank without a fed account gives a loan without a deposit, where does it the money come from? How would this even work?
- billfruit 4y agoI this case the bank is making a bet that the loanees, and depositors won't all ask withdrawals at the same point of time. If they all did, it becomes a run on the bank and it will fail.
- jljljl 4y agoWhen a bank creates a loan, it also creates a deposit. Say they make a loan to Bob: Loan -- an asset on the Bank's balance sheet. It's a promise that Bob will repay the bank a certain amount of money, plus interest Deposit -- a liability on the Bank's balance sheet. It's an account that Bob can draw from at any time, and the Bank will promise to honor or pay the deposit. These are created at the same time, and balance one another. The bank does not need the Fed to create the deposit at all, the create it out of thin air when issuing the loan. When Bob comes to withdraw from his account, the Bank will pay him from it's *reserves*. The banks reserves are a pool of assets, cash, and deposits from other customers that the bank holds in excess of it's loans. The bank can get these from a lot of places, not necessarily the Fed -- they could offer checking accounts to other customers, and hold some fraction of the assets in a customer's checking account in reserve. Banks offer all sorts of incentives to get people to deposit long term(CD, Savings Accounts, e.g.) for this reason, but they almost never have 100% of the money they are loaning out held in reserves. Their entire bet is that only a fraction of the deposits will be withdrawn at any time. The Fed doesn't need to be present for any of this, but they provide an important stabilizing function, ensure liquidity, and can adjust the money supply through open market operations or banking regulations.