Not true. The Fed can create money without USG bonds. It can buy corporate private sector debt (as it has recently with securitized loans) or it could buy any other asset or goods or servies. No. Only about 15% of the USG debt outstanding is owed to the Fed. They govt could repay 85% of its outstanding loans and it wouldn't affect the money supply. I'm not sure what this represents -- the Govt is the Fed govt budget. Foreign is the trade balance? Private is what?
Not really, calling it "loanable funds theory" can describe more than just FRB, but FRB is fine. If a bank can "dip into its reserves temporarily", how are reserves in any way a constraint on lending? Let's get back to this because you ask some other questions below and I don't want to be redundant. First, let's be clear what we mean, clean up the terminology: Commercial bank reserves come in two forms. One of these forms is the physical cash held by banks in their vaults (and their ATM machines, tellers drawers etc.) The second form of commercial bank reserves consists in the deposit balances held by commercial banks at the central bank. Physical cash reserves are held by banks to satisfy their depositors demand for cash withdrawals. Reserve balances at the central bank, on the other hand, are used to make payments to other businesses that have their own Fed accounts primarily other banks. The term "reserve" can be misleading as the terminology suggests that reserves are held as a backup to some unforeseen circumstance. Bank runs for instance. Indeed, even Investopidia makes this mistake when describing "reserves". So here lies the disconnect. 1) Customer deposits are bank reserves 2) Banks do not loan out reserves. More reading on the topic from Forbes Federal Reserve banks (again, here I've been sloppy with terminology, because what I'm saying is only true within the Federal Reserve System, of which most banks belong) create money out of thin air (the liability) and the promise to repay (the contract you sign to obtain the loan, is the asset). This is why loans docs are called "promissory notes". "loan" is a colloquial term we use, but technically, only non-banks, credit unions and other non-Fed backed entities make "loans", because they must lend money they obtained beforehand. So the term loan is an interchangeable term that can lead to some technical confusion. If you bought your car or your house from a Fed member bank, check out the docs. It's called a "Prommisory "Note" or just "Note", not "loan", but yes we in common terminology, call them "loans". If I take a $10k loan, the bank creates $10k out of thin air and marks up my account by $10 by typing in numbers on a keyboard. At the end of the day (but no more than a few days) The bank moves $1000 in "excess reserves" (at the Fed) to another account called "required reserves" at the Fed. You are correct in saying that if the lending and depositing takes place in the same bank, nothing goes anywhere (except the funds are moved from the "excess reserves" to the "required reserves" for the same bank at the Fed), but if the bank that lends is different than the bank that receives the deposit, the only thing transferred is the net difference in reserves between the two banks after they settle up at the end of the day and all of that takes place at the Fed. Reserves never leave the banking system, with the exception of physical cash which simply exchanges one safe asset (reserves) for another (cash). It would make no difference whatsoever to a bank's ability to lend. Only the Fed can reduce the amount of base money (cash + reserves) in circulation. Moving on.... QE failed to create any inflation (and was largely a failure of policy, because reserves aren't lent and the idea that creating reserves would increase lending was a failure to understand our system of money). Today there are over $2 trillion dollars of excess reserves, but banks don't lend reserves, they use reserves to meet reserve requirements. Now this leads into another conversation about paying interest on excess reserves, which we can have if you like, but it really has nothing to do with what we're talking about here as paying interest on excess reserves is really just about setting an interest rate floor.... Excellent....Agreed. The physical cash resides in a bank's vault, but the electronic portion of the reserve balance resides at the Central bank (Fed). Yes, as I described Yes, base money is cash + reserves. You should have read the articles I posted for you, it's all explain there. No banks do not lend out reserves. Not in the way I think you're claiming. Reserves in the US system are simply a mechanism to control interest rates. Since 2008 that's been totally mucked up because the banking system is drowning in excess reserves, which is why the Fed is paying interest on excess reserves as a way to move the target rate above zero. Agreed. No, the lending bank, assuming it does not have the excess reserves to cover the loan in question, must acquire the reserves through the interbank lending system (or the Fed which you rightly point out does not happen often for the reasons you cite). Again, no...This is not what limits a bank's lending. A banks ability to lend is constrained only by (in order of importance): 1) Finding credit-worthy borrowers 2) The amount of capital it has on hand and desires/ can legally risk 3) Regulations My hometown bank cannot make a $1 trillion dollar loan, not because it can't acquire the required reserves, we've already established the fact that a bank can always find the reserves it needs, even if it has to go to the Fed as the last resort. No, even if a bank finds a creditworthy borrower who can borrow $1 trillion dollars, the banks capital account must have the required capital to secure the loans it makes. that is, in the event of a default, a bank's solvency is determined by measuring the value of its capital against a number of its liabilities. To my knowledge, a bank could not exceed the value of its capital account by that much. I suspect that's part of what happened in 2008 where banks were leveraging their risk 40/1 (1 being the banks capital), so that when they failed, they were 40 times to short in their capital. Hence the change in capital requirements post 2008. Check out. Lending is capital- not reserve-constrained Prior to 1971 banks had to have reserves on hand. Reserves at the time were lent as you say, thus if too much money was held outside the banking system or abroad, banks would be unable to lend until there were more deposits in the system. Today banks are not constrained by the amount of money they hold in their reserve accounts as they were prior to 1971. They can make loans and know that the loans they make will eventually end up in the system creating many times the amount needed to create the required reserves for any given loan. Yes As I said, this is not the way it works. The money the borrower gets from the bank is not from the lender's reserves, it is created out of thin air secured by the loan contract the borrower now holds. Reserves are transferred in the background only as a way (prior to 2008 ) to manipulate interest rates. Again, you are correct, except there is a transfer, at the Fed, between that bank's excess and required reserve accounts. Agreed, but remember that when a borrower deposits money into another bank, that other bank adds the deposits to its "reserve account". However, in the aggragate across the entire Federal Reserve System no new net reserves are created because the lending bank has a liability equal to the amount borrowed. When the borrower repays, the asset and the liability cancel each other out. In the event a borrower fails to repay, would that add money to the system? No, because the bank that made the loan would have to repay it from it's capital account. Capital accounts are part of base money. So a defaulted loan adds to base money but is canceled out immediately once the bank that holds the bad loan uses it's capital account to "write off" the debt. If a bank makes too many bad loans and if forced to used too much capital (usually investor money) a banks liabilities will axceed it's capital and the bank is question is insolvent. Agreed, see above Again I think I've explained this. Read the article I posted about banking constraints. You don't understand the difference between Capital and Reserve constrains. You're literally mixing them up. Quite correct This is going back to something else I said and after this conversation is stripped of all context. If we can agree that GDP is an aggregate of spending (put simply). If GDP is $20 trillion and there are less than $20 trillion dollars circulating in the economy, than some of those dollars must have changed hands more than 1 time. Thus if you remove a dollar you are potentially removing its value times the number of times the dollar changes hands (in the aggregate). So if there is $10 in an economy with a GDP of $20, each dollar changes hands 2 times. If you remove 2 dollars, you expect GDP to fall to 16, not 18, because each dollar is passing through 2 hands. That was my point. With all due respect my friend, based on your responses, I assure you, you have not.
Yes, you are correct, the Fed can create money without gov assets, but it cannot "spend" it into the private sector it can only lend it or purchase assets. Thus all transfers are, because of double entry accounting cancel each other out. The Fed, to my knowledge, cannot purchase goods and services unless it's doing it on behalf of the US Congress or those purchases are part of it's "cost of doing business" as the Fed, but the Fed can't purchase food to feed the poor. In other words, if the Fed creates dollars and purchases corporate debt, as it did during QE, this is nothing more than an asset transfer. Corporations hold dollars created by the Fed, but still, have an equal liability in the bonds they sold. Only the US government can create "high powered money" in that the debt it creates it can maintain indefinitely. The Fed, for all the assets it purchased, is now selling off those assets, assets which have appreciated greatly. So the fed sells bank bonds it acquired after 2008 as a way to push liquidity into the system, is now removing liquidity when it sells those same assets. Because the Fed does not spend its profits, 94% are given back to the Treasury. Which, if you've followed what I'm saying, doesn't do anything to increases the government's spending power. Again, with all due respect, you simply don't understand how money enters the economy and as a result, you're not understanding how the government repays. If the government must tax in order to collect revenue, if it uses the tax to repay bond debt that was use to justify the creation fo dollars, the two cancel out. There is no money left. You are confusing Fed and Treasury operations. The red line is government deficit/ surplus for each year. The Green line is the increase/ decrease in assets relative to the government's deficits. The blue like in the foreign sectors increase/ decrease in assets relative to government deficit. The point is, as government deficit increase the private and foreign sectors assets increase.
This is getting really long and some of what I'm saying rests on other ideas. Let's take you claim that the Fed creates money, not the government. The explanation has to start with banks. Do you accept my claim and the article that I posted to lend evidence to that claim, that banks are not reserve constrained, they are capital constrained? If you can't be bothered to read it and understand it or tell me why you think it's wrong, then we're not really having a discussion, you're just making claims and ignoring the evidence, which is fine, that's your call, but if that's the case I'll leave this all right here and scincerly thank you for the time you took discussing this with me. Conversations like these help me in trying to understand how best to explain these ideas. Obviously in your case, I'm either wrong, or I'm doing a poor job trying to explain why I'm right.
When I say the government creates money via spending, you do realize that the Treasury spends money by marking up the accounts of the comapnies and indivituals it does business with, right? All the money that's greater than what it taxes is new money entering the economy. Right?
Because "temporary means just that." They have to meet their loan reserves regularly. It may be by the end of the day, but I'm not certain of that. Let's get back to this because you ask some other questions below and I don't want to be redundant. Is any of this inconsistent with anything I've said? It affirms what I said. Again you are being sloppy. As I've pointed out the word "money" can mean many different things. Exactly what kind of money are you talking about here? Are you (as I think) talking about deposit account balances? Then that is accurate. Are you talking about "base money" (i.e. reserves)? If so your statement is inaccurate. It is necessary to be precise when discussing this stuff. Loose use of ambiguous words like "money" is what causes a lot of confusion in people. And why wouldn't a loan by a not FR member bank (i.e. a state chartered bank) not expand deposits the same way as a FR member bank does? It works the same way for all depository institutions that create deposit accounts. No, it has nothing to do with whether the bank is a FR member bank. "Promissory Note" is a legal term which describes and instrument where the maker of the note is promising to pay it, based on certain conditions. Again, be precise. What does "creates $10k" actually mean? Are you saying the bank prints $10k in cash? No it does not. Are you saying the bank creates $10k in reserves, which is the same as cash? No it does not. Does it create an increase in a deposit account of $10k? Yes, that is what it does. Right. And if the only transaction involving the two banks is the one loan, the lender bank would transfer reserves to the payee's bank. Which is the constraint on lending. If the lending bank does not have the reserves to transfer to the payee bank (and still have the required reserves) it is now in violation of banking regs, or worse. Correct. Only the Fed can reduce, or increase the amount of base money in the system. When banks lend, they are increasing the amount of deposit accounts -- not the amount of reserves. That is true -- a combination of being gun shy from getting burned in the recession, slower economic activity and money velocity,and greater regulations have meant that banks have not lent out to their reserve limit, as they commonly do when the economy is more robust. Agreed. Same as you just quoted above. Right. I scanned them and read the relevant sections. You should read the my post, it's all explain there. Banks do not "lend out" reserves if the borrower has an account with the lending bank (as in the examples your articles used). However, the bank must have the reserves to transfer upon the borrower spending the loan proceeds. You're going backwards! We already defined "reserves": "Commercial bank reserves come in two forms. One of these forms is the physical cash held by banks in their vaults (and their ATM machines, tellers’ drawers etc.) The second form of commercial bank reserves consists in the deposit balances held by commercial banks at the central bank. Reserve affect interest rates because, like anything else, supply and demand affects price. Interest rates are so low in part because the Fed has flooded the money system with reserves to keep interest rates low. Agreed. OK, key point to understand here, we seem to not be connecting on the basics. When I make a payment, whether by withdrawing cash from my deposit account, or writing a check or wire transferring the money, what happens is my account an my bank is debited, my bank's reserves are transferred to the payee's bank (or given to me in cash which is then given to the payee and deposited in the payee's bank and adds to its reserves) and the payee's account is credited at his bank. Do you dispute this account? It is fundamental to understanding how lending works -- and the point often missed by those claiming lending requires no reserves. Of course it does. If a bank lends $100,000, it better have (or get the ability to have) the reserves to transfer to the ultimate payees bank. Why is the creditworthiness a constraint? Under you scenario, if a borrower defaults, so what? If the bank created the money out of "thin air" so what if there is a default on the loan? Why would that hurt that bank? Whoa! You're adding a new term here. Exactly what is "capital" and if a bank can just create money out of thin air, why would the bank's capital be at risk and why would it matter the amount it has on hand? Yes, the reserve requirement is a regulation that limits what a bank can lend. But you are denying this. Are there other specific regulations you are referring to? What, and how to they limit lending capacity. No, the Fed isn't going to let your hometown bank borrow a $trillion from the Fed discount window. Background The discount window helps to relieve liquidity strains for individual depository institutions and for the banking system as a whole by providing a reliable backup source of funding. Much of the statutory framework that governs lending to depository institutions is contained in section 10B of the Federal Reserve Act. The general policies that govern discount window lending are set forth in the Federal Reserve's Regulation A. As described in more detail below, depository institutions have access to three types of discount window credit--primary credit, secondary credit, and seasonal credit. All discount window loans must be collateralized to the satisfaction of the lending Reserve Bank. https://www.frbdiscountwindow.org/en/Pages/General-Information/The-Discount-Window.aspx So unless your hometown bank has a trillion in collateral it can put up for the Fed, its S.O.L. That page also explains other discount window lending restrictions that explain why it isn't a source of endless funding as you seem to think it is. Yes, a bank's capital also imposes regulatory restrictions on it. "Reserve requirements place not such limit on lending for reasons I have explained often. Commercial banks hold reserve accounts at the central bank for the sole purpose of facilitating the payments system (clearing house). Many countries have no reserve requirements other than the accounts must not be in the red on a sustained basis. The US is currently considering eliminating the positive requirements. This is what I've said. The banks need the reserves to pay for the loan proceeds. The loan doesn't require reserves (if the borrower has an account at the lending bank). But the bank needs reserves to transfer to the payee bank of the payee who receives the loan proceeds from the borrower. Yet in describing what happens in a loan, this guy (like others you've relied on) says nothing about the bank needing the reserves to cover the application of the loan proceeds by transferring reserves to the payee's bank. Here's what he says about a bank meeting its required reserves: They can borrow from each other in the interbank market but if the system overall is short of reserves these horizontal transactions will not add the required reserves. In these cases, the bank will sell bonds back to the central bank or borrow outright through the device called the “discount window”. There is typically a penalty for using this source of funds. At the individual bank level, certainly the “price of reserves” may play some role in the credit department’s decision to loan funds. But the reserve position per se will not matter. So as long as the margin between the return on the loan and the rate they would have to borrow from the central bank through the discount window is sufficient, the bank will lend. He acts like the Fed discount window is some kind of long term funding agency that can support banks making loans well beyond their reserve capability. We know that is not true from the Fed's own website. You are not reading my posts, and assuming. Where did I say "reserves are lent"? Please re-read my posts as I have never said that! Wait, you earlier agree that only the Fed creates reserves, and bank lending does not. Now you are arguing that "he loans they make will eventually end up in the system creating many times the amount needed to create the required reserves ..." You are being inconsistent. Bank lending does not create reserves. If you dispute that we need to go back a few posts. If you do not dispute it you need to clarify your position. Yes As I said, this is not the way it works. The money the borrower gets from the bank is not from the lender's reserves, it is created out of thin air secured by the loan contract the borrower now holds. [/quote] Please re-read what I wrote. I did not say the money (there you go being sloppy again -- what "money" does the borrower get?) the borrower gets from the bank is from the lender's reserves. What I said was: The lending bank uses its reserves to transfer to the payee's bank for the payee's account. The payee will deposit the payment received into his account, increasing the payee bank's reserves. This is true whether the borrower take the loan proceeds as actual cash or writes a check or executes a wire. If he takes cash and pays cash to the payee who deposits it in his bank, the lending bank's reserves are reduced by the amount of the loan proceeds, and the payee bank's reserves are increased accordingly. The same exact same thing happens with a check payment or wire transfer, except they use electronic forms of money, or a bank's deposits at the Fed. The lending bank's account is debited and the payee bank's account is credited. It's explained in basic language but in detail here: http://www.rayservers.com/images/ModernMoneyMechanics.pdf Explain exactly how you think "reserves are transferred in the background" to manipulate interest rates. Who do you claim transfers them? What triggers the transfer? How does this manipulate interest rates? And if the bank doesn't have excess reserve, it's a problem because no they need more reserves. That is true, but we are not talking about the aggregate. We are talking about how much an individual bank can lend. That is not true. Capital accounts may be made up in part of base money, but they are not part of base money. Base money are reserves, which is cash (in the vault) and cash equivalent bank deposits on account at the Fed. We've already been through this. What? Explain how "a defaulted loan adds to base money" or to reserves. Why does it have to use its capital account to "write off" a loan created out of thin air? You're not making any sense now. Why does the bank that created money out of thin air have to repay it? That doesn't sound like "thin air". So apparently when a bank makes a loan its not creating "money" out of thin air, is it? How am I mixing them up? OK, but in this sense, what is changing is not the real value of what is produced, but the dollar value. If you remove $2 dollars, GDP falls to 16, but it is still $20 in "real" terms. Similar things. I've heard the argument before. It always comes down to the same thing. The loan transaction is examined by the effect of the loan proceeds being spent is ignored.
Not sure I understand. The Fed creates base money out of thin air. It can buy a private debt (or asset) and then it gives that newly created money to the seller/loaner. What is cancelled out? Well, I'm not certain of the law exactly and I'm not going to look it up. Suffice for our discussion to say that theoretically there is no reason the Fed cannot distribute newly created money in this manner. It does not require Govt debt. On the balance sheet. But now money is introduced into the system. The corporation takes the dollars and deposits them in a bank. Now the bank lends out money, and viola. You have money without Govt bonds. I never asserted that the Fed increases the Govt spending power, at least directly. Indirectly, because it primarily buys Govt bonds, it creates some demand for them. But only to a limited extent. I think not. Yes, if at some point the Govt paid down all of its debt, then Fed would have to use some other vehicle to distribute money into the system (like corporate bonds). But since the Fed hold only about 15% of outstanding Govt debt, there is a lot of debt the Govt can pay down before it starts affecting the money supply. No, you are. The Fed creates and destroys base money. Not the Govt. Well OK. If the Govt borrows, that represents an increase in assets in the private sector (people holding USG bonds). So what?
It started with your first post! You already agreed the Fed created base money. Why? No, for the reasons I have stated. I've read the relevant parts and explained why they are not telling you the whole picture. I've showed you were even your articles agreed the lending bank has to get reserves. I've showed you the error where they seem to believe banks regularly walk up to the Fed discount window to get long term funding for loans, and I've shown you the Fed itself saying that is wrong. Why don't you show me in those articles where they explain what happens after the loan is made that the borrower writes a check on the loan proceeds to buy a car? None of your articles talk about that. That is that part they are missing.
I've asked you to explain how it is new money and you either missed it or failed ot respond or didn't get to it: USG spending creates no money. If it borrows money, it gets the money from a lender and then spends it. What money has been created? If it taxes the money, it gets the money from a taxpayer and then spends it. What money has been created? When the government borrows money, it (through a broker which are the primary dealers) gets money from the entity that ultimately buys the debt. The money goes from the buyer to the Govt (through the broker). The Govt then takes that money and spends it back into the economy. Where is the money creation happening? You just have a transfer from the ultimate buyer of the debt to the Govt and then back to whomever the Govt spends it on. There is no new money creation. They only way money creation happens is if a bank buys and holds the USG debt (which is only 2-4% of outstanding debt) in which case, like any other loan, additional deposit accounts are created. Or, if the Fed eventually buys (through a broker) the USG debt (which is may 10-15% of outstanding debt) then new base money is created. But it is not the USG borrowing, but either a depository insitution or the Fed buying the debt, that creates the new "money" (either in the form of additional deposit accounts or new base money).
Edit to the sentence above in bold. It is only bank loans that create new "money" in the form of increased deposit account balances.
Iriemon, I'd like to say I've thoroughly enjoyed this discussion. It's been a long time since I've been this deep in the weeds on the mechanics of banking. I realize that I have confused a few things, specifically deposits and reserves. I was thinking of cash deposits, which are added to a banks reserves, but other types of deposits are the banks liabilities and belong on the other side of the balance sheet, but are still used to offset the need for additional reserves. I believe my overall point is still correct with respect to the "money multiplier theory". That idea rests on the idea that banks lend deposits, but we'll get back to that as I review in my own time so we can discuss without the confusion.... In the meantime, let's see if we can keep the conversation going. I'll address some of you're other points, but try to do it in smaller bites.... With that, here is my first response.... In light of everything that's been said, I'll ask a very simple question. Does the amount of reserves in the banking system determine the amount of loans that can be made? Or... Does the amount borrowed from banks determine the amount of reserves in the system?
It makes no difference as to whether a deposit is in hard cash or its electronic equivalent. Both will add to the bank's reserves. The exception is where a loan is made to a customer who has an account with the lending bank. In that instance, no reserves are added, and as you say, the deposit of the loan into the customer accounts creates a liability on the banks balances sheet (the deposit account) as well as an asset (the note receivable). But when the borrower spends the loan proceeds, the lending bank transfers reserves to the payee bank (unless the payee's bank happens to be the same bank as the lending bank). I've never claimed that a bank "lends" deposits. In the meantime, let's see if we can keep the covnersation going. I'll address some of you're other points, but try to do it in smaller bites.... With that, here is my first response.... No so simple, but ultimately, yes, it will create an overall limit on aggregate loans when there is a reserve requirement. If there are, for example, $1000 in reserves in the banking system with a 10% reserve requirement for banks, the bank with the initial $1000 in reserves can loan $900. The payee bank that receives the $900 deposit from the payee can lend $810 and so on. The theoretical loan limit will be $9000. No. As we have already agreed, lending does not affect the overall amount of reserves in the system. The only way reserves can be increased is by the Fed creating new reserves.
The exception is where a loan is made to a customer who has an account with the lending bank. In that instance, no reserves are added, and as you say, the deposit of the loan into the customer accounts creates a liability on the bank's balances sheet (the deposit account) as well as an asset (the note receivable).[/quote] Ok so we agree that if Joe borrowed $100 from his bank, it would look like this: And now that the loan is approved and the $100 is deposited in Joe's account at the same bank. Whew...Agreed. That's what "Fractional Reserve Banking" is. The idea that when depositors deposit money the bank holds a fraction of it and lends the rest. http://www.investopedia.com/terms/f/fractionalreservebanking.asp Interesting.... Ok, so I think we might have identified another disconnect, maybe? Your explanation assumes that the interest rate is allowed to rise on its own, but that's not how the banking sector works. The Fed manipulates reserve levels to achieve a target rate (at least until 2008 ). If the CB sets a target rate, then we can agree that it will add or remove reserves in order to "defend" that rate, correct? (again, this is pre-2008 rules and assuming the Fed returns to this system after it removes the excess reserves from the banking system over the next 3-5 years). Today with so many excess reserves the rate should be zero if it weren't for the Fed paying interest on excess reserves. If that's true and borrowers in the aggregate wish to borrow, then, without injections of new reserves from the CB interest rates will rise. Assuming the CB wishes to maintain it's rate (and historically it does), whatever the rate is, it will automatically add reserves to the system, thus it's not the amount of reserves that determine the amount that can be borrowed, but the other way around. It is the amount that's borrowed that determines the level of reserves at any given level of interest. It is the change in rates which is meant to encourage or discourage lending, not the level of reserves. Thus it's the decision to change the interest rate that causes the level of reserves to change, not the level of reserves that causes the interest rate to change.
Right, until Joe takes the loan proceeds and buys a car or whatever he took the loan out for. People don't borrow money just to have it sit in their account and pay interest on it. We had agreed to that earlier. It a bit semantics and taking short cuts that lead to confusion. Banks don't actually "lend deposits." I'm not sure how you get from my post to me assuming that the interest rate is allowed to rise on its own. How does my post "assume" that? The Fed sets a target for certain interest rates and uses various mechanisms to achieve it, which are ultimately affect by supply and demand. What does that have to do with the reserve requirement setting a limitation on aggregate loans?
If reserves are the true constraint on lending as you claim, then as the level of excess reserves decreased the interest rate would rise because there are fewer availible reserves. You already said this. So if the interest rate is to stay the same, then the CB must add reserves in order to maintain the rate which contradicts your claim that, practically speaking, lending is constrained by the level of reserves. You said: No, it won't because the Fed will add reserves to defend what ever rate it's set. So the reserve requirement has no effect on the amount of loans in the aggregate. So if there are $1000 in reserves and the interest rate is 5%, then if the number of borrowers increases, the amount of excess reserves will decline putting upward pressure on the rate. The Fed, assuming it wished to maintain it's rate of 5%, would add reserves until the banking sector felt 5% was a fair price given the level of reserves. As I already said, creditworthy borrowers are the true constraint. Once you run out of people that can take loans under whatever rules and regulations that are in place, that is when banks will have trouble finding new borrowers not when banks run out of reserves because banks won't run out of reserves.
I don't think I said anything about interest rates and reserves. Interest rates may rise or not, depending on demand for credit. That assumes that 1) there is demand for credit which causes the interest rate to rise; and 2) the CB wants interest rates to remain low. I agree that when you reach the practical level of lending potential, more loan activity is desirable, the CB would need to introduce more money into the money supply. But that fact doesn't contradict my claim at all. To the contrary, it supports it. The fact that interest rates may raise as lending capacity is reached demonstrates that reserves are a constraint. If reserves were not a constraint, then banks could continuing lending indefinitely and there would be no need to ever expand the money supply. In fact, the Fed may not want to maintain a lower interest rate, for example, if the economy is overheating and there are signs of inflation. The fact that the Fed may add reserves isn't an argument that reserves will not constrain lending. Again, to the contrary, it demonstrates that they do. Depends on the circumstances. In a situation we are in now, where banks are gun shy and there is a plethora of excess reserves, then the reserve limitation is not what is constraining banks from lending. But that doesn't mean that they never can.
How is it semantics when Fractional Reserve banking and the money multipler are defined as lending deposits? Now I'm not trying to back you into a corner and say that you believe something you don't, I simply want to point out, that you don't believe (based on what you've said) that FRB is a valid explanation for how banks lend, whether you realize it or not.
So what is the best way to finance a win, win, win , win version of the USA - Mexico Wall that would turn some USA and Mexico desert land green and productive again? Should not any plan that is truly win, win, win be financed in such a way that it cost American taxpayers as little interest as possible? How about fixing up roads, railways and bridges all across America? http://www.politicalforum.com/opinion-polls/483090-what-do-you-think-my-alternative-wall-theory.html What do you think of my Alternative Wall Theory? An alternative wall..... to The Donald's Mexico - USA wall would include...... a massive ocean water desalination facility plus....... a huge fish farm.... that extends along much of the alternative wall......... infinite financing for the project will be made possible once we humans line up our valuation of human life..... and all life..... more so along the line of how the being of light of NDE fame views life.......... (Did you know that ONE nation has experienced COOLING IN ITS CLIMATE SINCE 1950)? That same nation led the world, on a per capita basis in planting trees and in desalination of ocean water for agriculture, reforestation projects and for towns experiencing drought. You got it.....ISRAEL! You can find this out by Googling Global Dimming
During the time of USA Civil War President Lincoln made a significant improvement in the way money entered the economy. Here in Canada in 1940 P. M. Mackenzie King initiated an excellent monetary policy that worked extremely well for 34 years. We seem to have to realize that we are facing a crisis before the political will is there to make positive changes in central banking policy....... or direction. http://www.politicalforum.com/polit...t-work-fast-enough-address-wais-collapse.html A carbon tax will NOT work fast enough to address WAIS collapse. A tax on carbon will take centuries to address the real issues associated with the impending collapse of the West Antarctic Ice Sheet! http://www.sciencemag.org/news/2015...antarctic-ice-sheet-raise-sea-levels-3-meters Just a nudge could collapse West Antarctic Ice Sheet, raise sea levels 3 meters We need to be researching and discussing options that can work much faster! Every cubic meter of ocean water that is desalinated and added to the water table of North Africa or Qatar of Jordan or Israel...... will NOT be putting pressure on the oceans to overflow New Orleans, Bangladesh, The Netherlands and parts of Florida! Japanese engineers don't merely design good cars! http://www.ssb-foundation.com Sahara Solar Breeder Foundation Yes... I believe that financing a large scale demonstration of The Sahara Solar Breeder Foundation and / or the Sahara Forest Project will be a more effective response to climate change than a carbon tax.
I've explained how lending works and increases deposits, did you not read my posts? I don't know who is saying that fractional reserve banking means banks "lend deposits" but it wasn't me. Wherever you got that from is either a) ignorant of how the system works, or b) using shorthand language to describe something more complex. If you have an issue with "lend deposits" take it up with whoever is saying it. I'm not here to defend phantasms. Also, I never said that "FRB is a valid explanation for how banks lend". I've explained how banks lend. Fractional reserve banking is a system whereby banks can lend the "base" money they as a fraction of their deposits which creates new deposit accounts when the payee of the loan proceeds deposits the lent money in another bank (or if the borrower does not have an account with the lender bank) creating new deposits, enabling the payee bank to lend a faction of the "base" money it obtained in the transaction. What I've said is that the reserve system creates a limit on how much banks can lend out, because, effectively, if the bank doesn't have the reserves - i.e. base money, it can't make a loan. It can do an accounting creation of a deposit but when the loan proceeds are spent the bank must have the reserves to cover the transaction. The bank must be able to fund the loan. Respectfully, you have demonstrated with repeated, inaccurate, and sloppy use of terms and words, that you're understanding of how banking works is misinformed. You've looked at sources that have only partially, or sloppily, or inaccurately described the process and made conclusions based on phrases and terminology that you don't fully understand, or misunderstand. You misunderstanding is belied by your inconsistent positions (e.g. you've said banks don't create reserves, and then said that bank lending creates reserves) and tacit acknowledgment that reserves do indeed limit lending (e.g. your acknowledgement that the Fed needs to create more reserves to sustain lending growth). You seem have this crazy idea that any little podunk bank can magically create any amount of money to lend. Your position is believe by inherent contradiction. If that were the case you'd have the Corner Bank of 3d Street Omaha competing with JP Morgan on hundred million dollar loans. You claim a bank can create money out of "thin air" but then agree that if its loan goes bad its in trouble. Throughout our discussion, I have addressed every one of your questions. But you have repeatedly ignored mine when I ask something that probes you belief just a bit. If you want to carry on this discussion, why don't you address some of my questions you've dodged? The fact that you've avoided addressing these questions demonstrates you cannot defend the inherent inconsistency in your misunderstanding. +++ OK, key point to understand here, we seem to not be connecting on the basics. When I make a payment, whether by withdrawing cash from my deposit account, or writing a check or wire transferring the money, what happens is my account an my bank is debited, my bank's reserves are transferred to the payee's bank (or given to me in cash which is then given to the payee and deposited in the payee's bank and adds to its reserves) and the payee's account is credited at his bank. Do you dispute this account? It is fundamental to understanding how lending works -- and the point often missed by those claiming lending requires no reserves. +++ It is consistent with what I've said. But when a loan is made, even if the bank does not need immediately the reserves to credit the deposit, it must have the reserves to fund the use of the loan proceeds. Otherwise a bank with $1000 in reserves could make a trillion dollar loan. You're not suggesting that, are you? +++ "Federal Reserve banks (again, here I've been sloppy with terminology, because what I'm saying is only true within the Federal Reserve System, of which most banks belong) create money out of thin air (the liability) and the promise to repay (the contract you sign to obtain the loan, is the asset). " Again you are being sloppy. As I've pointed out the word "money" can mean many different things. Exactly what kind of money are you talking about here? Are you (as I think) talking about deposit account balances? Then that is accurate. Are you talking about "base money" (i.e. reserves)? If so your statement is inaccurate. +++ Whoa! You're adding a new term here. Exactly what is "capital" and if a bank can just create money out of thin air, why would the bank's capital be at risk and why would it matter the amount it has on hand? +++ What? Explain how "a defaulted loan adds to base money" or to reserves. +++ Why does the bank that created money out of thin air have to repay it? That doesn't sound like "thin air". So apparently when a bank makes a loan its not creating "money" out of thin air, is it? +++ +++ So you're claiming that the 3 trillion in tax revenues the Govt collects are simply destroyed? The Govt collects $3 trillion in taxes, borrows $0.7 trillion, and spends $3.7 trillion. If the $3 trillion is destroyed, where is the Govt getting the other $3 trillion that it spends? +++ USG spending creates no money. If it borrows money, it gets the money from a lender and then spends it. What money has been created? If it taxes the money, it gets the money from a taxpayer and then spends it. What money has been created?
A little sample of your misunderstanding here. You cite this link claiming it says banks "lend deposits". Here's what it actually says: What is 'Fractional Reserve Banking' Fractional reserve banking is a banking system in which only a fraction of bank deposits are backed by actual cash on hand and are available for withdrawal. This is done to expand the economy by freeing up capital that can be loaned out to other parties. Many U.S. banks were forced to shut down during the Great Depression because too many people attempted to withdraw assets at the same time. Note, it does not say that banks "lend reserves." It says "only a fraction of bank deposits are backed by actual cash." You are superimposing your own misimpressions onto what is actually stated. Something you've done with me several times as well.
Econ4Every1, I deeply appreciate your commenting on this discussion. I've discussed some aspects of this subject, with a number of teachers here in Nova Scotia and they are surprised to learn of the rather amazing shift that took place here in Canada between 1940 to 1975. At this time Nova Scotia teachers are a highly motivated audience because they are in the middle of a "Work to Rule" situation that could easily turn into a full fledged strike. I am no economist, just a cleaner at a school, and I am so glad to have your help in putting some better information in front of teachers at a level that I simply cannot do myself. ...... To address this particular question, I personally would tend to not want to argue too strongly against those words, because I suppose the person making that statement may intend to say that the full amount loaned out by a bank, to some degree is related to the total assets of that bank. This seems to be significantly valid....... isn't it? http://www.politicalforum.com/canad...ate-teachers-nova-scotia-liberal-party-2.html Thread: Subject: Government Update on Teachers (Nova Scotia Liberal Party)
Iremon.... I hope you don't mind my bolding and enlarging one sentence in your reply.... For several years now I have been thinking that Credit Unions here in Canada, especially the largest Credit Unions that back up many smaller local credit unions, may be in a position to now compete with some much larger banks and alter the situation here in Canada. What I mean by this is....... let's say that the government of Nova Scotia is figuring out how to finance a significant amount of building of new schools. They know that certain banks will loan them the money at a certain percentage of interest but........ L..... S...... And M......., (one of the largest Credit Unions, almost a Central Credit Union, from what I have read).... is now in a position to shave perhaps a full percentage point... maybe two points off the rate offered by another lending institution due to the basic Credit Union charter that..... ... credit unions are technically out to do anything that will benefit credit union members..... and any proposal that could assist Nova Scotia's schools...... would be assisting credit union members, potentially thousand of them. So yes...... I am wondering of some of the largest Canadian credit unions are now in a position to compete at a much higher level...... and attempt to save the provincial government of Nova Scotia millions of dollars in interest payments..... Are you willing to get into this topic because I believe that it could easily be reworded to fit with the situation faced in many USA states?
You didn't read or somehow didn't understand what I said. I'm not claiming you are entirely ignorant on this topic, what I'm trying to tell you is that, by definition, Fractional Reserve Banking, is the idea that banks lend reserves to the general public. If you believe this, then your understanding of lending is wrong and I've cited several articles to back that up. If you know this and want to point out that banks lend reserves to other banks, you clearly don't understand the implications of what you're saying. Something I go into in more detail below. If you understand this, then I politly suggest you stop using the term "Fractional Reserve Banking" as it's undermining your credibility on the subject as it isn't an accurate description of how the banking system works. This idea is supported by the Bank of England (The Brits properly updated their academic texts in light of the changes of fiat currency) It's also supported by Paul Sheard, Chief Global Economist, and Head of Global Economics and Research, New York Standard and Poors (previously cited) Another Excellent articel by Matthew Kerkhoff Chief Investment Strategist at Model Investing Now I've given you four different authorities and cited the works from varying and unrelated backgrounds, from which I get my information. Not from personal blogs, not from conspiracy sites, but from recognized authorities on the subject. If you don't accept it, that's fine, but if you expect me other others in this forum to believe you because you said so, then you really need to reconsider why you are posting here at all. And I've tried to counter by explaining that banks will always have the reserves they need to fund loans because, as I said, banks don't lend reserves to customers, thus reserves never leave the banking system. How can the system run short of reserves if this is the case? (before you argue, read the works I've cited) As such, as people increase their borrowing, reserves increase as a response, automatically. The FOMC doesn't have to meet and decide if reserves will increase, it happens automatically, thus the amount lending determines the amount of reserves, reserves do NOT determine the amount of lending. As a result, the real constraint on lending is finding creditworthy people who are willing and able to borrow. Can you cite a single instance of a financially stable bank not being able to acquire the reserves it needs to fund a loan since the Fiat system has become how we operate? No, for reasons I've already cited. Respectfully, in turn, I admitted that at one point I was confusing terms, but part of the problem is your own misunderstanding of how the system works. (See above). I was letting you confuse me (I told you I was a bit rusty). You are either looking at a single bank when you explain banking and you can't "see" the consequences in your head, or you think that banks loan reserves. If you say you understand they don't loan them, then you must know that the reserves are always in the system available to lend to other banks. Please cite where I said that. I explained to you that banks are capital constrained, or equity constrained (they mean the same thing). The Bank of England said it in the spring of 2014, writing in its quarterly bulletin: Banks attract customer deposits, which are effectively loans to the bank, to balance their books. The greater the deposits the more loans that can be funded without having to borrow reserves. This is because loans and deposits sit on opposite sides of a bank's balance sheet as I've already shown in a visual diagram you didn't object too. Equity sits on the same side of the balance sheet as deposits. Banks sell equity shares and pay profits to the holders of those shares. In order to become a bank, I believe the Fed requires a minimum of $6 million dollars in equity. You've heard the term "leverage", right? What is it you think the banks are leveraging? Their equity. If a bank can leverage their equity 10/1 that bank, with $6 million dollars in equity, could safely fund $60 million dollars in loans. If a loan defaults it reduces the bank's equity. When a bank has greater liabilities than its equity (plus deposits) it is considered insolvent. There is a LOT more detail on how all of this works. Assets held by a bank are "risk-weighted" so they don't get included dollar for dollar. If memory serves, most Sovereign nation bonds are risk-weighted at 0% (though that was changing the last time I looked at it, Mortgages are risk-weighted at 50% (adjusted by the credit of the borrower). This is all outlined in Basel III: an international regulatory framework for banks.. Reading this stuff is like watching paint dry, but its all there. The fact that you don't know that banks are equity or capital constrained (pick the word you prefer) is surprising to me given that you clearly have some knowledge on the subject. That's fair, but I wasn't ignoring your questions, I was trying to find some common ground before addressing them. But here goes.... No I don't dispute this account, with the exception of withdrawing cash (which in the aggregate is usually a wash) as I've pointed out to you, several times, is that when banks transfer reserves to each other, they are still 100% available to borrow, thus not limiting reserves in any way. I've already addressed this in this post. If there is something else you think needs explaining, beyond what I've already explained, let me know. I've already explained capital, but to answer your second question. A bank can only create a loan if it can create an asset at the same time, thus a bank can't simply create money and deposit it in its own account. It would lack the asset that the borrower provides. Capital or equity is taken from people's real, existing money. I could be wrong on this, but I don't believe you can buy equity shares in a bank with borrowed money. I explained that it was temporary. Here.. Let's say the rules state a 1/1 bank leverage ratio.... Let's say a bank has: $20 in equity and $20 in deposits on the liability side (totaling $40) $10 loan and has $30 in reserves on the asset side (totaling $40) If the borrower defaults on the $10 loan, the bank will temporarily have $10 on its asset side in default. It can keep that money there for as long as banks are allowed to attempt restitution. After that, the $10 loan is repaid with $10 in bank equity. This is why I said what I said because the money still exists even though it's in default. Afer the default, at some point the bank must "write off" the bad debt, after that, the bank's books look like this: (-$10 for the write off) $10 in equity, $20 in deposits (Totalling $30 in liabilities) (-$10 in loan contract assets) $0 in loans and $30 in reserves. (totaling $30 in assets) (When a person defaults, the money they borrowed is still in the economy, thus the -$10 from equity rebalances the economy as the equity is applyed to the loan contract, -$10+$10=0. So the $10 in equity has been destroyed and the $10 created from thin air still exists in the economy. Since this sums to zero, nothing in the aggragate has been added to the economy). Moving on.... The bank still has equity and is still in the balance (assets/ libailties). Now let's say it makes another $10 loan to one of its own customers who deposit the money back in the bank. The bank's balance sheet would look like this: $10 in equity and +$10 deposit (the new loan) $30 in existing deposits (totaling $40 in liabilities) +$10 (the new loan) loans and $30 in reserves (totaling $40 in assets) (Do you see how the new loan created the deposit?) If the borrower defaults again, the bank will have zero equity and will be insolvent unless it can obtain more equity funding. Now if the customer transfers his loan to another bank, because as you rightly point out, no one borrows money simply to deposit it, so let's look what happens.... $10 in equity and $30 in deposits (the loan customer withdrew his $10 loan). (total $30 in assets) $10 in loans (the bank retains the value of the loan contract) -$10 in reserves are transferred to wherever the borrower spends his $10 $20 in reserves ($30 total assets) See how that works? The bank can't create unlimited funds. It can only create loans in relation to the equity they hold (whatever the equity ratio is) It's hard to believe I need to explain this, but since I already explained and documented that banks don't lend reserves and they don't lend customer deposits, where else would the money come from if not "thin air"? Why do they have to pay back defaulted loans? Again, I'm surprised I'm being asked to explain this.... Because if a bank didn't risk the equity of real investors, banks wouldn't have any incentive to ensure that people have good credit. This is what happened in the run-up to 2008. The risk in the banking system was poorly managed and banks increased their risk and the system collapsed under the weight of that risk. The other reason they have to repay is because those are the rules of Basel III (see above) Yes, it's destroyed First, the ratios are different. The government over the last 26 years has spent $73 trillion dollars and collected $61 trillion in taxes. The rest is deficit spending which is new money added to the economy. Again, I've tried to explain this to you already and you never addressed it. Given the cyclical nature of taxing and spending, it's difficult to "see" what's really going on. I explained that on the very first day of government, how does money enter the system if the government doesn't create it. You've responded by pointing out that it's the Fed that creates money and to some extent that is true. But the Treasury can create or destroy money by crediting or debiting bank accounts. I try first to put things in my own words so you can debate me, but I think 5 min with L. Randle Wray might help you better than I can. [video=youtube;tEiNLmg2tYA]https://www.youtube.com/watch?v=tEiNLmg2tYA[/video] Now having answered all of your questions I want to reiterate the enjoyment I get out of these kinds of discussions. It's been a while since I have dug this deep into banking and I enjoyed refreshing my own knowledge and understanding, which is, of course, why I discuss these issues in public forums in the first place. I took some time to refresh what I know and I hope that you find my answers satisfactory, at least in the sense that I answered your questions. -Cheers, Chris - - - Updated - - - Read my reply, I explain it all above.
