Injin And Scepticus...

[Injin]

I hear you.

But would you say that:

- QE as currently operated tends to mainly increase bank reserves or bank capital?

Deposits.

- Which would this tend to increase more: The supply of base money or credit money?

Base.

Credit money will continue to decrease until the new fraud ratio can be ascertained.

Base money will continue to increase until pensioners stop withdrawing it and sticking it under the bed.

[Timm]

Deposits.

Thanks for replying - do you mean by this that the money has been made available (by QE) to meet liabilities: To enable payment if people with deposits turn up at their bank and want the money they thought they had?

Base.

Credit money will continue to decrease until the new fraud ratio can be ascertained.

Base money will continue to increase until pensioners stop withdrawing it and sticking it under the bed.

That's pretty much what I thought your position was. I wonder if Scepticus would concur?

[Injin]

Thanks for replying - do you mean by this that the money has been made available (by QE) to meet liabilities: To enable payment if people with deposits turn up at their bank and want the money they thought they had?

Yep, also to pay the states bills.

That's pretty much what I thought your position was. I wonder if Scepticus would concur?

I think he does, but the difference between us that he thinks that lying to people creates a new reality.

[the_duke_of_hazzard]

The fact that you can make the statement proves it.

How?

[Injin]

How?

The sum total of your statement includes the actions you had to perform to make it.

[CokeSnortingTory]

The only observation I can make about Injin/scepticus threads is that they usually go on for about 13+ pages, and end up as disagreements about definitions.

[scepticus]

At the risk of trying to get back on topic:

It's common to hear the statement here that "QE is just recapitalising the banks". And as the main limit on the creation of credit by banks is their capital base, one might expect their recapitalisation to result in a rapid growth of credit money at some point (subject to demand, which is a somewhat different issue).

Here is the deal:

Bank reseves sit on the asset side of the balance sheet along with the rest of the banks loans (remember reserves are bank funds on deposit with the CB). They earn no, or next to no, interest.

Deposits sit on the liability side. The difference between assets and liabilities is bank capital. The viability of the bank is determined by the cashflow from its assets, and the cashflow to service liabilities. Since reserves generate no interest cash flow, and certainly less cashflow than a banks liabilities, the presence of these reserves don't materially affect the viability of the bank.

WHat reserves provide is an interbank clearing asset. Therefore a huge volume of reserves means there is little or no danger of failure of overnight clearing. During the panic of 2008,some banks were in danger of failing during this overnight clearing process. THis would have been a failure of liquidity, and this possibility was removed by the creation of new reserves. However RBS needed more thanliquidity - it needed capital, which came from taxpayer investments in RBS shares.

But if QE is actually bolstering the reserves of banks, then that allows them to pay out on on a lot of promises thy had made that they could not previously have kept because they didn't have the money. It would however have a limited effect on how much credit they could dreate unless people withdrew their deposits and used that money to invest capital in the banks.

reserves cannot be used to take loan losses. these are taken against capital. therefore it is capital which determines how much a given bank can lend.

reserves only become relevant when they are so scarce that they run out over nigh on a regular basis, and then the overnight interest rate will sky rocket, which will spill out into the economy. likewise, when reserves are so numerous that there is no possibility of them running out, the overnight inter bank rate cannot really be anything else than zero. Even if banks use excess reserves to speculate short term, they cannot but end up in the reserve of another bank as a result, so overall the system is unchanged, with the possible exception of some velocity effects. so the creation of credit is limited by reserves only when the volume of credit already created results in overnight scarcity of reserves. so reserves are an upper limit, but bank capital is the first roadblock to lending. after that risk and growth will be roadblocks to new lending before reserves will.

one way round the zero short term rate effect created by excess reserves is for the CB to pay interest on the reserves. However in this case one would expect depositors to demand higher interest rates (since paying of interest on reserves is a CB rate rise), so even in this case the reserves will not necessarily result in an improvement to the banks capital position.

hope that helps.

[scepticus]

Is it just me wondering why we are discussing mediation of loans over different time scales?

If a bunch of people put money in a bank, returning X money for Y risk, then the bank loans out over periods of A and B, what has this got to do with banks extending credit, based on promises alone being unsustainable? The bank could do exactly the same with lumps of gold, although they would be bound be existing capital levels for any credit issued. Managing time maturities is the role of a bank regardless as to what the currency is based on.

my point is that maturity transformation can only be achieved with a fractional reserve, or more correctly, by a leveraging of equity.

a full reserve banking system could not perform maturity transformation, since it could only act as a warehouse in which deposits of a given maturity are matched with borrowers seeking the same maturity. So the level of 10 year loans available would be determined purely by the amount of 10 year term deposits held by the bank.

Currency based on promises, but guaranteed by a central bank (and government) is doomed to be inflationary. The commercial banks can cause financial chaos after irresponsible promises made default, so to prevent the chaos, they get bailed out. The commercial banks also know intermediating as many promises as possible makes them maximum profit. Combine this with the commercial banks having little regard for the quantity of currency, they have the incentive to 1. Mediate irresponsible promises 2. To mediate as many promises as possible.

I agree with the above

The alternative? The bank passes on the risk of losing money you place in a bank. If you risk losing the money, it is likely that people will choose steady banks for security, or risky banks for bigger gains. A steady bank may make less profit, therefore giving less/no interest, but you know what you are getting - security. The opposite is true for the alternative. In such a system, there is no need for a central bank to provide lender of last resort facilities, nor for the government to step in.

the trouble is that bank panics begin by affecting one or two banks, but ultimately all get run and all fail. in the 19th century in the US the banks coped with panics by bonding together and suspending convertability of deposits. instead the clearing house would issue clearing house notes which could bee redeemed at any bank. the clearing house would cease publication of information on individual banks. once the panic was over the clearing house notes would be retired, and individual bank info would be published. at this point the insolvency of individual banks may be announced.

so there is a need for a central bank even in free banking, a free central bank is needed to ensure the system survives temporary panics. This was a free market solution developed by independant banks. ultimately this system evolved into the FED.

[nixy]

I think he does, but the difference between us that he thinks that lying to people creates a new reality.

Scepticus?

Does truth matter?

[Injin]

my point is that maturity transformation can only be achieved with a fractional reserve, or more correctly, by a leveraging of equity.

a full reserve banking system could not perform maturity transformation, since it could only act as a warehouse in which deposits of a given maturity are matched with borrowers seeking the same maturity. So the level of 10 year loans available would be determined purely by the amount of 10 year term deposits held by the bank.

Full reserve banks do not loan in that way and maturity transformation can also be achieved by having savings.

Edited December 18, 2009 by Injin

[Injin]

Here is the deal:

Bank reseves sit on the asset side of the balance sheet along with the rest of the banks loans (remember reserves are bank funds on deposit with the CB). They earn no, or next to no, interest.

Deposits sit on the liability side. The difference between assets and liabilities is bank capital. The viability of the bank is determined by the cashflow from its assets, and the cashflow to service liabilities. Since reserves generate no interest cash flow, and certainly less cashflow than a banks liabilities, the presence of these reserves don't materially affect the viability of the bank.

WHat reserves provide is an interbank clearing asset. Therefore a huge volume of reserves means there is little or no danger of failure of overnight clearing. During the panic of 2008,some banks were in danger of failing during this overnight clearing process. THis would have been a failure of liquidity, and this possibility was removed by the creation of new reserves. However RBS needed more thanliquidity - it needed capital, which came from taxpayer investments in RBS shares.

reserves cannot be used to take loan losses. these are taken against capital. therefore it is capital which determines how much a given bank can lend.

reserves only become relevant when they are so scarce that they run out over nigh on a regular basis, and then the overnight interest rate will sky rocket, which will spill out into the economy. likewise, when reserves are so numerous that there is no possibility of them running out, the overnight inter bank rate cannot really be anything else than zero. Even if banks use excess reserves to speculate short term, they cannot but end up in the reserve of another bank as a result, so overall the system is unchanged, with the possible exception of some velocity effects. so the creation of credit is limited by reserves only when the volume of credit already created results in overnight scarcity of reserves. so reserves are an upper limit, but bank capital is the first roadblock to lending. after that risk and growth will be roadblocks to new lending before reserves will.

one way round the zero short term rate effect created by excess reserves is for the CB to pay interest on the reserves. However in this case one would expect depositors to demand higher interest rates (since paying of interest on reserves is a CB rate rise), so even in this case the reserves will not necessarily result in an improvement to the banks capital position.

hope that helps.

Tenners, sceppy - it's all about the tenners.

Reserves, capital, asset, liability are all a point of view, ways of looking at an issue.

A point of view about tenners.

[Timm]

Here is the deal:

Bank reseves sit on the asset side of the balance sheet along with the rest of the banks loans (remember reserves are bank funds on deposit with the CB). They earn no, or next to no, interest.

Deposits sit on the liability side. The difference between assets and liabilities is bank capital.

<snip>

reserves cannot be used to take loan losses. these are taken against capital. therefore it is capital which determines how much a given bank can lend.

<snip>

Thanks for taking the time to reply.

So if bank capital is the difference between assets and liabilities, and reserves are part of the assets, then losses taken from capital must be taken from assets. But as they can't be taken (in the short term) from outstanding loans, wouldn't this mean that losses are either taken from reserves, or that there is another element of capital that you have not mentioned?

[scepticus]

Thanks for taking the time to reply.

So if bank capital is the difference between assets and liabilities, and reserves are part of the assets, then losses taken from capital must be taken from assets.

no, losses are taken against capital only. When a loan asset is written off, assets decline relative to liabilities, which implies a fall in capital. it is as simple as that. a fall in capital implies an increase in leverage unless action is taken to divest liabilities by disposing of other performing assets and then using the proceeds to divest liabilities. The resulting shrunken balance sheet ought to exhibit reduced leverage of the bank capital.

But as they can't be taken (in the short term) from outstanding loans, wouldn't this mean that losses are either taken from reserves, or that there is another element of capital that you have not mentioned?

losses are only taken against the bank's capital account. a liquidity shortfall would result in insolvency as well, and could in theory occur even if thebank in question is perfectly well capitalised. clearly in a fiat economy with a very accomodating CB, liquidity is not going to be an issue. so the real issue is bank capital - hence all the taxpayer re-caps.

[Injin]

no, losses are taken against capital only. When a loan asset is written off, assets decline relative to liabilities, which implies a fall in capital. it is as simple as that. a fall in capital implies an increase in leverage unless action is taken to divest liabilities by disposing of other performing assets and then using the proceeds to divest liabilities. The resulting shrunken balance sheet ought to exhibit reduced leverage of the bank capital.

losses are only taken against the bank's capital account. a liquidity shortfall would result in insolvency as well, and could in theory occur even if thebank in question is perfectly well capitalised. clearly in a fiat economy with a very accomodating CB, liquidity is not going to be an issue. so the real issue is bank capital - hence all the taxpayer re-caps.

You do talk some rot.

[Injin]

http://www.newyorkfed.org/research/current_issues/ci15-8.pdf

Of some interest here, I think.

The general idea here should be clear: while an individual

bank may reduce the level of reserves it holds by lending to

firms and/or households, the same is not true of the banking

system as a whole.

No matter how many times the funds are lent out by the banks or used to make purchases, total reserves

in the banking system do not change.

The amount of tenners doesn't change when you leverage, only claims to them do. As the claims are called in, either leverage increases. tenners do or the banking system fails.

Edited December 18, 2009 by Injin

[Timm]

no, losses are taken against capital only. When a loan asset is written off, assets decline relative to liabilities, which implies a fall in capital. it is as simple as that. a fall in capital implies an increase in leverage unless action is taken to divest liabilities by disposing of other performing assets and then using the proceeds to divest liabilities. The resulting shrunken balance sheet ought to exhibit reduced leverage of the bank capital.

losses are only taken against the bank's capital account. a liquidity shortfall would result in insolvency as well, and could in theory occur even if thebank in question is perfectly well capitalised. clearly in a fiat economy with a very accomodating CB, liquidity is not going to be an issue. so the real issue is bank capital - hence all the taxpayer re-caps.

So you don't think QE on its own materially increases a bank's ability to lend?

[Injin]

So you don't think QE on its own materially increases a bank's ability to lend?

Paying interest on reserves breaks this link between the

quantity of reserves and banks’ willingness to lend. By raising

the interest rate it pays on reserves, the central bank can

increase market rates and slow the growth of bank lending

and economic activity without changing the quantity of

reserves. In other words, paying interest on reserves allows the

central bank to follow a path for short-term interest rates that

is independent of the level of reserves. By choosing this path

appropriately, the central bank can guard against inflationary

pressures even if financial conditions lead it to maintain a high

level of excess reserves.

In other words, they are keeping price inflation low by destroying the economy.

Edited December 18, 2009 by Injin

[scepticus]

http://www.newyorkfed.org/research/current_issues/ci15-8.pdf

Of some interest here, I think.

yes, loans extended, defaulted or paid back do not alter base money at all.

The amount of tenners doesn't change when you leverage, only claims to them do. As the claims are called in, either leverage increases. tenners do or the banking system fails.

yes, but the fact that the bank can access enough tenners to meet likely claims does not ensure it has sufficient capital to meet ALL claims. it is always this way with banks, and has to be for them to do maturity transformation.

increasing liquidity does not solve all the problems.

[Timm]

Paying interest on reserves breaks this link between the

quantity of reserves and banks’ willingness to lend. By raising

the interest rate it pays on reserves, the central bank can

increase market rates and slow the growth of bank lending

and economic activity without changing the quantity of

reserves. In other words, paying interest on reserves allows the

central bank to follow a path for short-term interest rates that

is independent of the level of reserves. By choosing this path

appropriately, the central bank can guard against inflationary

pressures even if financial conditions lead it to maintain a high

level of excess reserves.

In other words, they are keeping price inflation low by destroying the economy.

Interesting.

I hadn't thought of it that way.

[scepticus]

So you don't think QE on its own materially increases a bank's ability to lend?

no not at all. it is useful to fend off a bank panic but not to get lending going.

the main purpose of QE was to restore M4 to its previous levels by replacing what was lost by the de-leveraging of the shadow banking and consumer sectors. WHen the govt buys a bond from a private individual the money spent goes into the individuals deposit account, and creates an identical amount of reserves at the individuals bank.

The excess reserves are a side effect of this propping up of M4, not the end in and of itself.

So QE prevents onset of deflation, but it can't get lending going unless the other pre-requisites are there first. Hence it is not inflationary until the missing factors that cause banks to want to lend materialise, and even then the level of excess reserves won't be the driving factor behind new lending.

The other pre requisites are a reasonably low risk business environment and a sufficient capital cushion at banks. The new Basel rules have set the bar a lot higher for capital requirements so this here is a deflationary force also acting against inflation.

[scepticus]

In other words, they are keeping price inflation low by destroying the economy.

lol, that is the standard capitalist modus operandi. When growth is leading towards full employment, wage claims rise and erode profits so firms raise prices to maintain profits. This leads to CPI inflation and further wage claims.

So what the capitalists do then is they get the CB to raise interest rates to a level where a decent amount of unemployment is caused which then pulls the rug out from under the workers wage claims. This is allowed because the CB generally has a mandate for price stability first, and employment second. For price stability, read profits.

Chronic unemployment is absolutely required for capitalism to function in a way that delivers profits without leading to inflation.

[Injin]

lol, that is the standard capitalist modus operandi. When growth is leading towards full employment, wage claims rise and erode profits so firms raise prices to maintain profits. This leads to CPI inflation and further wage claims.

So what the capitalists do then is they get the CB to raise interest rates to a level where a decent amount of unemployment is caused which then pulls the rug out from under the workers wage claims. This is allowed because the CB generally has a mandate for price stability first, and employment second. For price stability, read profits.

Chronic unemployment is absolutely required for capitalism to function in a way that delivers profits without leading to inflation.

Sorry, fiat money and the state have nothing to do with capitalism.

Lots to do with dipshit collectivism and communism though, being part of the ten planks and everything.

Regardless, none of the above changes what the fed is doing, which is destroying the lives of millions in order to keep itself going. Central banking is a crime against humanity.

[Injin]

Interesting.

I hadn't thought of it that way.

To achieve the effect of inflation you can do one of two things.

1) Raise the amount of money

2) reduce the numbers of people who have access to it.

They are doing both.

[Bloo Loo]

no not at all. it is useful to fend off a bank panic but not to get lending going.

the main purpose of QE was to restore M4 to its previous levels by replacing what was lost by the de-leveraging of the shadow banking and consumer sectors. WHen the govt buys a bond from a private individual the money spent goes into the individuals deposit account, and creates an identical amount of reserves at the individuals bank.

The excess reserves are a side effect of this propping up of M4, not the end in and of itself.

So QE prevents onset of deflation, but it can't get lending going unless the other pre-requisites are there first. Hence it is not inflationary until the missing factors that cause banks to want to lend materialise, and even then the level of excess reserves won't be the driving factor behind new lending.

The other pre requisites are a reasonably low risk business environment and a sufficient capital cushion at banks. The new Basel rules have set the bar a lot higher for capital requirements so this here is a deflationary force also acting against inflation.

I think QE was provided to shore up busted banks balance sheets with liquidity...nothing more....this to counter the loss of value of Financial assets bought with M4 Credit.

[Timm]

I think QE was provided to shore up busted banks balance sheets with liquidity...nothing more....this to counter the loss of value of Financial assets bought with M4 Credit.

This is the basic question behind the thread: Is QE providing liquidity or capital?