Money Created From Nowhere Disappears Again Upon Default

[DoctorJ]

This is more complicated than I thought. I was quite happy with the idea that a bank would create money as debt but I never thought about people defaulting.

According to the 'money as debt' vid there have to be some defaulters (as the total money in existence cannot repay this debt plus the interest on the debt (P/P+I)) for the system to work. Alternatively, it could be saying that defaulting is an inevitable consequence of the debt money system.

As far as I can remember the 'debt as money' vid does not include the central banks in the equation so this may be confusing me

Edit: (I just read Madman's post and its making a lot more sense now)

Edited August 20, 2007 by DoctorJ

[domo]

Alright guys, let me put an end to this mystery....

you cant deposit a house with a bank (its secured agains a debt) and a bank does not create money it lends it.

[gfromls]

Alright guys, let me put an end to this mystery....

First of all forget fractional banking. Assume infinite multiplier i.e. a bank has zero reserves (e.g. inauguration of the newly formed bank was 9:00 AM today).

The bank has zero reserves. I have house which I inherited 20 years ago from my relative. I have neither any debts nor any outstanding mortgage. I go to the bank to borrow money (let's say 125,000 and my house is worth 250,000) at 11:00 AM. The bank creates the loan from thin air but asks me to secure it against my house. The bank has not made any money. It lent me 125000 but assumes right over half my house. You see the bank only creates money when someone agrees to put an equivalent asset in the bank deposit. If no one puts an asset in the bank, the bank can not create money. So on day one of the bank opening, they did not create £1m at 10:00AM. They can't except when someone comes with an asset to deposit. Deposit could be anything. Your house, cash earned from employment etc. So the bank has the right to create money but YOU are the one that asks the bank to switch on the printing press. In efect, the bank was given the right to create money only for the borrower but not for itself and since by creating and lending it to the borrower they went -125000, they kept half of the borrowers property to keep even. Theoretically speaking if everyone in UK went to the bank to borrow money AGAINST their house, the bank would create and lend 1Trillion but will assume it's rights over all houses in UK. Again the bank is not positive or negative in balance sheet, it is equal (balanced). The bank has not made any money for itself. What it created was for to give out and go negative. It has a zero net profit even after creating 1Trillion. It hopes to make money by charging interest on the loaned(created) amount. It also hopes that people won't default and the assest price (against which loans are made) does not fall in value otherwise it's balance sheet will look negative and it may be declared bankrupt.

Upsides and Downsides of this arrangement...

Consider an economy. New inventions have been made which promise great rise in standards of living. Consider also that in this economy has banks that do not create money (call it gold, as it was done historically). Only when someone deposited gold (i.e. savings) in a bank was it possible to lend that gold to an inventor. Since not many people saved, new loans could not be made. So investors sat seeing their prototypes rusting away. Somehow by creating gold and lending out, they could get the inventor started. But gold can't be produced from thin air. They needed a different system; PAPER MONEY with embedded confidence that it was worth it. Given the example in the previous paragraph, the new system worked fine. The inventor was successful and the whole nation enjoyed the fruits of creativity.

Downside....

In the new system (paper money), by creating money, this diluted other peoples purchasing power (especially when inventor ideas did not bear fruit). The new system, in effect, had the affect of forced savings on the rest of the population. In the new system consumption could be before saving. Eventually both will settle out but for a while consumption could be ahead of saving. If the extra consumption was not compensated by extra saving later, inflation was born.

So all in all, the new system was wonderful but had a downside of inflation.

Fix inflation then somehow....

So the instrument of IRs were used to dampen out the appetite of borrowers by increasing the cost of borrowing to hammer down on excess credit creation and keep faith in the paper money system.

Where did it all go wrong then ...

1. It was hard to work out what exactly inflation is and how to measure it and hence IRs.

2. The assets which the bank kept (houses, MBS etc.) could go down in price.

3. A speculative rise in assets could make borrowers ask for more money creation from banks and result in a disbalance between consumption and savings.

3. For a while politicians could lower IRs and disbalance consumption and saving for political gain.

Hope it helps. Any questions please ask.

Cheers,

Madman

yes i do.

so when the loan is repaid, the money that was created is destroyed. the bank profits from the interest (6% or so). but the money loaned out is gone (0).

in the current situation lots of loans are being repaid (due to margin calls ect), those loans are repaid and the bank profits from the interest. however if the loan defaults the bank makes a loss. (but in both cases, the loan "money" has gone)

even though the FED ect are pumping "new" money into the system, the amount is not as great as the amount being destroyed when loans are repaid + defaults.

so all talk of the FED ect dropping money out of helicopters ect (and that being inflationary) - is wrong...... it is infact slight inflation, to counteract massive deflation.

is that almost correct?

Edited August 20, 2007 by gfromls

[zhinzhon]

I am also trying to get my head around "Money is debt".

I have watched the google vid and now have more questions than answers. I am correct in assuming that although money is created out of thin air it still has value and therefore it is as good as gold.

The money isnt just plucked out of thin air, but works like a cheque. When I write a cheque to you for £50, it is a promise that you can take a piece of paper to your bank, which will deduct the amount (if available) from my bank and give you the value in cash. Just because the cheque is made of paper does not diminsh it redeemable value.

Money cannot be created or destroyed it is merely transferred from one form to another and from one owner to another.

[sikejsudjek]

Don't forget that the 'multiplier effect' of fractional reserve banking is lost when many defaults occur. Although in theory credit is destroyed by defaults balancing things out, in reality the multiplier effect of banks (i.e. using repayments on old loans also as deposits for new loans) is reduced. Hence less credit being created, and a recession until bank deposits build up again to allow previous levels of new lending. The system is designed for boom and bust.

[Ah-so]

I am a banker. We have a magic ox that lays a large deposit on the hour, every hour. We keep it quiet from you lot, but it seems to work and keeps the business going. This is not a load of bullsh!t.

Edited August 20, 2007 by Ah-so

[gfromls]

I am a banker. We have a magic ox that lays a large deposit on the hour, every hour. We keep it quiet from you lot, but it seems to work and keeps the business going. This is not a load of bullsh!t.

so how/ why do banks need to be bailed out by central banks?

[DoctorJ]

I am a banker. We have a magic ox that lays a large deposit on the hour, every hour. We keep it quiet from you lot, but it seems to work and keeps the business going. This is not a load of bullsh!t.

Its called Merv

[HPC Convert]

From what I understand, if money is created by a bank for a loan/mortgage and the borrower defaults then the money disappears from the system. Is this right?

If so, what do the banks care is there is a default or a repo? I always thought that they were concerned about getting their money back but they created the money from nothing in the first place.

Priceless level of ignorance to even ask the question. Do you honestly think that a bank just magics money from its pocket and lends it out? If people repay plus interest then they make money, but if people default then the bank just scrubs the debts with no repercussions?

Good god, Ive just appreciated a whole new tranche of sub prime borrowers that really have no clue about finance whatsoever.

[the_austrian]

Upsides and Downsides of this arrangement...

Consider an economy. New inventions have been made which promise great rise in standards of living. Consider also that in this economy has banks that do not create money (call it gold, as it was done historically). Only when someone deposited gold (i.e. savings) in a bank was it possible to lend that gold to an inventor. Since not many people saved, new loans could not be made. So investors sat seeing their prototypes rusting away. Somehow by creating gold and lending out, they could get the inventor started. But gold can't be produced from thin air. They needed a different system; PAPER MONEY with embedded confidence that it was worth it. Given the example in the previous paragraph, the new system worked fine. The inventor was successful and the whole nation enjoyed the fruits of creativity.

The point is that when you lend money you give up the right to use that money for a fixed period. To lose that right has a value which should be determined by the market. Instead we have the banking system making rates artificially low.

If the invention is worthwhile it should be able to attract a loan which reflects the hardship of the investor losing the right to that money for a fixed period. Because banks make money available cheaply the inventor is able to get funding for a project which would not be viable if he/she had to pay market rates for the funding.

Downside....

Because banks are able to borrow "fractional money" from the central bank interest-free they are able to pass those cheap rates on to their customers. This encourages a speculative bubble as assets which are borrowed against steadily rise in price. Eventually there is a disruption which causes assets to fall in price which triggers a credit crunch because lenders fall into negative equity.

[GDS]

this is incorrect. a bank cannot create any money out of thin air. banks must loan money from somewhere in order to loan it to you. banks are just an intermediary between the capital markets and the public, or between the public and the public. they just recirculate and match money from those who have excess cash to those that need to borrow it.

new money can only be injected/created by the BOE.

Not true. Banks do not simply recirculate money borrowed from their depositors. Though their initial deposits come from the Bank of England, bankers themselves have stated quite plainly that when banks make a loana to customers fresh deposits are created - “brand new money”, as one of them unequivocally stated. These new deposits themselves then act as the backing for further loans. This process of money creation (now accounting for 97% of our national currency) is described very clearly in the Money As Debt video, here: http://video.google.com/videoplay?docid=-9050474362583451279

the reason why banks must pay back loans to the boe is that the books must always balance. losses must come out of the commercial banks profits and if they cant pay it back then the bank is bankrupt.

Yes, even though banks are licensed to create new money in the form of credit to borrowers, they have to play by the rules of the system, so their books must balance. A loan is entered on one side of the ledger as an asset of the bank, and on the other side as a debt owed to the bank by the borrower (ie, your debt is an asset of the bank, even though the money they created for you didn’t exist until you “borrowed” it and paid it into somebody else’s account).

If borrowers default on their loans, their debt is wiped out, but so are the bank assets which balanced it, on the other side of the ledger: so widespread defaults seriously reduce the assets against which banks are allowed to create new money in the form of loans.

Since our means of exchange now consists almost entirely of credit created in the form of bank loans, new borrowing must constantly be undertaken to replace what is continuously disappearing from circulation, as debts to the banks are serviced and repaid. So if, because of a sharply reduced asset base, the banks are no longer able to “lend” out more than is being removed from circulation by debt repayments, money will become painfully scarce.

for those that say that if commercial banks default to the boe then the money is still in the system - yes it is, but this doesnt really matter. the boe can increase/cut money supply at will anyway so it makes no difference. money has no meaning to the boe, its purpose is to create an equilibrium between supply and demand of money,if it really wanted to, it could inject an extra £100billion tomorrow into the bank system.

the BoE's purpose may be to keep “an equilibrium between supply and demand of money”, but the tools it has for achieving this, under the present debt-based system, are pretty poor. The MPC could do a far better job if it were given the responsibility of estimating the amount of currency required and issuing it directly, as a debt-free input to the economy, rather than using the present crude hit-and-miss method of raising and lowering interest rates in an attempt to get people to borrow enough, but not too much, into existence. http://www.freewebs.com/whosemoney

[Timm]

Priceless level of ignorance to even ask the question.

What a very silly thing to say.

People come to this site looking to increase their level of understanding. They hope to leave with more knowledge than they came with. One good way of doing that is by defining an area in which their knowledge is deficient, and asking for advice from those who have more expertise or knowledge. Insulting people who take this intelligent and pragmatic approach to the assimilation of knowledge will simply alienate them, meaning they will not learn anything here and therefore they wont come back. I wonder, is that your aim? Are you trying to discredit this site and its informative potential? Your comment indicates that you are very happy in your lack of learning, and that curiosity should be tamed; therefore I ask you:

Are you sir, a shill for ignorance?

.

[Mr Yogi]

the BoE's purpose may be to keep “an equilibrium between supply and demand of money”, but the tools it has for achieving this, under the present debt-based system, are pretty poor. The MPC could do a far better job if it were given the responsibility of estimating the amount of currency required and issuing it directly, as a debt-free input to the economy, rather than using the present crude hit-and-miss method of raising and lowering interest rates in an attempt to get people to borrow enough, but not too much, into existence. http://www.freewebs.com/whosemoney

Please excuse my ignorance when it comes to matters of economics. That is why I tend to stick to my 'twee' anecdotes. But I'm trying to learn...

...I always though that 'inflation' was a measure of the increase of money in circulation.

The Bank of England has a responsibility to keep inflation within planned limits.

The Bank of England has control over the money supply.

So why do they just faff about with interest rates to control inflation?

Can't they simply control the amount of new money being introduced into the system?

Edit...

Or would the efect just be same with restricted supply pushing prices (interest rates) up anyway?

Ah... I think I may have worked it out for myself!

Edited August 21, 2007 by Mr Yogi

[mfp123]

Not true. Banks do not simply recirculate money borrowed from their depositors. Though their initial deposits come from the Bank of England, bankers themselves have stated quite plainly that when banks make a loana to customers fresh deposits are created - “brand new money”, as one of them unequivocally stated. These new deposits themselves then act as the backing for further loans. This process of money creation (now accounting for 97% of our national currency) is described very clearly in the Money As Debt video, here: http://video.google.com/videoplay?docid=-9050474362583451279

Yes, even though banks are licensed to create new money in the form of credit to borrowers, they have to play by the rules of the system, so their books must balance. A loan is entered on one side of the ledger as an asset of the bank, and on the other side as a debt owed to the bank by the borrower (ie, your debt is an asset of the bank, even though the money they created for you didn’t exist until you “borrowed” it and paid it into somebody else’s account).

If borrowers default on their loans, their debt is wiped out, but so are the bank assets which balanced it, on the other side of the ledger: so widespread defaults seriously reduce the assets against which banks are allowed to create new money in the form of loans.

Since our means of exchange now consists almost entirely of credit created in the form of bank loans, new borrowing must constantly be undertaken to replace what is continuously disappearing from circulation, as debts to the banks are serviced and repaid. So if, because of a sharply reduced asset base, the banks are no longer able to “lend” out more than is being removed from circulation by debt repayments, money will become painfully scarce.

the BoE's purpose may be to keep “an equilibrium between supply and demand of money”, but the tools it has for achieving this, under the present debt-based system, are pretty poor. The MPC could do a far better job if it were given the responsibility of estimating the amount of currency required and issuing it directly, as a debt-free input to the economy, rather than using the present crude hit-and-miss method of raising and lowering interest rates in an attempt to get people to borrow enough, but not too much, into existence. http://www.freewebs.com/whosemoney

the fractional reserve banking issue is seriously overblown by this board. the whole point of reserve banking is just the fact that a bank must hold a proportion of reserves in case someone decides to withdraw some of their deposited cash.

consider this case of 0% reserve banking.

i deposit £100,000 at a bank.

the bank lends out that £100,000 to person b.

i have £100,000 in deposit at the bank, person b owes £100,000 but has £100,000 in cash. so thats £200,000 in cash in the system??

no. because should i choose to withdraw my £100,000 at the bank, i cant do this, as the bank hasnt got the money, it must find the money from elsewhere or get it back from person b.

although on paper there is £200,000 credit, its not actually possible for both that £100,000 to be in circulation at the same time.

if i lend you my car, and then you lend the car to someone else does that mean that there are now 2 cars in existence?? there is a car that has been lent out and then there is the car that is owed to me.

if you look at the entire banking system as a whole, that £100,000 must come from some other part of the system. all in all a zero sum game.

only the boe can inject new capital in the system, which is what they do to implement monetary policy i.e interest rates.

Edited August 21, 2007 by mfp123

[Madman]

By the way guys, do not insult people if they ask a stupid question. I have learnt from this site a lot. Sometimes I think I can add to the knowledge (and hence a layman version of, how money is created, see my previous post in this thread). My post was intentionally slightly inacurrate. This because I wanted to take the confusing bits out and provide a jist of the core understanding. I will, however, build up on the correction slowly and add more sophistication so people can understand it easily.

gfromls,

The money is only destroyed if the person who loaned it returned it back.

Imagine Mr A went to Bank and asked the bank to create money for him by depositing his house. Mr A took the borrowed money (£X) money and bought a BMW. Now let's say 2 days later Mr A's house was flooded and the value of the property reduced to zero. Bank realises and asks for it's money back from Mr A. Mr A defaults, bank looses money. Now the bank has created a sum of £X but it can not get it back from the economy (or BMW dealer) because Mr. X passed it to the car dealer before. So when a borrower defaults, it increases inflation.

Consider the present situation. In the US borrowers (mortgaged house holders) have defaulted (couldn't keep up the payments and also asset prices dropped). But the money which they initially borrowed to buy the house, they have passed it to someone else (the seller). So the money is in the system. But if the seller who got the new money via a borrower, does not use the money (e.g. digs a hole in his garden and buries it), it will not cause inflation. So it is only when money changes hands after being created, does it causes inflation. Now let's carry this further. Imagine the seller, rather than burying in the garden, deposits it in a bank. Now because of the current economic climate, where trust in new borrowers has vanished, the bank does not lend it to a new person due to fear of defaulting. So the money sits in the bank. Conclusion: money dug in the garden or sitting in the bank without being lent out is the same scenario. It is effectively withdrawn from circulation. Since inflation is about the volume of money changing hands (velocity of money: momentum), inflation is zero. If the assests on which the money was changing hands rapidly died, it resulted in deflation of that asset.

So the point is that, it is both about the volume of money AND circulation (velocity) that causes inflation. Otherwise deflation. In the present circumstances the newly created money (M4) is with savers deposited in banks (this one is global, money created in US can and is deposited in Japan). So the money is there and always will be but because it has stopped changing hands (banks not lending due to a fear of default), deflation will persist in the economy. Especially those areas where risk is default is high e.g. housing in US.

Point 2: Some posters have indicated that you do not deposit your house with the bank. That is true. the argument I chose was to present things in layman terms. The truth is that money is lent on a confidence that if something goes wrong, it can be claimed back. So money lent on housing is secured lending. It could also be lent as unsecured but against a confidence e.g. because the borrower has a good paying job and good credit history, he is likely to repay back. One extreme case of this confidence is lending to goverments. It is generally known that if you lend to the goverment, it will pay back. The confidence or promise to pay out by the goverment manifests itself as a bond.

Point 3: Fractional banking

As long as the bank has a balanced sheet, it is okay. However, it is in the bank's business to lend money out as they make a profit from it. So as soon as they have a saver depositing money, they want to lend it out. But at times savers come to withdraw their cash. Since it can be hard to demand a loan from a borrower, the banks are obliged by the laws to keep a certain percentage of savers money as dead cash. Since the bank does not make money on dead cash, they can deposit it at the central bank and earn interest.

Let's say there is lots of economic activity in the economy and the goverment wishes to dampen it out. They can do it by saying to the bank not to make new loans, or making loans expensive. They generally do not say 'not to make new loans', they respond by either raising IRs or asking the bank to have more fractional reserves (especially when lot of people want to withdraw money). In my opinion, the reserve ratio should be up to the bank to decide. If there is a good bank, run properly, it's balance sheet is level, then why stop it from expanding.

[DoctorJ]

Do you honestly think that a bank just magics money from its pocket and lends it out? If people repay plus interest then they make money, but if people default then the bank just scrubs the debts with no repercussions?

well no. thats why I asked the question. work it out

[Ah-so]

Yes, even though banks are licensed to create new money in the form of credit to borrowers, they have to play by the rules of the system, so their books must balance. A loan is entered on one side of the ledger as an asset of the bank, and on the other side as a debt owed to the bank by the borrower (ie, your debt is an asset of the bank, even though the money they created for you didn’t exist until you “borrowed” it and paid it into somebody else’s account).

Of course the books must balance. All books balance, that's the point of them.

A bank's deposits and borrowings always exceed deposits, and all deposits come from a third party. Don't care what your websites say.

[gavp]

From what I understand, if money is created by a bank for a loan/mortgage and the borrower defaults then the money disappears from the system. Is this right?

If so, what do the banks care is there is a default or a repo? I always thought that they were concerned about getting their money back but they created the money from nothing in the first place.

I think you've misunderstood the principle of how the bank 'creates' money.

Heres how it works:

Adam deposits £1000 at the Bank of HPC.

Now assuming that the bank operates a 10% reserve, that means £100 of Adam's money has to be held in reserve, but the remaining £900 can be lent out by the bank.

So Bob comes into the bank and gets a £900 loan.

Now from the perspective of someone outside the system we started with £1000 but Bob now has £900 while Adam still has a balance on his account of £1000 so between them they have £1900. The bank has apparently created £900 from nowhere! Except of course that the bank knows, and we know, that Bob's £900 is part of Adam's £1000 so the total amount of money, once debts are taken into account, is the same as at the beginning.

Now suppose that Bob puts his £900 in an account at the Bank of HPC. They have to place 10% of this (i.e. £90) in their reserve, but they're free to lend out the remaining £810.

So Clive pops into the bank and takes out a loan of £810. Now apparently between them they have £1000 + £900 + £810 = £2710. The bank has seemingly 'created' £1710. Except of course that no new money has been created, all that has happened is that the bank has created a chain of debt from Clive to Bob to Adam.

So if Clive defaults on his loan then the bank has a problem. They can't simply wipe it off the books because at some point they're going to have to pay back Adam's original deposit. So they have to make up the shortfall from their own income or, if that's not going to make up the difference before Adam wants his money back, by borrowing from someone else (e.g. another bank or, as a last resort, the central bank).

So, in conclusion: because banks can't create money at will, they can't erase debts at will either. Hope that clears it up.

[Deaneybear]

Someone said that defaults were needed to keep fractional reserve banking system working.

I think that when central banks lend money out of no where they charge interest on it. The interest returns back to thin air.

So if you imagine BoE lends NR 5mil and NR pays 500k interest then there is only 4.5m left in the system, which is not enough to pay back the loan.

Even if NR was to make 500k from someone else the problem would presist. So the only away to solve this problem is that every now and again someone owing money goes bankcrupt and interest is no longer charged on that money or more loans are injected to pay off the interest on other loans.

I maybe completly wrong however this system will lead only to mass inflation or bankcruptcy.

[the_austrian]

the fractional reserve banking issue is seriously overblown by this board. the whole point of reserve banking is just the fact that a bank must hold a proportion of reserves in case someone decides to withdraw some of their deposited cash.

consider this case of 0% reserve banking.

i deposit £100,000 at a bank.

the bank lends out that £100,000 to person b.

i have £100,000 in deposit at the bank, person b owes £100,000 but has £100,000 in cash. so thats £200,000 in cash in the system??

no. because should i choose to withdraw my £100,000 at the bank, i cant do this, as the bank hasnt got the money, it must find the money from elsewhere or get it back from person b.

although on paper there is £200,000 credit, its not actually possible for both that £100,000 to be in circulation at the same time.

if i lend you my car, and then you lend the car to someone else does that mean that there are now 2 cars in existence?? there is a car that has been lent out and then there is the car that is owed to me.

if you look at the entire banking system as a whole, that £100,000 must come from some other part of the system. all in all a zero sum game.

only the boe can inject new capital in the system, which is what they do to implement monetary policy i.e interest rates.

"the bank hasn't got the money"

The bank didn't give your money to person b it gave him/her bank credit loaned from the central bank.

If there is a good bank, run properly, it's balance sheet is level, then why stop it from expanding.

The problem with banks "expanding" in this way is that we are incentivised to get into debt and acquire assets against which we can secure that debt (because the debt is artificially cheap).

I think you've misunderstood the principle of how the bank 'creates' money.

Heres how it works:

Adam deposits £1000 at the Bank of HPC.

Now assuming that the bank operates a 10% reserve, that means £100 of Adam's money has to be held in reserve, but the remaining £900 can be lent out by the bank.

So Bob comes into the bank and gets a £900 loan.

Now from the perspective of someone outside the system we started with £1000 but Bob now has £900 while Adam still has a balance on his account of £1000 so between them they have £1900. The bank has apparently created £900 from nowhere! Except of course that the bank knows, and we know, that Bob's £900 is part of Adam's £1000 so the total amount of money, once debts are taken into account, is the same as at the beginning.

Now suppose that Bob puts his £900 in an account at the Bank of HPC. They have to place 10% of this (i.e. £90) in their reserve, but they're free to lend out the remaining £810.

So Clive pops into the bank and takes out a loan of £810. Now apparently between them they have £1000 + £900 + £810 = £2710. The bank has seemingly 'created' £1710. Except of course that no new money has been created, all that has happened is that the bank has created a chain of debt from Clive to Bob to Adam.

So if Clive defaults on his loan then the bank has a problem. They can't simply wipe it off the books because at some point they're going to have to pay back Adam's original deposit. So they have to make up the shortfall from their own income or, if that's not going to make up the difference before Adam wants his money back, by borrowing from someone else (e.g. another bank or, as a last resort, the central bank).

So, in conclusion: because banks can't create money at will, they can't erase debts at will either. Hope that clears it up.

That's a pretty good summary except that with a 10% reserve the bank could lend £9,000 to Bob straight away. The "telescoping" that you describe could work if banks were able to distinguish between notes issued by separate banks. But when a bank issues currency it is impossible to determine from which bank it came so when Bob borrowed £900 (not £9,000) as you describe, he could put it straight back into the same bank and take out another £810. The bank could treat this money as if it came from another bank because there is no way tell tell if it did or not.

Bob and the bank can continue to do this until they get up to £9,000. In practice there is no need to go through the process of re-depositing each loan and the bank can give Bob £9,000 at the outset.

[goonboy]

I think you've misunderstood the principle of how the bank 'creates' money.

...

Heres how it works:

...

Heres how it works:

A thousand Adams deposit 1000 squid each.

The probability of any particular Adam taking his money M out on a particular day is X

From X and M the bank works out the out going cashflow. O

Some Bills turn up and borrow some of the cash pool.

The Bills start paying back the loans, the probability of a Bill missing a payment is Y.

The Bills also pay interest I.

From Y and I the bank calculates incoming cashflow In

If ( O < In )

pr0fit$ !!!

else

D'oh!

Simple enough even for poor old goonboy to understand

[Japhy Rider]

"the bank hasn't got the money"

The bank didn't give your money to person b it gave him/her bank credit loaned from the central bank.

The problem with banks "expanding" in this way is that we are incentivised to get into debt and acquire assets against which we can secure that debt (because the debt is artificially cheap).

Please Austrian (and everybody else) I beg you to stop mixing up the issues of Fractional Reserve Banking and money creation.

They are completely different things.

That's a pretty good summary except that with a 10% reserve the bank could lend £9,000 to Bob straight away. The "telescoping" that you describe could work if banks were able to distinguish between notes issued by separate banks. But when a bank issues currency it is impossible to determine from which bank it came so when Bob borrowed £900 (not £9,000) as you describe, he could put it straight back into the same bank and take out another £810. The bank could treat this money as if it came from another bank because there is no way tell tell if it did or not.

Bob and the bank can continue to do this until they get up to £9,000. In practice there is no need to go through the process of re-depositing each loan and the bank can give Bob £9,000 at the outset.

No this is wrong. Either you are confusing FRB with some other process or you have mis-understood the principle.

In the example you use the bank cannot simply loan £9,000 to Bob unless he makes corresponding deposits of £8,100 (as was described very clearly in the previous post)

After Bob receives his first loan of £900 the only way he can get any more money is by re-depositing the £900. (So he doesn't get to use the money for anything else)

So whether the money is loaned backwards and forwards to the same person or to multiple people is irrelevant. Each loan made is made from a deposit of real money.

You have put the cart before the horse, in that you are correct in thinking that under a 10% reserve system there will be £9000 in loans for every £1000 in reserves

But you have missed out the process by which we get to that equilibrium which is by people making deposits of £8000.

The example of cars earlier up the thread is a good one: Under a 0% reserve system, if I lend you my car and you lend it to someone else then we have loans outstanding of two cars - But there is also a deposit of one car. So the total cars in circulation is only one and will always be one, no matter how many times it is loaned on from person to the next.

Under a reserve system i would be required to keep a bit of the car - say the wing mirror. The next person would also have to keep a bit, say one wheel. So as you can imagine if this process were to continue we would end up with 100 people all possessing bits of the same car. Each one will have borrowed and then deposited a little bit less car each time. so we might have total loans equalling as much as say 80 whole cars but this would be matched by deposits equalling 79 cars.

I am deliberately not going to say anything about money creation here just to make it clear that it is in no way linked to the principle of fractional reserves.

Cheers,

JR

Edited August 22, 2007 by Japhy Rider

[the_austrian]

After Bob receives his first loan of £900 the only way he can get any more money is by re-depositing the £900. (So he doesn't get to use the money for anything else)

The money you put on deposit can still be used...

if I lend you my car and you lend it to someone else then we have loans outstanding of two cars - But there is also a deposit of one car. So the total cars in circulation is only one and will always be one, no matter how many times it is loaned on from person to the next.

The second car has been magicked into existence by the central bank.

[DoctorJ]

What a very silly thing to say.

People come to this site looking to increase their level of understanding. They hope to leave with more knowledge than they came with. One good way of doing that is by defining an area in which their knowledge is deficient, and asking for advice from those who have more expertise or knowledge. Insulting people who take this intelligent and pragmatic approach to the assimilation of knowledge will simply alienate them, meaning they will not learn anything here and therefore they wont come back. I wonder, is that your aim? Are you trying to discredit this site and its informative potential? Your comment indicates that you are very happy in your lack of learning, and that curiosity should be tamed; therefore I ask you:

Are you sir, a shill for ignorance?

.

well said Timm

[Japhy Rider]

The money you put on deposit can still be used...

Not without calling in the loans down the line.

The second car has been magicked into existence by the central bank.

No it hasn't. It doesn't exist there is only one car but it has been loaned twice. If I call in the loan, then in order to give me my car back you will have to get it back from the other fella. Thus the chain of loans and deposits are undone and we still only have one car.

I think that you have convinced yourself that FRB is an evil scheme devised by the illuminati to rob us all.

It isn't, but until you sit down and do the sums for yourself, you won't be able to see it.

RB

Edited August 22, 2007 by Japhy Rider