EDIT: http://ecedweb.unomaha.edu/ve/library/HBCM.PDF it seems to be more about loans being spent and thus the spent money being at another bank and loaned out again
" limit financial speculation by requiring private banks to hold 100pc reserves against their deposits. "
Normally, banks aren't required to actually have the money they lend out, so when a loan is credited to your account that money is created (and when you repay the loan, the money is destroyed). In many countries banks are required to hold a certain amount reserve (I think it's about 1.5% in the USA - the UK doesn't have such a requirement), so this is simply requiring that the banks have 100%, which means banks can only lend money they actually have.
EDIT: Did you mean how does the whole money creation thing work at all? There's a very clear guide at:
http://www.bankofengland.co.uk/publications/Documents/quarte...
It's for the UK, but pretty much all modern countries work in a similar way.
Say I deposit $100 in a bank. The bank has $100. Now, say the law requires a 10% reserve. They can lend $90--which they actually have. That person takes the loan, and deposits it in their bank. Now, there are $190 in deposits from the original $100. But the bank never lent money it didn't have. Instead, the money creation comes from the fact I get to treat my $100 deposit as good as cash on hand, even though 90% of it has been lent to another person.
In summary, though, if we imagine that the bank is required to hold 10% reserve: I go to the bank and get a loan for $900. This is credited to my account. There is no requirement for this money to actually exist. The same day, you go and deposit $100 in actual dollar bills. Your account is credited with $100.
The bank's liabilities are now $100 (in your account) plus $900 (in my account) for a total of $1000. The banks reserve is $100 (real dollar bills you gave them). This is 10% reserve so the bank is legally OK. $900 has been created.
That's how it works. More detail in the PDF I linked.
Amongst other things, this means that how profligate a bank can be in lending money depends heavily on how much all the other banks are lending. So long as all the other banks are lending just as much out and their savings terms are competitive, the outflow of loaned funds will be balanced by an inflow of other banks' loaned funds. What happens in practice is that there's a glut of easy credit during booms which dries up during busts, making the boom-bust cycle worse. You can find some discussion of this here: http://www.bankofengland.co.uk/research/documents/workingpap...
It's interesting to realize that you can create money in the same way that a bank. Just give your friend a promise that you will pay him in the future and he could use it as money with third parties. Most people wouldn't accept it, but that is a different issue.
If somebody is in the mood to destroy more preconceptions about economy I recommend Warren Mosler 'Seven deadly innocent frauds of economic policy', it can be a good introduction to Modern Monetary Theory:
Unfortunately, in the (deadly?) Eurozone this is indeed how it works.
And most don't realize yet.
«In accordance with Article 123 of the Treaty on the Functioning of the European Union, overdrafts or any other type of credit facility with the ECB or with the national central banks in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the ECB or national central banks of debt instruments.»
Despite that, I can't recommend it enough. It's just after starting to read it that what was going on in the economy of the world made any sense to me.
Also, mainstream economy is just totally wrong in many of its descriptive aspects, but they continue teaching falsehoods anyway. An example at hand is how the fractional banking and the creation of new 'money' by banks works in, virtually, all the modern economies.
This is the reason that the linked PDF by someone a few posts above is so important. They say what Modern Monetary Theory have been saying all the time but the source is the Bank of England.
I think it deserve to be linked again: http://www.bankofengland.co.uk/publications/Documents/quarte...
As Henry Ford said: "It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning."
Also, MMT is nothing new or groundbreaking, contrary to their claims. There have been chartalist and endogenous money creation theories for ages, and most mainstream economists are quite aware of them, contrary to the assertions of many MMTers. What separates MMT from the rest is its fusion with more dubious Post-Keynesian theories.
MMT people don't claim it to be any new or groundbreaking, on the the contrary, they claim is just common sense and chartalism. What they claim is that chartalism is true, especially in modern economies. This is a very difficult thing to dispute if you analyze how money works nowadays.
In my experience, the real problem with MMT, is that the implications of what an economy is or how it really works are politically indigestible for a lot of people and inconvenient for a few.
A good reading of the Public Choice journal and similar is a nice antidote to some of the zanier MMT and Post-Keynesian proposals.
I want to return the courtesy, this a reply to critics or MMT: http://www.levyinstitute.org/publications/modern-money-theor...
I have not problem with a lot of post-keynesian ideas by the way.
If anything, you've convinced me more that MMTers believe in a perfect State. Post-Keynesian ideas seem to emanate from it. Kalecki and Robinson were outright Marxists, the former basing their economics on class conflict and the latter praising North Korea and Maoist China. The entire Post-Keynesian literature is devoid of public choice considerations, sans one weak paper from ~2004.
Most critics dismiss the conclusions or address questions that are not really part of MMT.
Personally, I am specially interested in criticism of the most descriptive part of MMT, starting on chartalism but going beyond, banks money creation, sectoral balances, foreign exchange, etc..
(FWIW, I do intend on eventually writing a criticism of Post-Keynesianism in book form, but I'm still in earlier research phases.)
1) Alice deposits $100 in Bank X
2) Bob takes out $900 loan from Bank X and deposits it in Bank Y
3) Charlie takes out $8,100 loan from Bank Y and deposits it in Bank X
4) Eve takes out $72,900 loan from Bank X and deposits it in Bank Y
5) ... the cycle continues ...
Also, I would assume that the interest rates that my bank pays for my deposits would be a lot higher if it could lend out 9x as much as it holds in deposits.
The model where a bank lends out 90% of its total deposits still makes more sense to me and will result in $900 of total money created per $100 initially deposited.
1) Alice deposits $100 in Bank X
2) Bob takes out $90 loan from Bank X and deposits it in Bank Y
3) Charlie takes out $81 loan from Bank Y and deposits it in Bank X
4) Eve takes out $72.90 loan from Bank X and deposits it in Bank Y
5) ... the cycle continues ...
and if you sum the geometric series, which in this case is finite, you get $900 of total additional money created for the initial $100 Alice put in.
If Bob takes cash from Bank X and deposits in Bank Y, Bank X has less cash, that movement is reflected in their balance and in their reserves.
If Bob makes and electronic transfer from Bank X to Bank Y, at the end of the day, Bank X and Y have to clear their balance with each other. As some people have moved money in the opposite direction, from Bank Y to Bank X, the balance could be compensated.
If for some reason, people only retire money from a bank without never making deposits, you have a bank run and it's an indicator of mistrust in that bank.
This is known as a bank run, or (when it happens to lots of banks simultaneously) a bank panic. During the Great Depression, banks were frozen, and people were barred from withdrawing money from the bank for a certain period of time. The motivation for doing this was to halt the bank panics that were occurring.
Raising the required reserve ratio has very far-reaching implications. Broadly speaking, it tightens liquidity, making loans more difficult to come by, which decreases investment in infrastructure. This slows economic growth, because it's harder to find capital with which to start businesses, and it's harder for people to obtain money to purchase a home, further their education, etc.
[0] in the aggregate; not everyone would lose 90%, but 90% of aggregate cash assets would be.
When the government creates the same amount of money and directly spends it on infrastructure as opposed to loaning it to infrastructure providers... what changes other than the fact that the infrastructure becomes cheaper to the public since the provider does not need to pay back the loan?
It's massively less efficient. It's important to note that this is true by definition, not by assumption.
For starters, the provider absolutely does still "pay back" the loan either way. Infrastructure investment isn't free, and if the aggregate value produced by the investment adds up to less than what it cost in the first place, then we would have been better off not doing anything at all.
Secondly, the government isn't able to spend on all types of infrastructure, and when it does, it's almost always less efficient. Public works are only one type of infrastructure spending, and they're pretty much the only one that remains exclusively in the domain of government projects these days.
To give you an example of what "infrastructure" can look like, look at the website we're on. Silicon Valley has a robust network of companies and organizations that both provide capital as intermediaries[0] and increase the ROI of that capital[1]. This wouldn't be possible if there weren't sufficient liquidity
When money is created by the banks, it's created in response to market forces. Banks have to turn an economic profit of zero on the aggregate of all loans they extend, which means that they price them accordingly, and therefore the price of capital converges (in the long run) to the value added by that investment. This makes it difficult (though not impossible) to secure capital for projects that have an inferior risk-adjusted payoff.
By contrast, the government does not create capital in response to market forces. Keynesians would argue that this is the entire point of government economic policy - to smooth out short-term cyclical trends. The problem with "spending" all newly-created money on smoothing short-term cyclical trends is that it leaves zero liquidity allocated to long-term economic growth.
[0] most startups are still funded by banks, at the end of the day, with VCs serving as intermediaries - venture capitalists get their money from LPs, which tend to be institutional investors like banks (or substitutes for institutional investors).
[1] even aside from the money that YC provides a company, YC makes companies more successful (or at least more likely to succeed) through the other, intangible assets it provides.
George Bailey explained this, in one of the greatest movies ever made.[1]
CHARLIE
I'll take mine now.
GEORGE
No, but you . . . you . . . you're thinking of
this place all wrong. As if I had the money back
in a safe. The money's not here. Your money's in
Joe's house . . .
(to one of the men)
. . . right next to yours. And in the Kennedy
house, and Mrs. Macklin's house, and a hundred
others. Why, you're lending them the money to
build, and then, they're going to pay it back
to you as best they can.
Relevant section from 'Money as Debt': https://youtu.be/jqvKjsIxT_8?t=12m57s
The creation of non-bank demand deposits like money market funds put the nail in the coffin of using reserve requirements to manage the amount of money in the economy.
Today the biggest constraint to monetary creation is bank capital ratios. Under current rules banks have to have roughly 1 dollar if equity for every 12 dollars of loans and that can vary based on the type of loans the banks make.
Several places the paper state that the ultimate control of money creation is monetary policy i.e. not the banks. This is what I'd always thought before this idea of commercial banks having complete freedom became popular. It also states that the interest rate set by the central bank decides the rate of the loans, and thus the demand for them, and thus the amount of creation. Interestingly the link between the central bank rate and the commercial rate is not stated (I did not read it end-to-end). I always thought that ultimately they had to borrow from the central bank to remain solvent/meet reserve ratios. And that goes down as a debt to the central bank, whereas the central bank can genuinely create that loan from nowhere and is doing the creation.
Banks would essentially just facilitate transactions and act as conduits between borrowers and the central bank. I don't think it makes much sense for country like USA that places such a high importance on free markets and liberty.