Side note: "How the Economic Machine Works"[1] by Ray Dalio (manager of one of the world's largest hedge funds) is fantastic in describing these concepts in non-academic-economics terms.
[0]: https://www.federalreserve.gov/releases/h6/current/ [1]: http://www.economicprinciples.org/wp-content/uploads/ray_dal...
It gets wiped off the books and a dollar leaves the economy.
> The person you're giving it to will either spend it on consumption
Did you take a loan out from a person? No. You took a loan out from a bank. They don't spend deposits on consumption. They cover their expenses and profits with the interest you pay.
> or loan it to someone else until (ultimately) it is spent.
The amount of lending a bank makes is almost unrelated to the amount of deposits they hold. Reserve regulations impact this somewhat, but the reality is that banks make profitable loans whenever feasible. If they don't meet reserve regulations at the end of the day, they borrow at exceedingly low interest rates to cover the gap. A bank can make a billion in loans at 5%, borrow at 3% to meet regulations nightly, and still come out ahead. (Specific numbers made up. Overnight rates are actually closer to 0.25%. So a loan at 5% with no reserves is actually crazy profitable.)
> And if you deposit the dollar into the bank then the bank have to loan it to someone (they need to make money too!) who will then spend it on consumption.
The fed pays 0.5% on reserves that banks hold. As of a few minute ago, Chase's interest rate sheet showed <0.5% for all checking, all money market, and most savings accounts. So in reality, Chase can hold your deposit and pay you interest and still make money.
If your savings has a "good" interest rate of, say, 1%, a single loan of $100K at 4% could still cover the cost of $800K in deposits. Banks absolutely do not have to loan out every dollar deposited to make money.
http://www.federalreserve.gov/monetarypolicy/reqresbalances....
https://chaseonline.chase.com/resources/RateSheetForCons7021...
> It won't reduce the amount of money in circulation.
When a bank loans you money, they are creating money. When you pay it back, you are destroying money. The view that your deposit is "loaned" to someone else is very inaccurate and misleading in a modern banking economy.
http://www.bankofengland.co.uk/publications/Documents/quarte...
The Fed does require a certain reserve percentage that the bank cannot loan out. It's only fair that they pay some interest on that.
However, making 0.5% is losing money because of inflation. Furthermore, no bank is going to loan you money for 0.5% - they're going to charge you a lot more.
> Banks absolutely do not have to loan out every dollar deposited to make money.
No legal requirement, sure. But they have every reason to loan out as much as possible. It's why they advertise loans, credit cards, etc. Banks have plenty of expenses, too, which means if they don't make loans, they go bankrupt.
Inflation is also irrelevant. What matters is the spread between what they pay a depositor in interest and what the Fed will pay for holding the deposit in reserve. So long as that spread is positive, they make money just for holding your money. Can they do better by lending and increasing the spread? Sure. Do they have to in order to make money? Not really.
This is also really odd stuff to choose to nitpick out of the discussion of how money of created in the modern economy.
I'm not sure if you're under the impression that I'm claiming that holding reserves is the primary way banks make money. I'm not. The discussion about reserves is to answer the claim that a dollar deposited with Chase will automatically result in a 90 cent loan to someone else. It will not.
The case in point was for a 'wealthy person' (not my term, I don't like it but let's roll with it) who holds the debt of a student borrower. The hypothesis of an above poster was that money repaid on loan service (from the borrower student to the rentier) would not result in increased consumption in the economy and that if the money remained with the debtor that they would be more likely to stoke consumption in the economy. My point was that if someone gives you money you can either spend or invest it (let's forget physical currency for now - in our current monetary system there's not that much central bank money [physical/reserves] in the economy as a percentage of gross domestic product, save for the US with USD1.46 trillion, owing to persistent current account deficits and the Triffin dilemma and other factors - but I digress). But let's take your argument as an example. If I hold $100k of a student's debt, and that debt is 'extinguished' then it doesn't change the money stock in the economy. If a debt between 2 individuals is "wiped off the books" then a dollar doesn't "leave the economy".
>> The person you're giving it to will either spend it on consumption >Did you take a loan out from a person? No. You took a loan out from a bank. They don't spend deposits on consumption. They cover their expenses and profits with the interest you pay.
I'm not sure I really follow what's going on in this segment of your response. Banks take deposits. They fund assets (often loans) with those deposits. Those funds are then used at some point for consumption.
>> or loan it to someone else until (ultimately) it is spent. >The amount of lending a bank makes is almost unrelated to the amount of deposits they hold. Reserve regulations impact this somewhat, but the reality is that banks make profitable loans whenever feasible. If they don't meet reserve regulations at the end of the day, they borrow at exceedingly low interest rates to cover the gap. A bank can make a billion in loans at 5%, borrow at 3% to meet regulations nightly, and still come out ahead. (Specific numbers made up. Overnight rates are actually closer to 0.25%. So a loan at 5% with no reserves is actually crazy profitable.)
Well, as much as I'd like to be able to change double entry accounting (and the laws of physics) this is not the case. The amount of lending a bank does is inextricably related to the amount of deposits they hold. If you 'deposit funds' with a bank, then there is a corresponding liability on their balance sheet (an entry on the right side). Other liabilities of banks include debt (both short and long term) and equity capital. Guess what? If you deposit money with a bank (or loan it money by purchasing its debt, or invest by providing equity capital) then whatever funds you provided the bank must be recognised on the bank's balance sheet. This new money you gave them goes on the left side (their assets). Now if you're a bank you can hold physical currency in your vaults (doesn't earn much interest, and there's a potential silverfish problem) or you can loan it out. You could loan it to the Fed[0] for 0.5% or you'd probably want to loan it out to someone else at a potentially higher rate (think mortgages, equities if you want to roll the dice, structured credit if you're feeling like it's 2007, you get the point).
>> And if you deposit the dollar into the bank then the bank have to loan it to someone (they need to make money too!) who will then spend it on consumption. >The fed pays 0.5% on reserves that banks hold. As of a few minute ago, Chase's interest rate sheet showed <0.5% for all checking, all money market, and most savings accounts. So in reality, Chase can hold your deposit and pay you interest and still make money.
Sounds like a money machine. Does Chase obtain all of their debt capital from depositors? Or is it possible that they pay more than 0.5% on some of their funding?
> If your savings has a "good" interest rate of, say, 1%, a single loan of $100K at 4% could still cover the cost of $800K in deposits. Banks absolutely do not have to loan out every dollar deposited to make money. http://www.federalreserve.gov/monetarypolicy/reqresbalances..... https://chaseonline.chase.com/resources/RateSheetForCons7021....
$100,000 * 0.04 = $4,000 (loans -> income) $800,000 * 0.01 = $8,000 (deposits -> expenses) -$4,000 (total profit)
Losing $4,000 every year on a $100,000 loan book doesn't seem like the best move for a bank. Furthermore, I ask this one question - if they don't "loan out" every dollar deposited, then what do they do with the monies? Hoard them in a vault?
>> It won't reduce the amount of money in circulation. >When a bank loans you money, they are creating money. When you pay it back, you are destroying money. The view that your deposit is "loaned" to someone else is very inaccurate and misleading in a modern banking economy.
As illustrated above, a deposit with a bank is a liability entry in their balance sheet with a corresponding asset to match. The asset would either be physical currency if that is what you deposited (how old fashioned) or the debt of another banking institution (which I'm guessing would be netted out at the end of each day - or intraday if that is your central bank's kind of thing - and balanced, or exchanged for central bank money). By definition the money is "loaned" to someone. Now we could really get into the nitty gritty of credit creation and "high powered central bank money" vs "private bank money" but there's probably not the need to get that into detail.
Anyways - I'm probably wrong with all of this though. It would be awesome if you could show the balance sheet entries which would correspond to the transactions which you're describing as then we could really just resolve any confusion using quantitative measures rather than long winded discussions :)
This is not a real scenario. Virtually no one's education is funded by direct loans from wealthy individuals. Student loans are issued by banks.
When you pay a dollar on your student loans' principal, that dollar ceases to exist. The bank might turn around and make another loan that recreates that dollar, but they are not obliged to do so. Banks are under no obligation to loan out everything they can. If they were, there'd have been no talk about "tight lending" after the housing crash.
> If I hold $100k of a student's debt, and that debt is 'extinguished' then it doesn't change the money stock in the economy. If a debt between 2 individuals is "wiped off the books" then a dollar doesn't "leave the economy".
This model of banking assumes a fixed monetary supply, which is not the case. Banks literally create money when they issue loans. If they didn't, the monetary supply would be fixed except in rare instances where the Fed creates money ex nihilo. As you are doubtless aware, the money supply fluctuates constantly. Where you imagine those fluctuations in supply come from?
The article I linked from the Bank of England also covered this, in bold, at the beginning. "Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money."
> Well, as much as I'd like to be able to change double entry accounting (and the laws of physics) this is not the case. The amount of lending a bank does is inextricably related to the amount of deposits they hold.
Deposits in this context are money. Loans are not. The bank gives you a loan for $100k. This creates an asset and a liability. (Double entry accounting is still mercifully intact.) The $100k sitting in your account now is literally money. You can spend it, transfer it, withdraw it, roll around on the floor in it, whatever you like. It's money. The $100k loan the bank marks down as an asset is not money. It can't be spent, only paid back. It can't be withdrawn, only sold.
The liability increased the monetary supply. The asset does not reduce it except when it's paid back, which is why banks literally create money when they issue loans and why paying off a loan literally destroys money.
The fixed supply model of banking is intuitive but it's also insufficient describe how modern banking actually works. Everyone agrees that monetary supply is not fixed.
> Sounds like a money machine. Does Chase obtain all of their debt capital from depositors? Or is it possible that they pay more than 0.5% on some of their funding?
It is a money machine.
I don't know what percentage of Chase's capital comes in the form of deposits.
> Losing $4,000 every year on a $100,000 loan book doesn't seem like the best move for a bank. Furthermore, I ask this one question - if they don't "loan out" every dollar deposited, then what do they do with the monies? Hoard them in a vault?
You're forgetting that the Fed pays 0.5% on reserves, which covers that $4000 cost. Obviously breaking even still isn't a functioning business strategy. The point is that banks do not have to lend every dollar possible in order to be profitable, not even close.
And yes, unloaned deposits are either held in the vault or transferred to the Fed. In either case the bank earns 0.5% on them.
> Anyways - I'm probably wrong with all of this though. It would be awesome if you could show the balance sheet entries which would correspond to the transactions which you're describing as then we could really just resolve any confusion using quantitative measures rather than long winded discussions :)
I'll decline to mock up a balance sheet for you. I'm not denying double entry accounting.
Which comes from depositors supposedly "hoarding" money in banks. (In fact, banks loan out a >1 multiple of deposits, called fractional reserve banking. So "hoarding" money in banks results in more money being spent, not less!)
Even in a hypothetical scenario where banks always loan the maximum amount they can, a dollar in the bank would result in less money in the economy than simply handing the dollar to someone on the street. Fractional reserve lending means that the bank can issue a 90 cent loan after receiving a 1 dollar deposit. And we assume that the 90 cent loan will stay in the bank as a deposit so that they can issue another loan for 81 cents. And so on. In this model, a dollar in the bank actually results in ZERO net money entering the economy. It's all deposits in the bank that can't be withdrawn because it would cause a cascading loan call.
At any point in this lending chain, if someone decides to withdraw the money they were loaned, it stops the chain and some amount of money less than 1 dollar enters the economy. It might be 90 cents, 81 cents, or 15 cents, but it will always be less than the dollar that was initially deposited. So even in the model where banks always lend as much as possible, there's still less money entering the economy than was deposited.
And of course, banks are aware of the cascading loan call problem and therefore keep more reserves in aggregate than the minimum so that they don't end up in this situation. Which means that the impact of a dollar deposited scales back even further.
If I borrow money from the bank, they simply list it as a credit to my checking account. I can then write checks to buy things. The vendor deposits my checks in his checking account. The money never left the bank, but it still resulted in commerce - for all intents and purposes, it "entered the economy".
There is no scenario in which you depositing a dollar in the bank "results in more money being spent, not less" in comparison with you spending a dollar. It quite obviously cannot be the case, because a spent dollar is economic activity of its own plus whatever economic activity occurs as the result of depositing the dollar, because the spent dollar is most certainly on its way to the bank as well.
Where exactly do the banks obtain the capital which funds their balance sheet? From something other than individuals with investable (deposits/debt/equity) funds?
> This model of banking assumes a fixed monetary supply, which is not the case. Banks literally create money when they issue loans. If they didn't, the monetary supply would be fixed except in rare instances where the Fed creates money ex nihilo. As you are doubtless aware, the money supply fluctuates constantly. Where you imagine those fluctuations in supply come from? The article I linked from the Bank of England also covered this, in bold, at the beginning. "Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money."
Indeed, if a bank makes a loan on its own book then there's a credit in the deposits account and a debit in the loans account. This has created commercial bank money. It's part of the M1 monetary aggregate.
Now as for the creation of high powered central bank money, I'll point you to the Federal Reserve Balance Sheet[0] where you can see that the Fed has created "around" 2.5 trillion dollars "ex nihilo" since 2008. Literally, they have printed that much money (it's reserve balances, but I'm sure the member banks could cash them in for physical if they asked Janet nicely). Now you might be surprised that the Fed (and other central banks) create money every single day. They also destroy it too. They do this by buying and selling securities which expand or contract their balance sheet.
> Deposits in this context are money. Loans are not. The bank gives you a loan for $100k. This creates an asset and a liability. (Double entry accounting is still mercifully intact.) The $100k sitting in your account now is literally money. You can spend it, transfer it, withdraw it, roll around on the floor in it, whatever you like. It's money. The $100k loan the bank marks down as an asset is not money. It can't be spent, only paid back. It can't be withdrawn, only sold.
If the bank creates a $100k loan "out of thin air" how can you withdraw it or roll around the floor in it? Do they print it out on notes which have the bank's name and logo on them?
> The fixed supply model of banking is intuitive but it's also insufficient describe how modern banking actually works. Everyone agrees that monetary supply is not fixed.
I'm not sure anyone ever said the money supply is fixed? That would be really problematic. The money supply changes by the second, you can see weekly numbers displaying fluctuations in central bank money and commercial bank money (ie: M0/M1/M2 etc) at the St Louis Fed[1]. It would be pretty weird for there to be a fixed money supply (even on the gold standard, after loss and destruction of the metal there's a ~3% annual expansion in supply iirc).
> I don't know what percentage of Chase's capital comes in the form of deposits.
54% in 2015[2]. Where do you think they get the rest of their capital? And how much would they have to pay for it?
> You're forgetting that the Fed pays 0.5% on reserves, which covers that $4000 cost. Obviously breaking even still isn't a functioning business strategy. The point is that banks do not have to lend every dollar possible in order to be profitable, not even close.
So depositing money with the Fed isn't lending it? Does that mean it doesn't show up on the left side of a bank's balance sheet?
> I'll decline to mock up a balance sheet for you. I'm not denying double entry accounting.
You'd be amazed at how simple it makes a discussion when you have a balance sheet and income statement. There's no conjecture, it's just facts. And thanks for the in depth debate! It's been a while since I TA'd this stuff in college.
[0]: https://fred.stlouisfed.org/series/WRESBAL [1]: https://fred.stlouisfed.org/categories/25 [2]: http://www.marketwatch.com/investing/stock/jpm/financials/ba...
Indeed, if a bank makes a loan on its own book then there's a credit in the deposits account and a debit in the loans account. This has created commercial bank money. It's part of the M1 monetary aggregate.
If I hold $100k of a student's debt, and that debt is 'extinguished' then it doesn't change the money stock in the economy. If a debt between 2 individuals is "wiped off the books" then a dollar doesn't "leave the economy".
I'm not sure if we're talking past each other or what.
> If the bank creates a $100k loan "out of thin air" how can you withdraw it or roll around the floor in it? Do they print it out on notes which have the bank's name and logo on them?
I'm not sure why you're pretending to have trouble understanding this concept. This is you being disingenuous.
The rest of this seems to be us definitely talking past each other. I'm not super interested in how Chase's assets and liabilities break out. I engaged in the conversation specifically because you seemed to be asserting that loan repayment doesn't destroy money. I'm not sure what you're asserting anymore, and the rest is tangential anyway.
There's also the discussion around fractional reserve lending, but I don't think we actually disagree much about the mechanics except that you think banks are essentially obliged to loan every deposited dollar and I don't, but I don't know this this is an interesting point to continue.
Borrow from whom? I've heard this idea before that the loans issued by a bank are essentially independent of the deposits, and it makes sense to me from a logistical perspective - is some BofA loan officer going to load up BofA's financials to make sure they have the money to issue the loan? No, they'll just do it, and it's someone else's job at the end of the day to "make it work".
But who are the banks borrowing from? If it's from other banks, doesn't it mean that in the aggregate loans and deposits are tied together?
In general, yes, the aggregated loans and deposits are largely tied together. There some fuzziness even here, though, as the Fed can inject money or move loans onto their books in a number of ways.