Banks create money, but it's less impressive than it sounds
attejuvonen.fi
attejuvonen.fi
> That banks do not have any special powers in relation to money creation
They most definitely do though: FDIC insured accounts have legal government backing—a random IOU from me can't achieve that, no matter how much anyone trusts me. Put another way, a bank deposit seems less like an "IOU" and more like a "WeOU"—"we (the bank or the government) owe you". That seems like quite a fundamental difference, no? It seems to distinguish "fake" and "real" money (or banks).
The reason I attacked Werner's article is that he mystifies money creation and perpetuates the misconception that banks' ability to create money is similar to central banks' ability to create money (he does not directly say so, but a non expert reader is likely to gain this misunderstanding when he uses terms like "fairy dust" etc.).
In the article I attacked 2 specific claims of Werner. One was patently false. The other was correct due to a technicality only.
Although "technically" I agree with your article, banks have a legal definition, legal power and legal responsibility. That makes them special and gives them the legal power to create money -- not without limits, though. Banks can -- subject to some rules -- borrow money from the central bank, which will create said money for them. With repo rates hovering zero and all processing happening electronically, "out of thin air" is not really that far from reality. :)
I would argue that if I issue you an IOU, that is not real money: I do not hold a banking license, I do not keep track of all IOUs, I have no audit to pass once-a-year. In fact, I might drink away your deposited cash next day. :) The Full Tilt Poker example is relevant, but I would argue that that is illegal banking: It happens, but it really shouldn't. Wirecard is the other extreme: They were a bank (legally) and created money against the rules (I'm a bit oversimplifying).
I guess the common person needs to be educated about legal powers: For example, what makes this house special that I own it? A large enough hammer can open the door, as easily as my keys. In fact, if I sublet it, I might not even have the keys! Ownership, as money, are legal constructs that only hold value if they are properly enforced. Of course, enforcement is easier the more society accepts the construct.
Yes, but that is relatively recent development. Bank money (and IOU-based money creation) is much older than deposit insurance.
I'm thinking of things like https://en.wikipedia.org/wiki/Liberty_dollar_(private_curren... which ended in FBI raids.
Full Tilt Poker created a small closed e-money system which was seemingly legally fine; it was the gambling that got them raided, because only mob bosses in politically connected US states are allowed to profit from gambling and the US will go after gambling providers in other countries.
Liberty reserve were facilitating money laundering. This is the difficult bit - if you provide an electronic facility for easy transference of ownership of debts or e-money, the authorities want access to the paper trail.
No, there's a big difference, in that you don't have the right to redeem ("put") the corporate bond any time at face value.[1] You do have that right for the IOU that is your bank account. This allows two people to carry on as if they both are full owners of the dollar in the bank account (both the depositor and the business it was lent to), and that mechanism is what allows the money supply to increase.
When you don't have that right, you, as the corporate bond holder, know that you can only get the money out early by selling the bond at its current market rate, whatever that is, which may force you to take a discount. This expectation -- and the necessity to redeem it for someone else's dollars on the market -- prevents it from being money creation.
[1] There are "puttable bonds" where you can do something like this, but it's over specific intervals and times, not immediate. https://en.wikipedia.org/wiki/Puttable_bond
Even if everyone agreed to use your IOU from the article the tax office is going to have quite a bit to say on the subject and probably start launching audits. And if the IOU start getting traction they are likely to trigger police raids and maybe a legislative response (look at how Facebook dropped their Libra for example). That seems substantially different from the IOUs the banks can create.
I wouldn't use bank-issued IOUs if I thought I had a choice. I'm pretty sure I'm forced to by government policy.
IANAL, but the IOUs created by Full Tilt Poker were also legal to use. When the government eventually pressed charges in the debacle, no charges were pressed against regular players of the poker site, including those who used these IOUs for small economic activity. If using these IOUs would have been illegal, then surely the government would have pressed at least some charges after spending years investigating the case?
But anyway, even if _using_ the IOUs was not illegal, creating them like a fractional reserve bank surely was illegal. So you definitely have a point that the regulatory environment creates a special status for the legal tender of the country.
When I give a Amazon gift-card to someone, it is an IOU against Amazon, and most people will gladly accept it as money.
- How do you explain that the M2 money supply is always going up? Where is all that new money entering into the system? Government contracts funded by government bonds? If that was the case, government contractors would be getting very wealthy and everyone would be working for them (directly or indirectly)...
- How do you explain the recent, significant, almost instantaneous jump in stock prices of major tech companies after the Fed printed and injected trillions of new dollars into the economy? Did these corporations all suddenly score huge government contracts from the bonds which the government created? Seems more like investors and company insiders used loan money from banks to do stock buybacks or increase their positions.
- Under the model suggested by the article, how does one explain why there are so many millionaires are in the real estate industry? If you assume the opposite argument that banks are able to print money (directly or indirectly), the number of millionaires makes perfect sense since everyone buys houses using 'loans' from banks; so it's natural that all this free money from banks would constantly inflate real estate prices; each new generation of citizens would inflate the prices of the properties which were bought by the previous generation with increasingly larger loans from newly printed credit from their banks.
What is claimed by the article does not match the evidence, even the people have wised up to this scheme which is why Bitcoin and cryptocurrencies have been able to hold their value.
"creating money" is ambiguous to be nearly meaningless, "creating money in a way that noone else is able to" is a lot less ambiguous
Nonetheless, this is all irrelevant, people cannot legally create money (that would be counterfeiting), they can only create assets; only banks can create money and they can cherry-pick who is allowed to get credit and who isn't using whatever rules or metrics they see fit. All the new money enters the economy through loans and government bonds. Companies and individuals who are close to the money printers get most value out of the new money since they get it first (Cantillon effect). By the time inflation kicks in, these people who are close to the money printer will be able to take another bigger loan in the future using their existing collateral which will undoubtedly be worth more due to inflation in the nominal monetary 'value' of that collateral.
Deposit insurance is a fundamental difference but it's not the main difference. Individuals and most non-banks don't have access to Federal Reserve accounts and therefore access to reserves. The main distinction between a bank and a non-bank is the ability to create IOUs ultimately backed by reserves (whether they have sufficient amounts or not) which can only be created by the FR (and in this context) to back a bad IOU. Whether the new reserves go directly to backing up the IOU or indirectly via added liquidity is irrelevant. A bank can create a misguided IOU that defaults, which if too big to fail, is a liability that the FR and thus all holders of the IOUs, cash, and reserves must bear.
I'm not claiming it's the same. I'm saying these are differences of degree (my IOU vs bank's IOU), whereas the difference between central bank IOU and bank IOU is fundamental. We have several historic examples of central banks ruining entire economies by printing excessive amounts of money causing hyperinflation. Do you have a single example of a regular bank printing so much money that it causes hyperinflation? No. Why is that, if it's so easy for a regular bank to print a trillion dollars of fraudulent money without anyone noticing?
Side note regarding non-bank IOU: I found the idea of having a payment card from my grocery store very appealing. If they run out-of-cash, they can repay me in food, which I'm pretty happy to take at any time. However, that is not how it works in 2020. The grocery entity and the banking entity need to be separated, and have different licenses.
Quite a few of the grocery chain cards here in Sweden have accounts backed by chain-owned banks. So at least here, the separation is not all that great.
I understand that this is basically insurance fraud, but the money is gone long before the fraud occurs and the government must pay out, unlike a single insurer.
Facebook's digital currency system is one recent example. Paypal's behavior is a much longer-running example.
Back in the days of the gold standard you used to be able to redeem a set weight of physical gold from the central bank for a dollar / pound of paper cash or minted coin. This conversion ratio was set by the central bank and acted as a final brake on inflation. When the gold standard was abolished and the dollar and pound became free floating fiat currency, it only became worth something because the government says it is. The “I promise to pay the bearer x pounds/ dollars” is just a hangover from the gold standard days when you could redeem money for gold directly from the central bank rather than through a private gold dealer. Now you can only redeem an equivalent amount of fiat currency at the central bank if day your dollar / pound note becomes damaged.
Banks can create deposits / reserves at the central bank out of nothing, they just have to promise to pay the central bank back at a later date, plus an equivalent amount of interest equal to the central bank set interest rate. This is how the central bank regulates the interest rate in the economy. If a bank charges another bank a higher level of interest for lending than the central bank, that bank can just go to the central bank instead and get charged the lower central bank interest rate. This acts as a brake on maximum inter-bank interest rates and ultimately what interest rates are charged by end consumers. The same is true for cash deposits, the central bank acts a floor / minimum interest rate for deposits as the central bank will pay interest at the central bank interest rate for deposits held at the central bank.
That's the only nitpick I have against your otherwise excellent comment: it's not that government says it is, it's the societal consensus that it's worth it.
Of course, government is usually a pretty big entity it the country's economy, and since it uses the currency for all of it's transactions, currency acquires some value at least from these transactions alone; however, if the society as a whole loses trust in the currency, government will not be able to define it's worth. And when it tries, it just leads to black market, barter-based economy and even deeper economical collapse.
This is why the Scots are wrong to get in a fuss about shops not accepting Scottish bank notes, as shops are not legally obligated to accept them as legal tender does not apply in this case. Also, Scottish bank notes are not actually legal tender anyway.
This entirely depends on the legal framework in a given country. Some countries have legal tender but no necessary obligation, absent a contract, to accept coins or notes in general as payment of the contract.
Moreover, in the context that a person is likely to not accept the government mandated currency as payment, they're not likely to accept debt either. Such situations are common in times of hyperinflation for instance.
If governments could legal mandate that their fiat currencies have value, there would be no such thing as hyperinflation. There is such a thing as hyperinflation. Therefore, governments cannot legally mandate that their fiat currencies have value.
But they can make them highly valuable by demanding and collecting taxes. If you have to pay 20c in tax every time you buy a chicken for a litre of milk (because the government values a chicken at $1 and charges a 20% GST), then you're going to need some source of dollars - even though all your private transactions are denominated in litres of milk (or bitcoins or whatever).
As for Scots getting into a fuss, they are right to get into a fuss if they're treated less equally than other British people. You can say "oh, but the legal situation is thus" but that doesn't make the legal situation _or_ the social situation right. It merely means it exists (not, I suppose, that a person who attacks Scots could understand the is-ought distinction).
No English person would be hurt if every English person accepted Scottish notes at par; as you observe, the Scots are not hurt. Therefore, by putting up a barrier to free trade, they hurt their neighbors for no beneficial reason.
This is true up until the point one of the banks goes bankrupt, especially if they were found to have printed a whole lot of notes not backed by central bank reserves.
In practice, I strongly suspect the government would step in and accept the notes directly if that ever happened.
I think you may be getting confused between legal mandate and confidence. Governments certainly can, and do legally mandate the value of money in the form of fiat currency, that is the very definition of a fiat currency. However, society and the market can lose confidence in said currency thus triggering hyper inflation.
I’m not familiar with the legal situation in all countries, but certainly the UK, USA, and EU define legal tender as what one must always accept as settlement of a debt. That allows one to refuse payment if a prior debt does not exist, that’s why it’s legally acceptable to for shops to refuse high value bank notes for example.
Disagree. The government only accepts their preferred currency for payment of taxes. This is, in my opinion, its initial source of value. Secondly, they may literally stop you from using an alternative currency if they can't figure out how to tax it.
By "transactions" I also meant tax collection, yes.
> Secondly, they may literally stop you from using an alternative currency if they can't figure out how to tax it.
Usually, at the point where society as a whole loses confidence in government-issued currency, it no longer has resources to stop you from using alternative currencies.
I can identify with what you’re saying and there are some very well known examples of local currency being subverted. You can see Bolivia in the news recently, or Argentina or everybody’s favourite trillion dollar note the Zimbabwean kwacha. Funnily enough, all have been using dollars ...
1) Politicians around the world are circumventing central banks with special laws, guaranteed loans programs.
2) Central banks can just "temporarily" buy treasury bills with fictional money -- the only thing keeping us from Weimar inflation is the fact the money hasn't trickled down enough, the population is on the decline, and most of the money goes into propping up asset prices.
See Debt: The First 5,000 Years by David Graeber.
Money is basically a small abstraction over explicit debt bonds linked to material goods, making it more easily exchangeable.
This comes from the fact most economic chains are far from synchronous (example: a farmer needing tools to prepare his field, but being able to pay for said tools only after the harvest, the blacksmith needing coal and iron ore to produce said tools, but not being able to pay until the farmer has paid him, etc).
In this context, the banker (or any other lender) acts as an intermediary, evaluating if the debt can be repaid and bearing the risk instead of the creditor for a fee.
This is misleading. Gold was replaced by other assets, notably 'T-Bills'.
Basically, USD are backed by Government debt, instead of Gold.
To imply the Fed just 'says it is' is misleading.
Since 2008 a lot of the assets on Fed balance sheets are mortgages = notably, underwater mortgages bought by the Fed at face value from banks that were going bankrupt.
But I think the point about Gold->Other Assets is important.
Euros are backed by assets as well.
RMB is the major currency based on the magic will of one man, Xi, who can effectively control currency with the press of a button. We think that is 'bad' because money should be separate from governance, but they look at it differently apparently.
So imagine if Johnson, Macron, Trudeau, Trump etc. could literally decide how much money to 'print', to which banks it goes, and to whom the loans would be made, and under what terms.
This is they key limitation on RMB becoming a truly 'global currency'.
The article is a very worthwhile read though, so as to dispel a lot of conspiracy theories about banking.
Funny enough, there is a lot of shady activity in banking, but it takes a good understanding I think to make sense of it.
Inflation drives interest rates; interest consists of the rate of inflation plus risk and margin, no bank is going to make a loan at less the rate of inflation. This self-regultes the rate of loans; the first people to take out loans gets them cheaper than late comers and have more favorable pricing.
Business loans drive companies to leverage capital by taking out loans using their business as collaterol in order to capture market share (and rarely, creating new markets or shrinking existing ones through technological change). If they do not do this, they will be driven out of business.
Net on net, because the markets are not expanding at pace with interest, prices rise. I like to think of this as the accumulation of cumulative interest; effectively when every business in a supply chain has to pass its labor and material through a bank loan, the end product becomes much more expensive than production cost.
Cumulative interest acts as a tax on the velocity of capital, and when that stagnates, business revenues drop and companies\people begin to play a game of musical chairs of solvency.
What this is supposed to do, in theory, is kill off rotten businesses and ownership, and provide a capital market to ensure the economy can continue expanding and when you have commonwealth companies; companies that pay majority profits to employee's and put employee welfare and interests first; this works because employee's invest in the company during downturns to reap profits in upturns.
In practice, in every downturn, wages stagnate because businesses shed labor and do not have to compete for labor during the upturn. Governments are motivated to assure labor shortages are solved because paying staff more because they demand it never improves profitability of a business and is always a serious detriment. Because wages stagnate and do not recover, the profits from upturns are captured by ownership and investorship.
This cycle, historically, is not new, and tends to repeat until the people become so impoverished they lose their concept of self repect and dignity and actually think burning things and killing people are effective means to solving their problems which tends to break down systems of government and force governemnts to devolve to basal forms such as tyrranies, dictatorships or autocracies out of necessity.
E.G. Many western countries have negative fertility rates despite being the most technologically advanced societies in recorded history, and the way governments are assuring labor shortages do not occur is through replacement-level immigration which further radicalizes politics (it provides people making arguments about genocide with a lot of convincing empricial evidence in favor of their argument).
The paper is short and concise enough and the diagrams are very helpful to the uninitiated.
Money Creation in the Modern Economy: https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...
Would be cool to make it even more accessible. Something that can be shared virally via WhatsApp by my aunt. :D
I don't think that is fractional reserve banking.
FRB is the system where a bank is required to have a reserve of X% before it can issue money, while in the current system the banks first emits money and then (in the US) it attempts to get a reserve[0] for that (and in the EU, it doesn't either, tho there are liquidity requirements).
People mean: Bank has less "hard cash/assets" than deposit liabilities Technical meaning: The bank is legally/practically constrained to a fixed minimum reserve fraction of liabilities to harder assets
So banks DO have a "fractional reserve" even when not practising technical "fractional reserve banking"... I think
I do agree that, 0 being an integral, that name lost its meaning, but it's still the same thing, so people keep using the same name.
[1] https://www.deflation.com/Articles/The-Roving-Cavaliers-of-C...
[2] https://researchdatabase.minneapolisfed.org/concern/parent/b...
Edit: I've just briefly skimmed it [1], but "The creation of credit money should happen after the creation of government money." would be true if the system was working at capacity. The fractional reserve requirements are not really a limiting factor, the banking system in aggregate is operating well below that limit if I remember correctly.
[1] The 2012 article, for a few seconds; I didn't look at the 30-year-old paper beyond noticing the date in the cover
His articles make for interesting reading even now given his general rejection of mainstream models being inadequate.
https://theconversation.com/i-predicted-the-last-financial-c...
Uhh, yes it can. That's what LIBOR is (supposed) to represent - short term unsecured lending between major banks. I.e. they can agree that the sending bank is now slightly more indebted to the receiving bank. It depends on what the involved banks agree on.
And because such things are based on trust they do blow up sometimes. For example during the panic in March there was a pretty wide gap between FRA rates (unsecured lending) and OIS rates (secured lending). FRA was quite a bit higher.
Edit: let me just add that this does not invalidate the rest of the article.
The various types of money usually have interest rates associated with them, and those rates tell you about the relationships between the types of money. For example there is an interest rate differential between the central bank money and the US treasuries (which are equivalent to USD money for most people most of the time), captured by the repo rate minus IOER. This differential blew up quite recently (in 2019), showing a temporary divergence between tbills and "real money".
In the past, before central banks, each region of the US had their own money, and merchants had conversion tables. They would literally tell you that, for example, Boston money is worth for me only 80 cents on the dollar. Much like today we quote prices on bonds.
Robert Shiller has some really good finance lectures on YouTube. The one about central banking:
Both this article and the stuff Atte is responding to end up with "X is merely Y" explanations. The (arguable, but widely accepted) reality of macroeconomic and monetary dynamics is that it is not merely microeconomics. A layer of emergence separates the two.
It's true that what banks do is not fundamentally different to what full tilt poker did. Even the "bank run" parallels the many bank runs in history, and associated monetary collapse.
You can find other parallels too. My favourite is employees. Say you have no money. You hire 10 people clean pools, with salaries due at the end of the month. They work. You get paid. If you get paid enough, you can pay salaries on time and make profit.
This is the same principle as monetary stimulus, where a government makes loans to stimulate economic activity. We do call that money creation, but it's not fundamentally different to what every employee does.
IRL, a poker site or pool cleaning business will (almost) always hit a point of reversal. Expansion becomes deflationary rather than inflationary. Further growth requires capital, rather than generating it. The business models that don't do reach levels where their money creation starts to have macro-scale effects. These tend to join the financial sector (eg, the stock market), where they are regulated in some fashion to curb monetary inflations and deflations.
What makes banks qualitatively different is stability. They can do this long term, continuously increasing scale, without bank runs. Quantity is a quality of its own. If banks expand mortgage lending, real estate will inflate... either with higher prices or with more building. This isn't money that was redirected from one sector to another. It's new money.
This is why monetary policy isn't just central banking. It's regulators. The regulator controls this sort of activity (eg mortgage lending) in order to regulate the supply of money.
- M0: In some countries, such as the United Kingdom, M0 includes bank reserves, so M0 is referred to as the monetary base, or narrow money.[20]
- MB: is referred to as the monetary base or total currency.[17] This is the base from which other forms of money (like checking deposits, listed below) are created and is traditionally the most liquid measure of the money supply.[21]
- M1: Bank reserves are not included in M1.
- M2: Represents M1 and "close substitutes" for M1.[22] M2 is a broader classification of money than M1. M2 is a key economic indicator used to forecast inflation.[23]
- M3: M2 plus large and long-term deposits. Since 2006, M3 is no longer published by the US central bank.[24] However, there are still estimates produced by various private institutions.
- MZM: Money with zero maturity. It measures the supply of financial assets redeemable at par on demand. Velocity of MZM is historically a relatively accurate predictor of inflation.[25][26][27]
By the way, you can issue money too. Let's say you buy a computer for $1.000 and promise the seller that you are going to pay him $1.050 by next year. You just issued $1.050 of M2.
Counter-intuitively, this money supply system is helping developed countries control inflation. In some developing countries, inflation is harder to control because people are issuing money on their own.
Namely that if money is created only when you lend it to people, but they have to pay back what you created + interest, there is never enough money to pay all debts back. So bankruptcy is built into the system. It’s like musical chairs. It has to happen.
It was years since I saw 'Money as Debt' but I remember it as quite flawed in its arguments.
Let's say there's a silly town with a single evil bank. The good people borrow a hundred dollars in total. Horror! The evil bank is now owed one hundred and ten dollars. This can never be repayed, there is not enough money!
Except the good janitor at the bank has his wage of ten dollars credited to his account by the bank for the value created by his labour. He pays the grocer, the landlord and so on and now the silly town people can pay all their loans, should they ever want to.
And then the old grocer dies and his estate defaults on its debts. And it turns out the bank overvalued his house. The banks is now down ten dollars on its loan assets. But the bank still has its liabilities to the other good town people the grocer paid when he took out the loan. Suddenly the town can pay back all their debts and still have ten dollars left owed to them by the bank! The evil bankers are foiled.
'Money as Debt' goes to all this trouble to explain that money is debt. Then we are supposed to be shocked by the fact that debt can be created by no more than signing a paper! It's stupid.
And regarding the silly example, don't sweat the details. Try to think of the concept of what my example is trying to get across. Let's say the grocer died and a house fire and he hadn't payed for his insurance.
I understand the example, but surely these are outliers? Banks won’t give you a mortgage without insurance, and most people do pay their insurance. So banks can’t be taking that much of a hit except under extreme circumstances. Most of the time they do pretty well out of defaults. They just take the house and sell it. They’ll only lend to you in the first place if you have reasonable collateral (again 2008 housing crisis is a lesson they learned on that) but they still ultimately got the asset + all the money paid in interest up to that point. Am I missing something?
In the end, debt is a type of relation between people. And banking is a business with its own costs and risks.
But, probably more importantly, that relies on an ever increasing economy, which relies on ever increasing use of natural resources, which = earth is screwed.
It comes down to the definition of money. Yes non-financial intermediaries are very similar to banks and "create money" but money is defined as the amounts on bank's balance sheets so by definition non-financial intermediaries cannot create "money", but they are doing something very similar.
Also Nonintermediated debt is probably a better example. If you own a CD from a AAA corporate its effectively money but technically isn't.
A bond from an AAA corporate might not be money, but it's so liquid that it's as good as cash to me. :D
You can see different countries have different definitions. https://en.wikipedia.org/wiki/Money_supply#Definitions_of_%2...
Werner’s second claim is patently false, because the ”evidence” he presents in his paper only describes banks’ ability to create money out of thin air — he presents no evidence for non-bank entities’ inability to create money out of thin air. Thus, he presents no evidence that banks possess an ability non-banks do not possess. And yet, he claims to have done the opposite."
This is awful semantic gaming to "prove" that a false claim was made. If the definition of "money" is fuzzy and there are different kinds of money, if "bank IOUs" and "private IOUs" are materially and legally different from one another, then the strongest interpretation of Werner's words must be taken: He is talking about the sets of money that do not include IOUs from random private entities.
Clearly, banks are special in this regard and the amount of bank-created money on the money supply is enormous, whereas the impact of private IOUs is so minor that we can disregard it.
If we remove the distinction between private IOUs and bank IOUs, indeed you would have an example of a private entity creating money out of thin air, for a more loose definition of money. However, as we established, removing this distinction is unwarranted, bank IOUs are treated quite differently both legally and materially.
If we maintain the distinction between private IOUs and bank IOUs, then your example becomes simply irrelevant. Any IOUs that may be issued by private entities that are materially and legally different from bank IOUs have no bearing on Werner's claims.
I believe the empirical evidence for private non-bank entities not being able to create bank IOUs is that they're not banks. Am I missing something?
That's not what "empirical evidence" means. Empirical evidence is something we observe in the world. If we set a definition "all murder is illegal" and then we conclude "legal murders do not exist", do we have "empirical evidence" that legal murders can not exist? Of course not. We can conclude the claim is true by definition. That's not empirical evidence.
> You ask for empirical evidence ...
I never asked for empirical evidence for non-banks' inability to create money out of thin air. Werner claimed to have empirical evidence for this, and I merely pointed out that he does not have empirical evidence for this, contrary to his claim. If Werner had instead said "due to accounting conventions, we declare banks' IOUs to be money and non banks' IOUs to not be money", I wouldn't have any problem with that.
Hmm, you're right...
> We can conclude the claim is true by definition.
...which means we don't even need any empirical evidence to say that banks are different and unique from non-bank entities!
> I never asked for empirical evidence for non-banks' inability to create money out of thin air. Werner claimed to have empirical evidence for this.
No, he doesn't. He claims that he has empirical evidence for banks creating money out of thin air, nothing more.
> If Werner had instead said "due to accounting conventions, we declare banks' IOUs to be money and non banks' IOUs to not be money", I wouldn't have any problem with that.
Doesn't that go without saying, considering that non-bank IOUs, such as poker website deposits, aren't considered part of the money supply under pretty much any definition?
That's correct, and I said so in the article. I said that (although there is no empirical evidence) the underlying claim is true on a technicality.
>> Werner claimed to have empirical evidence for this.
> No, he doesn't. He claims that he has empirical evidence for banks creating money out of thin air, nothing more.
Here is a direct quote from Werner's paper: "We now know, based on empirical evidence, why banks are different, indeed unique … and different from both non-bank financial institutions and corporations: it is because they can individually create money out of nothing."
When Werner claims to have empirical evidence that banks possess a unique ability to create money out of nothing, he is technically making 4 claims:
1. Banks possess said ability
2. Non-banks do not possess said ability
3. Empirical evidence shown for claim 1
4. Empirical evidence shown for claim 2
Claim 4 ("empirical evidence shown for claim 2") is patently false.
This is a more reasonable reading:
Banks are different because they create money out of thin air. That has been generally accepted so far, but where is the empirical evidence for banks creating money out of thin air? It's in the paper. That's the contribution of the paper, to show empirically how new money is created.
We don't need evidence (empirical or otherwise) for non-banks not creating money, because that would be proving a negative.
If you want to attack the strong interpretation of the claim, you would have to show how non-banks do create money, which you didn't, because as we already agreed, deposits at non-bank institutions are not considered money.
I implore you to apply the principle of charity (steelmanning) instead of wasting your time on semantic disputes.
> we already agreed, deposits at non-bank institutions are not considered money.
...due to a technicality / accounting conventions. Yes, I conceeded that already in the original revision of the article. Nonetheless, I made a pretty good case why the IOUs created by Full Tilt Poker could be considered money, even though they were created by a non bank institution. Yes, the IOUs created by banks are "more like money", but in my view, the difference is not that large.
I think this is wrong in a subtle way. Regular banks have a reserve requirement that limits their ability to create money. They must hold a certain number of federal reserve notes to meet the reserve requirement. The Federal Reserve can create federal reserve notes.
The requirement was removed in the US in March 2020 but has been a formality for most banks for a long time.
https://www.federalreserve.gov/monetarypolicy/reservereq.htm
Even without laws requiring reserves, banks still want to hold some precautionary reserves to eg settle interbank transfers or to serve cash withdrawal requests.
But those precautionary reserves can be very small without causing much trouble. In Scotland in the 19th century they had about 2% gold reserves and where doing fine.
What's more important are equity cushions to take the blow of losses before the depositors do.
Scottish banks typically had about 30% equity cushions because that's what depositors demanded. (These days laws require about 8%. Depositors don't care much anymore, because government deposit insurance numbs them.)
Imagine a fraudulent banker who keeps adding billions to his own account. Suppose no-one notices. The banker starts to buy mansions and islands with this made-up money. Every time his bank transfers money to other banks (to buy those mansions), the bank loses some reserves. At some point the bank has no reserves left. Even if the reserve requirement was 0, having no reserves would mean that you could no longer transfer money to other banks.
And Scotland also didn't have them during their free banking episode.
What the Scottish banks had instead where crazy high equity cushions (like 1/3 of assets, instead of the about 8% common these days). But not because of any law, but because customers insisted.
Equity cushions are much more important in protecting depositors than reserves.
* What makes this author's explanation credible?
* Does anyone actually understand how money works, or are people trying to rationalize what we already have?
* All that really matters (to me) is the value is relatively stable and it doesn't create a crazy imbalance of power.
* Money does an okay job maintaining a stable value for some stuff (e.g. food), but an incredibly lousy job for other stuff (e.g. land).
That got me to thinking about a game I was recently playing and frustration with it's two in-game currencies, neither of which have anything to do with external transactions (such as obtaining DLC). One of those currencies could fluctuate in value based upon supply and demand (actually, how much you were trying to sell). Now that leaves me wondering if the game developers discovered that it was impossible to balance the game with a single currency (i.e. avoid an imbalance of power through the fluctuating value of currency).
In other words, did art avoid emulating reality because the premise of reality is fundamentally flawed?
I would say, no.. considering the divergence of expert opinions. Limited consensus have formed around high profile economists (eg Keynes, Friedman) but generally erodes as history throws up new examples that don't fit neatly into popular theories.
Monetarism is still the working understanding behind most central banking, but japanese staglation and later events (arguably including the current covid economy) have demoted it from "a theory of the truth about money" to "a method of doing central banking."
I do think that since pure fiat currency became the norm in the 70s, our understanding of money has improved. We are forced to conclude that "the truth about money" can only be found in financial systems, because there is nothing else anymore.
It's not really a question academics are trying to answer, atm. One reason is that trying to answer "what is money" is associated with all sorts of ideological quackery with a bad reputation. Another reason is that high prestige economics deals with a more pertinent question: "what should central banks and regulator do."
The economist who answers this question becomes the next JM Keynes or M Friedman. At the least, he becomes a central bank governor. This limits the field of search to stuff a central bank can do. Economic understandings are also generally curbed by what can be measured, and this also limits the field of search.
> * All that really matters (to me) is the value is relatively stable and it doesn't create a crazy imbalance of power.
> * Money does an okay job maintaining a stable value for some stuff (e.g. food), but an incredibly lousy job for other stuff (e.g. land).
These are not universally agreed to be products of monetary systems. Stability is, under the current theories used by central banks (mostly monetarism) but the others are explicitly "out of theory."
I would disagree and think it needs more details. There is difference between just 'how money works' and 'how economy works'. The first question 'how money works' is mostly just insitutional and legal knowledge of existing processes of central and commercial banks.
OTOH, 'how economy works' is empirical field of knowledge about complex emergent phenomenon - the economy, and contains questions like how would economy reacts on specific monetary policies. That is what macroeconomic theories like keyensianism and monetarism are about.
Microeconomics is "how the economy works," and while there are still divergent opinions, there's stability in that divergence. Ricardo is still foundational when it comes to trade, for example.
The premise of macroeconomics is that how money works is different to that. That started with keynes, and continues through keynesianism. Monetarism literally refers to "a theory of money."
The point is that it isn't mostly just institutional and legal knowledge of existing processes of central and commercial banks. Those things regulate and affect money, but how it works is macroeconomics.
But what happens when there is a run on the central bank of a country? If another bigger country (example Germany) bails out a smaller country (example Greece), then the panic stops. If no other country steps in, the currency becomes worthless (example Zimbabwe).
But what happens when there is a run on the largest central bank in the world (United States)? A bank so big that no other country can possibly bail them out, even if they wanted to? What happens when there is a run on the reserve currency of the world?
No one knows. It never happened before.
Also, what set of conditions will cause this run on the reserve currency? People have a lot of educated guesses, but because it has never happened in the past, there is no scientific data available on what does and what doesn't cause it.
No one knows.
It didn't help that Greece had just elected a extremist government to replace the corrupt one they had before. But all told, Greeks paid the price, not germans. The German bailout is populist rhetoric, and untrue.
In any case, every major monetary event is unique so "never happened before" is always true. That said, there have been many, many monetary collapses. The roman crisis of the 3rd century is a famous, empire-spanning one. The reason the gold standard was abandoned in 1971 was essentially a run on gold/dollars, the reserve currency of the world.
BUT I think the first part is actually a pretty good approachable explanation of the Federal Reserve and how our money works.
(from: https://nakamotoinstitute.org/reciprocal-altruism-in-the-the...)
I was just thinking about the immutability debate in the Ethereum blockchain world, where the community split due to a difference of opinion/interests on whether their system of money should allow a transaction reversal due to unintended effects of a certain contracts code on the state of the system (https://en.wikipedia.org/wiki/The_DAO_(organization)).
Those who were in the "code is law"/"immutability despite errors/malicious behavior" faction insisted that no change should take place, resulting in the loss of money/decreased action (state change) potential for the original holders affected by the unintended state change.
The more popular/valuable (by market cap) system of money (ETH) was the one where this change took place, though this was a one-time event. The state of the system was since not adjusted to reverse effects of hacks, accidental transfers/state changes of smaller impact (still millions of dollars equivalent).
Reversible systems need adjudicators which determine if a reversal should take place, and since this is a complex, subjective consensus issue, they pretty much must be humans, resulting in unpredictable and possibly unstable sociopolitical processes.
Fiat money derives its value through its utility (widespread acceptance in the exchange for goods) and its contractual enforcement ability provided by a states monopoly on violence (resulting in working contract law) and as the primary means of paying taxes.
An (unbacked) IOU has less value than central bank (digital or cash) money, because whether it results in delayed reciprocity is more uncertain (credit default risk, bank runs). In the same way, more irreversible money/settlement systems (like cash https://en.wikipedia.org/wiki/Real-time_gross_settlement) carry less of this type of uncertainty and risk but more of others (legal, last resort to violence to enforce state/or even consenus change, large losses due to mistakes).
Lock some amount of ETH up, get some amount of stable dollars out, which inflates the total amount of money in the system.
Now if you realize that that $100 is a mere IOU from the U.S. of A. you may get a feeling you are onto something...
And honestly, that's really not so different than gold. Why would the gold standard work? What intrinsic value does gold have? Again it only has that value because we trust it. If we stopped caring about gold, maybe if asteroid mining were to quickly result in 10 times the amount of gold that's currently available, gold would quickly lose that trust; same as when a government started printing money with wild abandon. As long as governments are responsible about the money supply, money is just as good as gold. But only as long as they are.
As a example of how much the value of fiat currency depends on taxation: https://www.irs.gov/taxtopics/tc420
Even if you barter without using any currency, the IRS wants a cut.
Interestingly, Clydesdale's office address isn't shown on the note.
So it is essentially an IOU for bonds, just not redeemable in retail (by individuals) but in bulk (by commercial banks). If commercial bank wants 'redeem' some cash (for bonds), then it just acquire less cash in the next round of repo operations.
Doesn't this create a feedback loop?
Let's take the example where the bank loans out $10 and wants back $11. The money created in this example is not $1 (when the loan is eventually paid back and the bank makes $1 profit), it's $10 (when the loan is initially given out).
Let's imagine that the bank does not want to make a profit and only wants back $10. Even in this example the bank is creating $10. If you sum up how much money everybody has, people have $10 more money the moment the loan is given out.
It also doesn't always get the dollar, or even the principle. Lots of people borrow the $10 and only repay $5.
If the value created from the loan covers the interest, then the whole thing is a net positive for the economy,
otherwise it's a net negative.
The primary cognitive dissonance with other people comes from tying morality to prosperity. Or put simply "some people deserve money and when that criteria is not satisfied it is controversial", but what they really mean is that "someone should have the ability to have goods and services more than others", with the money itself only being a reductive surrogate to make that happen.
The further you abstract yourself away from that, the easier it becomes to operate and see opportunities, or how to exchange time for more food and shelter in a more efficient way. How to have enough resources that the money itself looses additional utility, no different than how an abundance of oxygen looses its utility while a known upcoming absence of oxygen will redirect all of your thoughts and resources into making sure that doesn't happen.
Yes, it should not be a mystery how banks can create money.
The universe of investible assets available for the central banks are small, they need your help in providing a service to them in the primary market (credit markets, corporate bonds). Direct issuances were always going to happen, if it wasn't the pandemic it would have been something else. Anything that slowed down China's growth would have resulted in the same outcome. There is no transparency in direct issuances, you just need to appear or structure your offering as credit worthy. There are no consequences. Some people are ready for this specific outcome, if you think you can steward money better (or just want a lot of it for whatever reason), you should structure an offering for this.
Central Bank direct and primary market operations are going to continue as their universe of investible assets is small, their monetary policy is not able to achieve the behaviors of market participants that they want as it requires associated fiscal policy changes from legislature and results. Central bank's stated goals for their monetary policy is disingenuous as they do not care about inflation targets or GDP numbers, but they do factor them in. They are just tools to alter and manage the yield curve as they just buy bonds from their friends at a profit.
Yield curve based monetary policy doesn't work to its stated goals due to a fundamental misunderstanding of what people want. Dropping yield curves don't cause as much growth in the real economy because people just don't want to give random entrepreneurs their money. People are willing to pay to not do that. Negative interest rates are therefore not controversial and can go much steeper than any central bank has experimented with. People would be willing to pay to keep their money.
Fed and Central Bank balance sheets should not be seen as a threat or overhang to the markets, as it doesn't need to sell credit assets, it just holds them to maturity. It and other sovereign wealth funds have an infinite time horizon.
Conspiracies about central banks and their ownership structure are irrelevant. Orphaned entities like trusts are common structures. There is a lack of transparency in some areas either way.
Don't just pay attention to the Fed, ECB and BOJ. There are plenty of Central Banks on the periphery of the EU who must react and expand their universe of investible assets before or after the ECB/Fed.
In smaller markets you can have a lot of influence as an individual. As in, you can get the ear of a regulator or the upper echelon, or even the stewards of a central bank, just by having a good idea and understanding their needs, interests and psychology. Compared to attempting to earn a pedigree you weren't born into.
The Swiss National Bank is amazing for Swiss people, but it should probably be considered a national security threat to the US markets. Since it is not, it is more likely that the SNB is part of a coordinated stock market growth arrangement with the US, as their stock purchases of individual companies with newly created CHF is not something the Fed is authorized to do, yet.
I wish more central banks were publicly traded like the SNB.
Liquidity of the currency shows the tolerance of distribution. Think of inflation like corporate stock dilution, if the market is liquid then you can create more without undermining confidence in that market. Think of government currency like shares of a country/economic union. People are uncomfortable with the idea of analogies that show the similarities between private organizations and states formed to serve the people.
Hyperinflation is not as big of a threat when all major currencies are doing it at the same time. Coordinated inflation masks hyperinflation of any individual currency as their value relative to each other stays similar while the supply of all of them is increasing. The price of individual consumptive goods can still increase dramatically, but the price of the currency and confidence in the currency is not shaken, so the credit markets remain resilient. Countries outside of the economic union who have freely adopted the currency have much bigger issues to reconcile.
Market signals are missing in the real estate market. A few hundred thousand playing with historically low interest debt (due to central bank activity) is a distraction, real estate agents and mortgage underwriters getting "so much business" should not be trusted, indeed this is all they see. Several million people defaulting is a bigger and looming issue.
Pay attention to the corporate credit market. The steeper the yield curve goes, the more it drags down the cost of credit for corporate issuers. Getting aggregate corporate credit information in these markets is hard but rewarding, you can predict what to expect - investment grade corporations bonds yielding 0% possibly issued at 0% - but it is hard to confirm the market appetite. This is where we are right now in market efficiency.
A bank can store money in the central bank, but it can also put cash in a vault. If the central bank has steep negative rates, why would they use it for much?
This used to manifest as "hoarding specie", but economies have also hit deflationary problems of hoarding physical cash. Not sure what that would look like in a world of widespread electronic payments. You'd probably have to pay a premium to get cash from an ATM. Banks would start making it easier to deposit small business cash and harder to obtain rolls of change. Eventually at high enough negative rates people would be paying an (electronic) premium on the face value - you give me a $10 bill and I paypal you $10.50?
I think you haved to be careful about attributing your success or ability in one field to a generalized philosophy that you have.
Just looking around empirically, "successful" and "unsuccessful" people seem to vary wildly in ideology. Stallman, Thiel and Bill Gates have pretty wildly varying ideologies and are all successful, I'm sure you could find 3 unsuccessful people with similar ideologies.
I'm moderately OK because society currently values ability to solve quite formally defined logic puzzles and I was in a sociological place to get a couple of pieces of paper that statistically indicated some combination of privilege and ability to do the former when I was 18-21.
That might not even last, never mind demonstrating philosophical superiority. If I make a few million or achieve inner peace in the next decades it still won't prove too much, since there's so many other people of all philosophies going in all directions.
I also make the darts and choose the walls
"I promise to pay the bearer on demand the sum of <value> pounds"
Signed by the Chief Cashier of the BoE
The current legal basis is the Banknotes (Scotland) Act 1845: https://www.scotbanks.org.uk/history/banknote-history.html
It explains how banks work today in a patient and and accessible way that helps you really "get" it.
Every time a loan is used to pay for goods or services, some fraction of that goes back to “the bank” where 90% of it can be loaned out again. Best case, where all money is moved electronically and instantly, I keep seeing that 100 dollars go out and come back a little smaller over and over and over again. The tenth time I see it I can write a loan for about $30.
The thing that seems to confuse people is the abstraction mechanism by which the $1,000,000 depositor doesn't see any of the $850,000 debt, and the by which they can withdraw the $1,000,000 without being involved in any debt transactions themselves. Fractional reserve banking doesn't create money out of thin air, it's just a system that allows for deposits to be put to productive use. The alternative is that deposits are entirely withdraw from the economy completely until the depositor wants to use them, which would be the economic equivalent of hoarding all your money under the mattress.
The rest of it also doesn't really "go to the bank", it's money that they must have on hand to service withdrawals, and absorb defaults and other losses.
It doesn't increase currency (M0).
But is there 'money' in your bank account? They increase money by a slightly broader definition (accounts + currency).
Even if you've got a narrower definition (and just want the physical paper to be defined as money, not entries in a database) then they don't increase the amount, but they greatly amplify its effect by increasing the velocity of circulation (which you did mention). One little bit of money is being thrown around between owners much faster, which effectively magnifies its impact.
Money is literally defined simply as "currency plus bank accounts" so obviously funding a bank account creates "money".
Your post gets into the velocity and momentum of money, which is yet another concept.
An advantage of that system was that banks did not lose reserves when customers withdrew money, ie converted deposits to cash.
(The banks lost reserves when those notes were eventually deposited with rival banks who demanded settlement in underlying reserves.)
Of course, even that system did not multiply the amount of reserves; you might call them M(-1), if you are so inclined.
Historically the underlying base money was gold, but you could imagine a system with private bank notes built on top of the federal reserve dollar just fine. You can even leave physical Fed cash in circulation, too.
They do it by keeping enough money laying around doing nothing, to service those withdrawals. If all of a sudden huge amount of customers started making huge withdrawals, they wouldn't be able to service them, because they wouldn't be able to liquidate those assets immediately. If banks were actually creating money out of thin air, this wouldn't be possible, because they'd just be able to create some money out of thin air to service them.
Unpaid loans and interest are not accounted for and create a need for even more loans to create more money out of thin air but of course those additional loans also have interest and are also unpaid so it spirals out of control.
Both the processing fee and profit margin circulate within the economy. They are not part of the loan, they are fees the bank is charging and using to pay its employees and shareholders who then spend that money. It is entirely possible that you are working for a bank and receiving that money as a paycheck, or your bank is purchasing services directly or indirectly from a company that you are working at.
When you think about it, central banks are not any different. They charge a fee and then send the profit to the government which then can spend it on services that eventually employ you.
You own a farm and borrow 50k from a bank that has $10k in its reserves. The loan has a duration of 10 years at 2% interest so you have to pay back 60k in total. You pay back $6k every year. The bank purchases $1k worth of food every year. The end result is that you have paid $60k to the bank and the bank has paid you $10k.
That bank debt is backed by all the kinds of bank assets that you mention. Plus perhaps some government deposit insurance.
The bank takes the new deposits and loans out 85% of it ($723k) to another small business. This small business goes and uses it to pay its employees and they all deposit the money in the bank. Now the bank has $2.573m in deposits.
The employees and the manufacturer can all withdraw the money at any time. So I struggle to see how this isn't creating money.
The fractional reserve system lets the bank loan the same dollar out multiple times. How isn't this creating dollars? If the bank takes one dollar and loans 85 cents to you and 73 cents to me, isn't there more money?
This isn't quite correct. If all parties go to withdraw their money at the same time, the bank will not be able to give it, because they only actually have $1M in reserve.
In practice, if there are more withdrawals than than the bank has in reserve, it is usually able to get short term loans from the central bank which than ACTUALLY creates the money and loans it to the bank.
However, over the long-term if too many of the bank's loans default, they won't have enough assets to cover the deposits, which is how banks usually fail.
It absolutely matters how many times the dollars come back to the bank because that is the pathway that lets the bank loan the same original dollar out multiple times.
In your example though, the bank has a different problem of offering unsecured loans, which could lead to some losses for them.
Not all of a sudden, as in instantly, no, but there will be. See below.
> There is $850,000 worth of debt held by customers, and another customer with a $1,000,000 balance
Yes, but what do those other customers do with that $850,000 of debt? They either deposit it in another bank, or they use it to pay someone for something, and that someone deposits it in another bank, or...
In short, virtually all of that $850,000 of "debt" ends up as $850,000 of additional bank deposits in other banks. And to those other banks, those deposits are simple deposits--there are no debts (yet) against them on the other banks' books. So there is nothing to stop the other banks from lending out as much of that $850,000 as they can again. Which means the other banks have just turned what was $850,000 of "debt" into $850,000 of new money.
> Fractional reserve banking doesn't create money out of thin air
Yes, it does. I just explained how.
> it's just a system that allows for deposits to be put to productive use
More precisely, it's a bad system for putting deposits to productive use, because it mismatches maturities and therefore leaves the entire financial system open to bank runs, which then have to be prevented by additional "protective" measures. Which will sooner or later fail, and fail all the more catastrophically because the protective measures enable financial institutions to hide the fact that bad investments are being made.
The correct way to put deposits to productive use is to make them time deposits, not demand deposits. In other words, if you have a spare $1,000,000 that you have no good use for, you deposit it in some financial institution for a period of time, say a year, or 5 years, or 10 years, and that financial institution promises you some particular rate of return over that time in exchange for the use of your money to finance productive endeavors. Of course this is just another way of describing a bond, or a certificate of deposit, or a money market certificate, or whatever your financial institution chooses to call it.
But suppose you buy, say, a 5 year bond with your $1,000,000, and then, a year later, you find you need the money? Well, that's what a bond market is for--so you can sell your bond, at a fair market rate, and get cash in exchange, while someone else has now invested their money for the remaining term of the bond. There is no need for the financial institution to treat your $1,000,000 deposit as a demand deposit, withdrawable at any time, while it is transforming maturities by investing that money in other productive endeavors that take time to mature, just to shield you from unavoidable uncertainty about the future. There is certainly no need to expose the entire financial system to possible collapse to do this. The only reason this wacky system persists is that people in power benefit from it, and ordinary people have gotten so used to it, since it has been around for so long, that they don't connect it with the occasional meltdowns that it causes.
The debt is an asset held by the bank until it is paid off, is sold, or is defaulted on.
Person A deposits $1M
Person A $1M, total deposits on hand = $1M
Person B takes $850k loan
Person A $1M, Person B $850k, Person B -$850k debt
Total deposits on hand is STILL only $1M. The combined balances are 1.85M but these are just entries that have no impact on what is actually in the bank's vault/account.
If A and B both ask for their entire balance at that moment the bank will have to go to the overnight window or some other facility to take a short-term loan that it will owe interest on and may need to provide collateral to receive.
In that case the bank's overall balance sheet would be $-850k of debt it owes someone. Because that debt isn't collateralized their rate will probably be higher. This is what led to things like the credit market freeze up that the Fed needed to step in to provide liquidity for. Banks usually borrow from each other not just the Fed, but when shit hits the fan banks might not be willing or able to loan to each other except at extremely high rates.
When the bank repays its loan (perhaps when Person C is paid by B and deposits the money into their account) the situation will unwind and we'll be back to the previous situation.
In real life it's much more complicated because the bank probably has many other types of assets like CLOs, CDOs, etc.
https://www.investopedia.com/ask/answers/040715/what-differe...
Sometimes the Fed will take assets as collateral for a loan and the bank is expected to repurchase it later at a slightly higher price a/k/a the Repo market
https://www.bankrate.com/banking/federal-reserve/why-the-fed...
yes there is - because consumer's behaviour is irrational, and they cannot easily calculate the required interest for such a bond. A demand deposit is easy for a consumer to understand, and the bank can pay less than the equivalent bond interest, and pocket the difference.
There are termed deposits that banks offer. But consumers have overwhelmingly not chosen to use them imho, because it doesn't offer high enough interest rates, and the hassle of illiquidity isn't suitable for a consumer context.
That will not work for normal accounts where peoples salary are deposited in, they need to use that money over the month.
Also my savings account, I dont know when I will need the money. There might be emergency expensive repairs needed to my house or car that I need to take from that account.
Yesterday, I read about the role of banks, I found two quotes:
“Banking was conceived in iniquity and was born in sin. The Bankers own the earth. Take it away from them, but leave them the power to create deposits, and with the flick of the pen they will create enough deposits to buy it back again. However, take it away from them, and all the great fortunes like mine will disappear and they ought to disappear, for this would be a happier and better world to live in. But, if you wish to remain the slaves of Bankers and pay the cost of your own slavery, let them continue to create deposits.” [1]
“Give me control of a nation's money and I care not who makes the laws.” [2]
[1] http://libertytree.ca/quotes/Josiah.Stamp.Quote.69BB [2] http://libertytree.ca/quotes/Mayer.Amschel.Rothschild.Quote....
Banks which participate in a central banking scheme (such as the Federal Reserve System) have a license to create IOUs which are authenticated by the government which sponsors that central bank. In other words, such banks can create IOUs that are backed by the full trust and credit of the government, not merely their own trust and credit as a business enterprise. I'm not sure I would characterize this as "impressive", but it is most certainly a privileged and unique position over the rest of us.
Alice asks ABank for a $100 loan at 10% interest to buy some fidgets from Bob Bob asks BBank a $100 at 10% interest to buy some doodads from Alice
ABank creates a $100 credit line for Alice, and creates an asset of $110 future revenue payments. BBank creates a $100 credit line for Bob, and creates an asset of $110 future revenue payments.
Bob and Alice make their deals each paying with their respective debit cards.
ABank and BBank settle their transactions with a net 0 transfer.
Alice and Bob both repay $100 to their outstanding loan.
Both ABank and BBank now own $10 in future revenue from Alice and Bob respectively. You can argue that 'technically' ABank and BBank didn't 'create' the money, they merely created the legally backed first row claim to that money that will be created.
-banks can create money when they issue a loan, because, if all things go well, the created money will create wealth.
-banks cannot create money when they return money to depositors, if they don't have that money, because if they did the created money would not correspond to created wealth.
I.e. fractional reserve banking exists because what can be created with money, i.e. the actual wealth, can come after money is created, and not before: first money is created out of thin air, then that is used to pay people, which create wealth. The old system with the gold standard was limited because it depended on the amount of gold that existed.
https://www.sciencedirect.com/science/article/pii/S105752191...
It's like saying that nation-states don't have a monopoly of force, because I can shoot my neighbour, or that I support abortion but I think you should be jailed afterwards.
Only banks can create money without getting locked up in jail.
That's the important point, and this article adds or takes nothing, other than a very weird dodge with the justification that somehow legality isn't a primary consideration.
It's as interesting as saying you don't have to pay your taxes, (small print: because you can choose to go to jail instead).
OPEC sells Oil exclusively in US dollars https://en.wikipedia.org/wiki/Petrocurrency
So when somebody creates an IOU trusted enough so it could be resold, they have effectively created "money" according to the above definition, because now that IOU can be traded _independently_ of the thing it was originally exchanged for.
I think what confuses lot of people about this is that creation of money is a 3-sided transaction, and we are conditioned to think of a market economy as a sequences of 2-sided transactions.
Also, what I find very funny, some libertarians want to impose government to only create money backed by a commodity, like a gold standard. Yet their fundamental axiom is to allow any two parties to enter (almost) any contract, in particular, allow them to create and resell IOUs. However, if the government has to enforce any contract that two parties can come up with, this is already giving too much freedom for the money to be created regardless of the actual commodities in existence, and regardless what the government does.
and this isn't the case (yet) with the USA - despite the rampant increase in money supply. Unlike other hyper-inflating economies such as Venezuela, the USA gov't isn't printing money to meet it's obligations, but instead turning illiquid assets (such as bonds and treasuries) into liquid assets (cash), that can then be used to grease more commerce and transactions. I don't believe this can cause hyper-inflation that many fear (and thus turn to buy gold/commodities), because the money is backed by debt, which has to still be paid pack.
Highly recommend this video to understand and this channel in general: https://youtu.be/K3lP3BhvnSo
Skip to 1:14.
Of course you sterilize (cancel out) that creation when you pay the credit card bill.
But I am engaging in some hair splitting, I admit.
In india, all deposits are considered liabilities (since you need to pay the customer interest on it).
All loans are considered assets (since you make money on them)
It's usually raised using deposits. Unless I'm missing something
Say a bank would accept deposit and issue loan in Bitcoin. We apply the same example as in the article. Someone deposit 100BTC. Another person takes a loan of 10BTC and owns the bank 11BTC. (that would be much bigger value than $100, but the principle is the same)
Would the total number of Bitcoin be higher than before those transactions ? That would break the hard limit on the total number of Bitcoin. My understanding was that hard limit was a key feature of Bitcoin.
The number of Bitcoins in the ledger/blockchain would not increase, but if you asked everyone how many Bitcoins they owned and summed it all, it would have increased.
To use the standard terms, the hard limit on the number of BTC in the ledger/blockchain is M1. You can have an increase in M2/M3 without an increase in M1.
Debt created by a bank through a loan can never truly be repaid. The debt is just passed on to another place in society, and the society as a whole remains forever indebted to the bank. Sinister in its very essence and a form of true evil.
If I have a check account with $0 balance and you have the same we have no money. If I write a check for $100 and you deposit it suddenly you have money - created from thin air.
Nothing in this blog post comes even close to supporting the idea that banks have no special money creating power.
The hidden assumption is that this "iou power" is not regulated or enforced by government control over the money supply.
That you can write a cheque and then not cash it, and that a poker site can commit fraud, do not make banks unspecial.
This is just a libertarian is/aught fallacy dressed up in a lot of words.
And I mean, the vast majority of money in circulation does not come from the money printer or even the central bank's own ability to duplicate money, it comes from the multiplicative recirculation by banks.
The banks have been both legally empowered and de facto relied on to do this money creation on behalf of the government in ways that other people and organizations are not allowed to do.
Just witness the largely successful regulatory crackdown on cryptocurrency services, or the fact that "point exchange systems" like Xbox live points to to great lengths to insist that their points are not recoverable into dollars to avoid regulations as actual evidence that banks are not accidental money creators but an empowered subsystem of the process of making money exist.
Though to make it absolutely the same position, Amazon's currency should not be tied to the dollar but freely floating.
Then there can be no run on Amazon's currency, just like there can be no run on the dollar. However, of course, both Amazon's currency and the dollar can lose in value compared to goods and services or other currencies.
Well, that's not just a legal barrier there, but also that the people on the other side of that transaction don't like to be robbed.
People deal in currency blackmarkets all the time, and all participants are willing. Obviously, being able to do business out in the open is much more efficient and productive. And especially eg Amazon as an above board organisation could not engage in blackmarket operations without endangering their legal activities.
If Amazon is selling their own stuff for Amazon bucks (and people still want to buy stuff from Amazon so that Amazon bucks have a non-zero market price), there's a minimum finite amount of Amazon bucks that I would gladly accept.
If Amazon bucks weren't very commonly used (think like bitcoin today), I would probably ask for a premium over USD just to make up for the inconvenience of having to exchange them.
If Amazon bucks were more commonly used in daily life than USD, I might even accept a slight discount.
> If you worked for amazon, would you accept amazon bucks as salary?
That's actually an even easier question. Amazon already pays their employees partially in Amazon stock. At a big enough stock offering (and frequent enough vesting), I'd happily accept an all shares compensation.
Now, Amazon bucks would be different from Amazon shares. But the only thing that matters to me when accepting compensation in shares is how easy it is for me to convert the shares (or bucks!) into something I actually want later.
I'm sure I could issue a OMGPWNIOU, but difference is, that no one will accept it as payment.
In this case they were like a _Ponzi Scheme_ and not like a fractional reserve bank as they had _no assets_ to redeem the claims of their depositors with.
Pokerstars (from what you've described) was operating in a manner similar to a fractional reserve bank.
If you want to characterize Full Tilt Poker's operation as a ponzi scheme, I have no problem with that. Full Tilt Poker was operating as a fractional reserve bank, and in addition to this it was siphoning assets of the bank to its owners.
Wow. This is a flat out lie. Banks operate on a fractional reserve system and they are allowed to loan out more money than they have. It's not just about swapping an IOU between a depositor and a borrower. With the recent COVID-19 regulations, banks don't need any reserves at all anymore. The Fed had been constantly lowering the reserve requirement over the years, effectively causing an infinite but controlled supply of money to enter the economy with financial firms being the biggest beneficiaries.