Money creation: who creates money?

IronWolf

Ok, there's a lot of confusion here, so let me explain it another way. People on youtube and certain blogs appear to be misinterpretting fractional reserve banking, mainly to ramp gold. Maybe we are all in agreement, but just explaining it differently.

When you deposit £100, you still have £100, it is yours, not the banks.
The bank will put £10 in reserve, and loan out £90 say. It can do this because it physically has £100 (the depositers).

That £90 has been "created", because £100 is still the depositers, and just because the bank has loaned out £90 doesn't mean the depositer has to wait until that loan is repaid. The "money supply" has increased from £100 to £190.

This is a conceptual money supply increase and is fractional reserve banking. If all depositers want their money back at once, the bank will collapse because it can't actually create money.

What fractional reserve banking doesn't mean, is that someone deposits £100, I put that in reserve with the central bank, and I can then lend out £140 if I want to. The bank cannot just create £140 to lend out.


Norfolk, ok I understand now, corporate bonds are not included in the ratio which is how lots of banks can get over 100%.

Norfolk_Jim

I though a deposit was a deposit. I was not aware that retail and commercial deposits were different in terms of loan to deposit ratios - though granted they are accounted for seperately on the balance sheet.

But if banks can only lend out what is deposited with them, there can be no credit bubble. For a credit bubble to form you need increasing money supply funding the expansion but other than places like Zimbabwe where they printed physical cash and recently the UK where the BOE did create money out of thin air and lend it out to the banks,
where has all this money come from in order that not just the UK but most of the Western world could overstretch itself

A system as described here would have a built in restraint in that it would be limited by the money supply available to it

How would I find out if there is in fact more money owed than there is money in existence to pay it back with. It would have to be the case if my suspicions were true but I dont know where to look for that info

jamesd

Norfolk_Jim wrote: »

In the case of Northern Rock the ratio was 322% hence a really small run on the bank caused a total collapse. For every 322 a depositor wanted to withdraw, that bank only had 100 in real money in reserve = utter disaster for Northern Rock

That's not what broke NR. What did that was the effective closure of the commercial money markets. When it had to refinance its borrowing it wasn't able to and ran out of money. It used the shortish term - few years- borrowing to fund its long term mortgage lending.

The run was just a little added pain at the end, caused by consumers acting logically in the knowledge that they would lose at least ten percent of the money deposited and 100% of any money above the limit if it went bust. This effect is part of why the limit has been raised and why the UK now has a similar 100% compensation scheme to the US - it reduces the incentive for consumers to take money out because all that can happen to most is loss of access to the money for a while. And there are now "living will"arrangements coming into play to eliminate that.

nicko33

debtcutter wrote: »

I can't think of another industry that has a theoretical ROI which is basically infinite.

with payday loans I think the return is even more than that

Norfolk_Jim

IronWolf wrote: »

Ok, there's a lot of confusion here, so let me explain it another way. People on youtube and certain blogs appear to be misinterpretting fractional reserve banking, mainly to ramp gold. Maybe we are all in agreement, but just explaining it differently.

When you deposit £100, you still have £100, it is yours, not the banks.
The bank will put £10 in reserve, and loan out £90 say. It can do this because it physically has £100 (the depositers).

That £90 has been "created", because £100 is still the depositers, and just because the bank has loaned out £90 doesn't mean the depositer has to wait until that loan is repaid. The "money supply" has increased from £100 to £190.

This is a conceptual money supply increase and is fractional reserve banking. If all depositers want their money back at once, the bank will collapse because it can't actually create money.

What fractional reserve banking doesn't mean, is that someone deposits £100, I put that in reserve with the central bank, and I can then lend out £140 if I want to. The bank cannot just create £140 to lend out.


Norfolk, ok I understand now, corporate bonds are not included in the ratio which is how lots of banks can get over 100%.

Yes thats what any rational person would think

And yes, the Gold rampers are a serious confusing influence with their obsession over some soft metal thats good for use in electronics are not a lot else

But what I would suggest is that the bank does not lend out the deposit money at all. It just keeps it.

Then the bank creates credits in its customer accounts - just numbers in a passbook or digits on a screen - but everyone - including other banks accept these numbers or electronic representations AS IF it was actual money.

After all, they dont phyically transfer your deposit money around, they just use it for the day to day ebb and flow of deposits vs withdrawals, which they have down to a fine art.

So long as everyone is happy with the credit "Money" and does not ask for a "cash" withdrawal en masse, all is well.
If a bank had sufficient assetts to cover all liabilities then banks would not need to be bailed out by governments. Their assetts could be used as security to ride out the temporary run.

As I think it works now - no bank can ride out a run on it as it has more liabilities than assets - worldwide

So - It boils down to two theories?

Banks set aside a fraction of their deposits and lend out the remaining funds as loans. But because most of those loan monies reenter the banking system you get a multiplier effect and the money supply grows as a result - but there is a fixed limit to how much Credit money will be created by the system.
A Multiple Deposit Creation system

or

Banks dont lend out the deposit money at all, they use it as the 10% fraction of total loans that regulation insists is in place. Then they create credits which people use as if it was money and repay at interest. The potential for increasing money supply is exponential unless a bust occurs.
The Debt as Money System

Now I'm sure all can tell I'm no economist and only know what I've read here or in the FT or online or on the much critiqued You Tube films - but I have the idea from somewhere that there has been much argument and debate about all of this for decades or longer , books, theories etc

Isn't it kind of wierd that there is any confusion at all? Shouldn't it be pretty simple really? Like it was when I was little - Johnny has 4p and spends 1p, how much does Johnny have left? 72p in non voting shares 13p in options and 1p adjusted for inflation!

Norfolk_Jim

jamesd wrote: »

That's not what broke NR. What did that was the effective closure of the commercial money markets. When it had to refinance its borrowing it wasn't able to and ran out of money. It used the shortish term - few years- borrowing to fund its long term mortgage lending.

The run was just a little added pain at the end, caused by consumers acting logically in the knowledge that they would lose at least ten percent of the money deposited and 100% of any money above the limit if it went bust. This effect is part of why the limit has been raised and why the UK now has a similar 100% compensation scheme to the US - it reduces the incentive for consumers to take money out because all that can happen to most is loss of access to the money for a while. And there are now "living will"arrangements coming into play to eliminate that.

If 10% was all they could lose you wouldnt need much of a compensation scheme. In practice its more like you would have maybe got 10% of your money back, not lost just 10% had there not been a bail out or compensation scheme in place

zagfles

Norfolk_Jim wrote: »

So long as everyone is happy with the credit "Money" and does not ask for a "cash" withdrawal en masse, all is well.
If a bank had sufficient assetts to cover all liabilities then banks would not need to be bailed out by governments. Their assetts could be used as security to ride out the temporary run.

That was what Northern Rock thought. They used their "assets" ie mortgages as security for loans from the money markets. But when the money markets started drying up, they became unstuck. Assets are only as good as the security that backs them, in the case of mortgages, house prices. If house prices go down, then their assets become less secure, and less people will accept them as security, or want higher rates of return for them.

As I think it works now - no bank can ride out a run on it as it has more liabilities than assets - worldwide

A run will always cause a problem, as people want cash, which the bank doesn't have as they've lent most of it out. They can't say to someone demanding their £100,000 deposit out - "here, take Mr Smith's mortgage".

So - It boils down to two theories?

Banks set aside a fraction of their deposits and lend out the remaining funds as loans. But because most of those loan monies reenter the banking system you get a multiplier effect and the money supply grows as a result - but there is a fixed limit to how much Credit money will be created by the system.
A Multiple Deposit Creation system

Yes. Though real money isn't multiplied, simply lots of IOU's created. Same as if you lend a tenner to a friend, who lends it to another friend, who lends it to another friend etc, lot's of £10 IOU's but only one £10 of real money.

or

Banks dont lend out the deposit money at all, they use it as the 10% fraction of total loans that regulation insists is in place. Then they create credits which people use as if it was money and repay at interest. The potential for increasing money supply is exponential unless a bust occurs.
The Debt as Money System

If banks could create credit out of thin air banks would never need bailing out, they'd never run into problems because they could just "create" credit! If a £10 deposit could enable the bank to create £100, then they'd just deposit that £100 and create £1000, and so on, and they'd never need the taxpayer at all!

Now I'm sure all can tell I'm no economist and only know what I've read here or in the FT or online or on the much critiqued You Tube films - but I have the idea from somewhere that there has been much argument and debate about all of this for decades or longer , books, theories etc

Isn't it kind of wierd that there is any confusion at all? Shouldn't it be pretty simple really? Like it was when I was little - Johnny has 4p and spends 1p, how much does Johnny have left? 72p in non voting shares 13p in options and 1p adjusted for inflation!

It really is that simple. Well almost.

Johnny spends 1p and lends 3p to his sister, who spends 1p and lends 2p to her friend. She spends 1p and lends 1p to Johnny.

There's 4p of real money, plus 6p of IOUs.

IronWolf

Norfolk_Jim wrote: »

Yes thats what any rational person would think

And yes, the Gold rampers are a serious confusing influence with their obsession over some soft metal thats good for use in electronics are not a lot else

But what I would suggest is that the bank does not lend out the deposit money at all. It just keeps it.

Then the bank creates credits in its customer accounts - just numbers in a passbook or digits on a screen - but everyone - including other banks accept these numbers or electronic representations AS IF it was actual money.

After all, they dont phyically transfer your deposit money around, they just use it for the day to day ebb and flow of deposits vs withdrawals, which they have down to a fine art.

So long as everyone is happy with the credit "Money" and does not ask for a "cash" withdrawal en masse, all is well.
If a bank had sufficient assetts to cover all liabilities then banks would not need to be bailed out by governments. Their assetts could be used as security to ride out the temporary run.

As I think it works now - no bank can ride out a run on it as it has more liabilities than assets - worldwide

So - It boils down to two theories?

Banks set aside a fraction of their deposits and lend out the remaining funds as loans. But because most of those loan monies reenter the banking system you get a multiplier effect and the money supply grows as a result - but there is a fixed limit to how much Credit money will be created by the system.
A Multiple Deposit Creation system

or

Banks dont lend out the deposit money at all, they use it as the 10% fraction of total loans that regulation insists is in place. Then they create credits which people use as if it was money and repay at interest. The potential for increasing money supply is exponential unless a bust occurs.
The Debt as Money System

Now I'm sure all can tell I'm no economist and only know what I've read here or in the FT or online or on the much critiqued You Tube films - but I have the idea from somewhere that there has been much argument and debate about all of this for decades or longer , books, theories etc

Isn't it kind of wierd that there is any confusion at all? Shouldn't it be pretty simple really? Like it was when I was little - Johnny has 4p and spends 1p, how much does Johnny have left? 72p in non voting shares 13p in options and 1p adjusted for inflation!

I'm no expert in fractional reserve banking, but I can't believe what you're saying actually happens, because it doesn't seem logical. And if something doesn't make sense then it isnt true.

If a bank can create money to loan out, why would it care about the credit worthiness of the person it's lending to? Why wouldn't it just lend out huge sums of money to everyone, if people didn't pay it back it doesn't matter because it was never real money to begin with.

While I dont believe banks transfer physical money around all the time, they do expect the bank transferring to them to actually have the money and be able to pay on demand. Why would they just willingly accept digital numbers from another bank?

The truth is that the current system, whereby banks only loan out to people that have a chance of paying back, only makes sense if they're loaning out "real" money (which I mean is backed up by a cash or an IOU for cash) rather than money they have literally just created on a computer.

kabayiri

The real answer to this question must be Mickey Thomas, the ex Wrexham and Man Utd player.

He actually did create money, until he was caught out of course. (Well, his fingers weren't actually on the printing press;))

Norfolk_Jim

zagfles wrote: »

That was what Northern Rock thought. They used their "assets" ie mortgages as security for loans from the money markets. But when the money markets started drying up, they became unstuck. Assets are only as good as the security that backs them, in the case of mortgages, house prices. If house prices go down, then their assets become less secure, and less people will accept them as security, or want higher rates of return for them.

A run will always cause a problem, as people want cash, which the bank doesn't have as they've lent most of it out. They can't say to someone demanding their £100,000 deposit out - "here, take Mr Smith's mortgage".

Thats right, they dont have enough cash to pay out the depositors. But if liabilites are less than deposits they can turn to the BOE as lender of last resort who would prop them up. Of course if liabilities are more than deposits the BOE would be less willing to prop them up because it would be throwing money into a bottomless pit - sound familiar?

Yes. Though real money isn't multiplied, simply lots of IOU's created. Same as if you lend a tenner to a friend, who lends it to another friend, who lends it to another friend etc, lot's of £10 IOU's but only one £10 of real money.

Totally agree with you - but all these IOUs are functioning as de facto money for as long as people continue to treat the IOUs that way

If banks could create credit out of thin air banks would never need bailing out, they'd never run into problems because they could just "create" credit! If a £10 deposit could enable the bank to create £100, then they'd just deposit that £100 and create £1000, and so on, and they'd never need the taxpayer at all! It really is that simple. Well almost.

Right. But just as Casinos prevent the Martingale system from working by having table limits - the BOE puts a limit on the money creation by insisting that 10% is kept in reserves and banks can not deposit in themselves to get around it. Thats why banks still want joe public to put their pennies in savings accounts.

Johnny spends 1p and lends 3p to his sister, who spends 1p and lends 2p to her friend. She spends 1p and lends 1p to Johnny.

There's 4p of real money, plus 6p of IOUs.

Brilliant! LOL - Give that man a prize. Good answer