I provided four cites, which is, let’s see, one, two, three, four more than you did.
Nowhere in that quote do I say anything remotely similar to that.
The country and the economic system I live in started in 1789. And you’re misusing schtick.
This is not the Pit, it’s Great Debates, so lets stop short of personal insults, please.
RickJay
Moderator
As best I can tell, the OP’s argument suffers from (at least) one basic flaw.
If Ultravires, Inc. loans you $1,000 and then goes bankrupt or goes out of business, you don’t get to say yippee, free $1,000. The right to receive repayment of the $1,000 is an asset to formerly Ultravires, Inc.
If I am bankrupt, that asset now belongs to my creditors. If I cease all operations, then the equity partners have a right to collect, and if there no equity partners and I am just a nice guy, then I suppose I could say, “You know what, just keep the $1,000” but who does that in financial transactions in any extent to make it problematic?
How many banks just say to you, “You know that mortgage or that car note? Forget about it. It’s on us.” Is that the alleged flaw in the system that everyone is so generous that they are just voluntarily refusing to accept being repaid?
This thread appears to be quite a mish-mash. Let me try to help disentangle some of it.
First of all, the “catastrophic flaw” in OP’s title is just some sort of joke. If there was some Gotcha where bankers could swindle billions from the taxpayers they’d be doing it. (And in fact they are doing that, but not in the simplistic way OP imagines.)
On the matter of fractional reserve (as it worked in the pre-2020 era :eek:) it was quite legal for a bank with only $10 in cash to loan $100 if it was in the form of a checkbook. It would have been absurd — the bank would fail as soon as Hermione’s Hookers presented an $11 check for payment — but legal. And quite workable for the simple reason that banks have hundreds or thousands of customers whose activities cancel out, not just a single customer wondering if his check to Hermione is going to bounce!
As for inflation figures being doctored: the BLS has charts breaking the CPI basket into its components. Yes, the 12-month change in Food has spiked to 4% due to the pandemic, while net CPI is zero. But these components fluctuate: Food’s inflation rate was zero (according to BLS) in summer 2016 when CPI was over 2%.
Is the “Cantillon Effect” real? I think it manifests in various ways: (a) the indestructible stock market, (b) the huge wealth accruing to insiders during the housing collapse and run-up thereto, and (c) the continued transfer of wealth to exporters like China while American wages decline. Are all of these examples of the “Cantillon Effect”? Am I missing a bigger picture?
I think the “Dr. No” personalities are attracted to sectors like news-media or politics. Bankers are invested in the status quo.
Is financial armageddon just around the corner? Maybe. But most of the doom-sayers have the details wrong, IMHO.
I guess I just imagined the subprime mortgage crisis then.
Bankers are not moral paragons that will refuse free money because it contradicts the status quo. If the OP’s “catastrophic flaw” were real bankers would have gone for it whole hog and we would all be eating bark by now. Long since, even; it’s not like fractional reserves are a new concept, after all.
With respect, I think this statement is confusing two concepts in a way that is wrong.
The point of fractional reserves (as noted by others) is that the amount of deposits on a bank’s books may be significantly less than the amount of cash in their vaults. Those deposits are loans to the bank, and liabilities on its balance sheet, not loans by the bank and assets on its balance sheet (I deposit $100 in my account, and the bank promises to pay it back to me on demand).
As you note, the classic run on a bank is when someone with $100 on deposit at the bank tries to withdraw it, and can’t because the bank only has $10 of cash. (and, I add, only a problem if the bank has no other way to get more cash–which it could, for example, by borrowing against or selling its non-cash assets).
A checkbook is completely different. It’s not a loan from the bank, nor is it a record of my deposit with the bank. Instead, it is a document I use to withdraw the amounts I have on deposit at my bank, just as I could using an ATM. Specifically, the check is an instruction from me to my bank, to pay a sum certain to the payee on the check (or whoever they have signed it over to).
My comment was in response to OP’s “none of them want to destroy the world yet.” I was agreeing with the literal sentiment. Do you think bankers acting in the 2007 crisis “wanted to destroy the world”? (But, unless I was misinterpreting OP, his was sarcastic.)
No. In my scenario Joe Borrower borrows $100 from Bank A, but instead of taking it in cash, he opens an account and takes a check-book. (This isn’t far-fetched — it’s typical for many borrowers.) At that point Bank A has Joe on their books TWICE: his loan is a $100 asset; his checking account is a $100 liability.
I showed this example to bypass a confusion upthread, that money has to “trickle through the system” to get “multiplied.” In fact, the multiplication is immediate as soon as Joe Borrower says he doesn’t actually need banknotes.
True, Joe may already have an account at Bank C, and ask Bank A to pay the funds there. But that step is obfuscation in the big picture — some Sam Scrounger may be doing the vice versa — so for conceptual purpose it may as well be short-circuited away.
I hesitate to speculate what the OP thinks, but suffice to say there’s nothing about his theorized doomsday model that requires the banks to have a desire for destruction either; greed would suffice. And if he meant to imply that non-doomsday bankers would necessarily realize the societal consequences of widespread abuse of the loophole and refrain from using it, well, the mortgage crisis provides a rather substantial counterexample.
When issuing such a loan, do banks really offer the loan for more than their legally-lendable surplus cash reserves? That sounds awfully reckless; the percentage reserve limit operates on the presumption that people aren’t all going to want to pull out all their money at once, but when it comes to a loan like this is seems highly likely that a checks summing to near the full amount of the credit line will be written fairly soon.
I guess I’m ignoring whatever far-fetched scenario OP intended, and looking at banking transactions more generally.
I thought we’d moved beyond OP and had twirled off into hyperinflation, Cantillon effect, and so on. :rolleyes: I didn’t think we were still speaking of a Bank that had ALL of its loans (and deposits) associated with one (1) single customer.
Sure, but that’s the easiest way for the scenario where “the bank extends a guy a loan for a guy for more cash than they keep in their reserve” to come up. For the situation you state to become a problem they have to extend the dude a loan for more than their entire cash on hand, and have him write a check for it. Only then can the bank gleefully declare selfrupcy and run away from their responsibilities, or whatever you’re proposing will happen in that scenario.
The catastrophic flaw is that any debt, even just a lawsuit, that offsets opposing debt creates money. If any debt can create money and debt is easy to create you see the problem. The non bank institutions you mentioned could include lawyers, it’s all the same problem, that it is just a byzantine mess that leads to financial crises that get larger over time. Even in the 1929 crash, that was using fairly straightforward financial instruments. Over time the more bizarre stuff becomes more common and the biggest example today is “tech companies” which are often just pyramid schemes with bizarre accounting practices, and Apple has it’s own hedge fund which invests in the same companies which invest in Apple.
I freely stipulate that my knowledge of economics and finance is woefully, pathetically inadequate, and I don’t pretend for a moment to be able to say anything intelligent on those subjects. That said, it really does look to me as though you’re not presenting a coherent argument at all, and are just asserting the same things repeatedly when anyone challenges you. To dispel this view, might I ask you to rephrase your actual claim in a simple, point by point manner, so that idiots like me can figure out what you’re actually claiming?
How about this hypothetical model? The USA has three groups: Bank A has $100. Bank B has $100. The rest of the country (C) has a total of $100. Feel free to break C into C1, C2, etc with dollar amounts for each if that helps make the point. What I’m hoping is that you can make a step by step list showing the following at each point:
-starting situation: A $100, B $100, C $100
-event 1
-event 2
-events 3 through 10
-end state: there is more than $300 in the system
Thanks in advance.
What’s with the “You”? In the excerpt you quoted in that post, I**** specifically stated that the thread had moved beyond OP’s scenario and I was not considering it.
Banks DO extend loans whose aggregate sum is FAR more than their cash reserves. Are you focusing on the specific case where much of the loan base was extended to a single customer? I see from his latest post that even OP has moved beyond that assumption, which was, perhaps, just an over-simplified thought experiment to simplify his presentation.
While I believe it’s perverse, it’s not a flaw persay, it’s the fundamental design principle. We live in a fiat, debt based system. All currency is ultimately derived from debt in this system.
Base money is debt owed to the Federal Reserve. Then you multiply that through fractional reserve banking, which is debt owed to banks.
Not all debt creates money though. If you try the crap the banks pull as a matter of course, you will go to prison for fraud. You, the average citizen, cannot loan out money you don’t actually have, so when you create a loan the money in your hand goes down by exactly that much. Not so with banks, and the difference comes from thin air.
Yes, but that’s mostly because of incompetence/malfeasance on the part of the central planners. And yes, I’d argue we live in something approaching a planned/command economy at this point - the government secretly picks whomever it likes the most based on no merits and with no accountability and allots them free currency (0% interest with infinite option to renew is not a “loan” no matter what you say) while competitors to their friends get driven out of business. But even before it got this bad, the consistent effort to move money from the hands of the lower 80% of the population to the upper 80% has been facilitated by this system.
Remember, crashes are excellent for the top of the economy. They are extremely profitable. Just… not for everyone else.
Nitpick: Base money is debt owed BY the Federal Reserve. (That debt is backed by debt (mostly Treasury paper) owed to the Federal Reserve and some other assets, incl. several thousand tons of gold bullion.)
Bank-created money is debt owed BY the commercial banks. (That debt is backed by the banks’ assets, mostly debt paper.)
The simplest way to think of a U.S. banknotes is as an IOU. “Dear Bearer: I owe you $100. (Signed) your friendly Federal Reserve bank.” (Never mind that when you go to redeem the $100 note they’ll look confused, hand you two Fifties and say “Is this what you want?”)
It is perfectly legal (as long as Hermione accepts it!) for me to give Hermione’s Hookers my own IOU for $100 when I stop there for some [del]hookers and blow[/del] snookers and snow. If my credit is so good that everyone in town happily accepts that IOU in lieu of Federal Reserve paper, and they keep passing it around to save a trip to the ATM, then that IOU becomes, in effect, “money”, whether it’s annotated “Legal Tender” or not.
A bank can make a loan as long as its deposits, which can include money the bank has borrowed from other banks, exceed the money it’s already loaned out plus whatever capital requirements it’s required to keep. Note that cash can have multiple meanings. “Vault cash” is the physical notes and coinage that the bank holds, mainly to provide that currency to its customers. Some internet banks have no vault cash at all. “Cash reserves” are the vault cash plus the money the bank has deposited in a central bank. “Balance sheet cash balance” includes the above two, plus short-term financial instruments that the bank possesses. In a basic discussion about loans and fractional reserve banking, we should have cash mean cash reserves. If we’re talking about what banks actually do, then we’re talking about a bank meeting its capital requirements, which means we should have cash mean the balance sheet cash balance. Banks go to a huge amount of effort to simultaneously meet their capital requirements and have their deposits invested in loans and other profitable financial instruments. This includes the temporary exchange of long-term financial instruments for short-term financial instruments. So to answer your question, yes banks do routinely exceed their cash reserves by the use of other sophisticated financial instruments. And there are certainly situations where banks recklessly claim they have “cash” that isn’t actually “cash”. When you hear about a bank experiencing a liquidity crisis, it does mean that depositors are withdrawing their money from a bank. However, it also means that those short-term financial instruments the bank claimed could be redeemed for actual cash aren’t actually redeemable.
Banks, being a highly-regulated entity, don’t get “abandoned” or enter some other limbo state. If the bank fails, or the owners choose to dissolve it, there is an orderly process by which that happens, most frequently involving the appointment of a receiver by the relevant regulator (the feds or the state banking commissioner, e.g.). That receiver is charged with sorting out the assets and liabilities. The failed institution has creditors (depositors and others from whom it has borrowed money) who have to be repaid, and the $10 lent to Bank B (the liability for B) is an asset of the failed institution, an asset the receiver has the legal obligation to turn into cash to repay the creditors.
Sometimes, of course, the assets are insufficient to repay the creditors; during the savings and loan crisis of the late 1980s, for example, the “assets” ended up including many half-constructed condos in overbuilt locales, carried on the books at values far exceeding what the market would pay. In those cases, then federal deposit insurance comes into play, and other creditors may be SOL. However, while there are any assets available (even an overvalued loan to Bank B), the creditors are going to be demanding Bank B pay up to make them as whole as possible. B’s liability never becomes ambiguous, because if the receiver can’t collect the money from B, then the receiver can sell the right to collect it to C or D or F.
How? If A owes B $17, and B owes A $10, then the net debt after offsetting is $7, not $27.
May I request that you provide more expansiveness in your posts and provide examples or discussable scenarios that back your ideas? You are raising some points that I think are worthy of discussion, but I think the brevity of your posts makes it difficult to comprehend your argument. For example, I’m guessing at how lawsuits and lawyers represent a catastrophic flaw to the traditional loan system. I thoroughly disagree with the statement that “‘tech companies’ <snip.which> are often just pyramid schemes with bizarre accounting practices.” There’s an element of truth to your ascertain, but it seems like you’re throwing out buzzwords relating to concepts that you have an idea about, but don’t actually understand. That’s fine if you’re seeking a discussion about a single point, or a related set of points. But your scattershot approach to identifying the “catastrophic flaw in the banking system” leaves me wondering if you have any understanding of the system that you are finding flawed, or if you are a blind squirrel in a nut-rich forest.
Its obvious that creating debt creates money under a fractional reserve system, and lawsuits are a way to create debt. It might not be the same kind of debt, but it shouldn’t matter for accounting purposes.
Is that, like, the sticking point, that you dont think debt creation is identical to money creation?
And for tech companies, apples Braeburn hedge fund is probably the biggest example of what you are saying. Apple makes free money just buying bonds and issuing them back at a higher rate
https://www.google.com/amp/s/seekingalpha.com/amp/article/4108372-apple-worlds-largest-bond-fund
Obviously retarded and unsustainable, and it’s an example of these artifical liability games. The only way banks could ever lend to apple at a low rate and then pay braeburn owned bonds at a high rate is if they are dipping below their supposed reserve requirement or something stupid like that.
Because A initially has $17 of assets as well, and the magical $10 of offsetting liabilities wiping out some of that debt results in free assets.
Each X represents a dollar.
Time 1:
Bank A
Assets X
Liabilities to B X
Bank B
Assets X
Liabilities to A X
Time 2:
Magical lawsuit gives artificial liabilities to A from B, ie, A loses
Bank A
Assets X
Liabilities X + X
Bank B
Assets X + X
Liabilities X
Time 3:
Liabilities cancel out
Bank A
Assets: X
Liabilities X
Bank B
Assets: X
Liabilities: nothing