It seems that today that there is more physical currency (US dollars) than there were 50 years ago. My question is, how does the physical amount of currency increase? (Yes, some bills are destroyed when new currency is introduced, but not as much is destroyed as is printed... so how does the extra get into circulation?)
I have read: Cecil’s answer to how much money there is (How much money is there? With the U.S. borrowing so much, why aren’t we broke? - The Straight Dope) and his answer to who owns the federal reserve (Who owns the Federal Reserve? - The Straight Dope). I do, however, disagree that lending really creates more money. In his example in his article about how much money there is, Cecil deposits $100, Slug borrows $85 and spends it at McGintys, and then the $85 gets deposited in a bank. He concludes now 2 people claim they have 185 total. However, this leaves out the fact that Slug still has a slip saying he owes 85. So, the total amount of is still $100.
So I also don’t see how the amount of physical money (greenbacks) could be different than the sum of all deposits and all loans. Is it? (This is a separate question, but I’d rather have an answer to the first, in the first paragraph.)
I should add that I had someone recently suggest that perhaps banks approach the federal reserve for a loan. When it is granted the reserve takes new greenbacks from the mint and hands them out to the banks with an IOU for the amount. Thus new currency is introduced, and the process continues, and as long as banks continue to request loans the federal reserve can control the amount of currency being introduced. This would also keep the books honest since the sum of all deposits/loans wouldn’t change (the bank can take a $1 million loan but has a debt of $1 million too). Is that the processes?
I have to stop you right there.
When a bank takes out a loan from the Fed, no new currency is printed or distributed. The Fed simply adds the amount of the loan to the bank’s reserve account (sort of an electronic ledger). These are called “Fed funds” in the banking industry. Transfers between reserve accounts are used to settle checks and to move money between banks. No physical currency changes hands. When a depositor has a check drawn on Bank A and deposits it to Bank B, Bank B sends the check to Bank B (via a clearing house such as a Federal Reserve Bank). The amount of the check is deducted from Bank A’s account and the same amount is then added to Bank B’s account. (It’s a little more complicated as they actually use settlement accounts, I’m simplifying.)
When a bank needs physical currency to stock its tellers or ATMs, it places an order with the Fed for $x. The Fed deducts $x from the bank’s reserve account and then ships $x worth of greenbacks to the bank. But most money is not reduced to greenbacks, it just exists as electronic entries in ledgers. The banking system trusts the Feds to keep its money electronically.
There are multiple definitions of the money supply. They start with currency and then add on reserves and deposits and stuff. Wikipedia has a good basic article to start with at Money Supply. It also goes into fractional-reserve banking, which is what the Cecil article you refer to is talking about. Almost all money today is electronic. Traditional physical currency is a tiny fraction of the world monetary supply.
I may not have clearly answered your question “My question is, how does the physical amount of currency increase?”
Simple, when customers demand more currency from banks than they deposit in banks (perhaps they want to keep more greenbacks in their cash register tills, in their wallets, under under their mattresses), the banks place orders with their Federal Reserve Bank for more currency. The Federal Reserve Bank deducts the amount of the order from the bank’s reserve account, sends somebody back to the warehouse, and has them ship some greenbacks to the ordering bank. When the warehouse supply starts to run low, the Federal Reserve Bank places an order with the Bureau of Engraving and Printing who fires up the printing presses and prints some more.
No it isn’t. Slug’s estate is still liable for the $85. What the OP missed is that while Slug has a slip saying he owes $85, the bank also has a slip saying they’re owed $85.
The debt cancels itself out between Slug and the bank, but there’s still $185 on deposit in the bank, when there was $100 before. That’s how lending creates additional wealth.
This has nothing to do with hard (paper) currency, which is a tiny, tiny, miniscule fraction of the actual amount of currency in existence. When banks need to replace paper currency, they simply order it from the Fed and pay for it electronically.
When Slug dies if his estate has any assets, the estate is still responsible to pay the loan from its assets. But let’s say Slug dies broke (or declares bankruptcy or flees the country and is never heard from again). The bank the made the loan has a problem on its hand. It has a worthless note from Slug. Slug’s debt was an asset to the bank. Suddenly, the bank’s assets and liabilities are out of balance. The bank has to take the money out of its capital, profits, or loan-loss reserves to cover the loss. If it doesn’t have enough capital, the bank is insolvent and the regulators step in to shut it down.
No new money is created by Slug’s death. The money he owed comes out of the lending bank’s capital.
Perhaps you know about matter and anti-matter – When they meet, they go poof and disappear in a blinding flash of economic activity. Maybe you’ve also read that the opposite can happen – where there was no matter at all, suddenly a particle and matching anti-particle can suddenly appears, as if from nowhere, and they go their separate ways.
Loans and debts work the same way. When a bank loans $100, then an equal-but-opposite asset and a debt are created at the same time, where neither existed before. Then the two go their separate ways – the asset remains at the bank, in the form of an entry in a ledger somewhere (called an “account receivable” or a “debit”), and the borrower gets $100 put into his checking account (called a “credit”) which he can spend somewhere else. This is generally counted as money, and it didn’t exist before. So the money supply just went up.
Of course, the amount of anti-money (the debit at the bank) also just went up. But as long as that is carefully contained in the bank’s ledger and doesn’t get loose in the world, it just sits there harmlessly. Eventually, the borrower pays back the debt, whereupon the bank’s asset (the account receivable) and the borrower’s debt (the account payable) mutually annihilate and vanish from the face of the universe. In the meantime, presumably, there was that blinding flash of economic activity somewhere.
Sometimes, if the bank doesn’t get their payment when they want it, they will turn that debit loose in the world (in the form of a dunning letter, or sell it to a collection agency, or a lawsuit, or a foreclosure). Then the anti-money careens through the environment, wreaking massive death and destruction as it collides with real money everywhere it goes, leaving behind only smoldering remains of the former wealth thus consumed.
Alas, I fear that no one will ever read the actual quesiton. I am NOT asking about the “creation of money” through loans. I understand that principle (though I debate it’s full validity).
My question is how does new dollar bills enter the economy–how do bills printed at the mint make it into circulation. (Again, yes, some replace old bills, but that is minimal.) There is more physical, with-a-president’s-face-printed-on-it CURRENCY (not “money”) than there was when we went off the silver standard. When there was a gold/silver standard the mint printed a bill as an IOU for the gold/silver someone gave them, and bang, more dollar bills entered the world. But now, how does a bill from the mint make it into the world?
I’ve read up on this and people make statements like, “It costs the mint 5 cents to make a quarter, but they sell it for 25 cents.” So if someone “buys” 4 quarters they give the mint $1, and unless mint uses it to pay employees (which is essentially priniting money and giving it to their employees, so I doubt that’s the case!) then no new currency is created.
I am also interested to see that people are claiming that there is not a 1-1 relationship between the SUM of ALL ledgers and the actual currency (greenbacks) but first let’s tackle how new greenbacks are introduced into the world without a greenback being taken.
(If you’re not catching the point, I am NOT asking about where the money from the ATM comes from. Someone at some point deposited that cold, hard cash, so the person at the ATM is just getting it back. Yes, the banks ship off cash to be held by the fed, but none of that deals with how new currency is introduced, so let’s please not continue down that shallow road.)
In addition, I agree with Alley Dweller. As for Friedo, I think you have missed something (besides the point of my question to begin with)–the bank may have “185” in deposits (really just $100 cash) but it also has a $100 IOU to Cecil and an $85 IOU to McGinty’s, as well as being owed $85 by Slug. (The end result being the bank still has $100 in cash and an IOU to Cecil.) So no new money is created when ALL ledgers are added up. The only person with a non-zero ledger is Cecil–who still has $100. (And yes, if Slug dies, the bank eats the 85 because it has $100 in cash and owes 185.)
So… How does NEW CURRENCY make it into the system?
Perhaps I’m missing something here–either that or I am being missed. Or perhaps its that there are underlying principles behind this answer that I don’t understand that would explain it.
“Simple, when customers demand more currency from banks than they deposit in banks (perhaps they want to keep more greenbacks in their cash register tills, in their wallets, under under their mattresses), the banks place orders with their Federal Reserve Bank for more currency. The Federal Reserve Bank deducts the amount of the order from the bank’s reserve account, sends somebody back to the warehouse, and has them ship some greenbacks to the ordering bank. When the warehouse supply starts to run low, the Federal Reserve Bank places an order with the Bureau of Engraving and Printing who fires up the printing presses and prints some more.”
This situation seems, to me, to be like a child (customers) asking their parents (banks) for money. The child can get the cash as long as the parents have it. If they run low they go to the ATM at their bank (the Federal Reserve) to withdrawl cash from their bank account (the “bank’s reserve account” as it was called above). But if the parents (the banks) have an account in the black, then when they get the cash from the ATM at the bank (the reserve) they are only getting back the cash that they’ve already given, aren’t they? I don’t see how new currency is entering the system with this situation.
I realize that the parents’ account may have more money in it than they ever PERSONALLY deposited in cash, since they might’ve gotten electronic money transferred from their employers bank account, for instance, but all electronic money is, it seems to me, a transfer of money between people, not the creation of new money. But perhaps in here is my fatal error, somewhere. But I think it may also have to do with the fact that my finance friends tell me when I think about money not to include the debts people owe (their loans), which at this point I can’t see why forgetting the debts makes any sense.
These days, there’s a lot of direct deposit. Even if there’s not, people get paid with checks, not cash. That money was probably not physical currency in the first place. It’s not like many people are getting paid in greenbacks.
The same is true for banks. Money gets created in ways that don’t depend on cash and banks have reserve requirements. If a bank needs more greenbacks, it gets more. If it makes money, it generally needs to deposit some of it.
As mentioned above, physical currency makes up a tiny portion of the total money supply. But if somebody (even banks) wants actual physical cash, they can just turn some of their money into a physical form.
It seems the posters above really DID understand your basic misunderstanding. You seem to think most deposits originate in cash form.
As the money supply increases, the demand for currency increases, because of fractional reserve banking.
As in your example, Slug is only lending the bank $85, but the bank is lending out more than that. It only has to retain enough cash on hand to cover ~10% (I forget what the current number is) of its deposits.
Basically, as others sad, the vast majority of the “money” in the system is electronic. Once in a while, some of that gets converted to hard cash. the banks exchange electronicmoney (plus postage and handling, I assume) for the equivalent hard cash.
There are some clever wonks somewhere I assume, who have a good idea what the demand is for hard cash, and what denominations. Plus, I assume the mints like any other business have a warehouse supply, so one order won’t clean them out. (It’s just a very secure warehouse). They allow for replacement, for extar cash to meet changing trends and handle growing deman. If suddenly the banks add $10 per ATM or debit transaction so people pull out $500 at a time instead of dribs and drabs, demand may go up. The local starbucks or transit company or bar or hookers begin accepting credit cards, demand for cash goes down.
Ignoring the fact it’s money, cash is a commodity like bread or coffee or gasoline. Demand goes up and down based on various factors. It’s just one more thing banks “sell” from the mint “wholesaler”. As long as cash is bought by tranferring “electronic” money to the mint, the total money supply is not affected and there is no inflation problem. The mint money is basically the same pocket as the central bank, so the regular banks are just saying “can I swap this $1M in Central Bank electrons for a stack of $10 bills?”
After all, whether you have $1000 in the bank or $1000 in your pocket (or $1000 line of credit on card) it’s the same effect when you get to the cash register…
Okay, it seems that everyone’s saying that the 2 things I think are related (creation of currency and creation of money) are too related to be separate questions.
Okay, so everyone is saying that money is independent of the actual cash. You all are right that I’m under the assumption that electronic money is tied to cash. Here is why (though perhaps I’m wrong–I know I’m wrong somewhere since money does increase). If electronic money is not tied to actual cash, how does electronic money get created (across ALL accounts). Sure, my electronic number can go up if someone else's goes down, but that doesn't create new electronic . The only way I can think of for electronic money to increase is for people to deposit actual cash, which would tie all electronic $ back to an actual dollar bill. Is there another way for electronic money to increase (if all electronic debts are considered as well)?
(Of course if a bank/the fed took actual dollar bills, converted them electronic $ and burned the cash, then it’d be perfectly fine to re-print new bills at a later date based on demand. But I’m willing to bet my shorts that everyone will say that is a laughable idea and nowhere near the truth.)
I see why electronic money reduces the need for currency to be in circulation, I don’t see how new money is “created.” Say the mark of the beast comes and there is no more cash, everything is electronic. How would one person’s gain not mean an equal loss for another person? If the population grows toward infinity how is it possible for everyone to have $100?
A brand new bank (“Bank A”) opens. The first customer comes in and deposits a crisp new $100 bill. Then Bank A sends the $100 to their Federal Reserve Bank and the FRB credits $100 to Bank A’s reserve account. When Slug gets his $85 loan from Bank A, Bank A deposits $85 in Slug’s account at Bank A, and now Bank A has $185 in customer deposits. Its assets consist of $100 in its reserve account plus Slug’s note for $85. So assets (reserve account plus note) equal deposits at the bank. All is well.
Slug wants to buy a car. He goes to the car dealer and writes him a check for $85 for the down payment. The car dealer goes to Bank B and deposits the check. Bank B (through an intermediary) sends the check to Bank A and says “Pay us.” Bank A says “we’ve got Slug’s note worth $85, would you take that?” Bank B says “Screw that. We want fed funds from your reserve account transferred to our reserve account and we want them today.” So Bank A electronically transfers $85 from its reserve account to Bank B’s reserve account. And it also deducts the $85 check Slug wrote from Slug’s account. Net result: Bank A has $100 in assets (Slug’s $85 note plus $15 in their reserve account) and $100 in deposits (the $100 in that first depositor’s account plus $0 in Slug’s account). All is in balance. (In reality, Bank A and Bank B aren’t going to negotiate about how to pay off the check. The clearing system automatically deducts $85 from Bank A’s reserve account and adds $85 to Bank B’s reserve account.)
Now Bank A is sweating bullets. What if that first customer who deposited that $100 wants to write a check? Bank A only has $15 in its reserve account, not enough to settle a $100 check if it gets deposited to another bank. Bank A can hope that it gets more deposits so that it has a little more breathing room. Bank A can try to sell Slug’s note to another bank in exchange for a transfer of funds into their reserve account (this is what happens when you hear about banks packaging up mortgage loans and selling them to Fannie Mae or Freddie Mac), but then they will no longer be collecting interest from Slug and won’t be making any money.
So you see that the reserve accounts that banks have at the Fed are the key to making money go around. Banks are happy settling their debts with electronic transfers between their reserve accounts and they don’t ask any embarrassing questions about where the balances in the reserve accounts came from.
And you are right, that at this point, all they are doing is shuffling reserves around between banks. No new reserves have been created.
But every once in a while, the Federal Open Market Committee meets and says “The economy is kind of sluggish. Banks don’t have enough money in their reserve accounts to allow them to make new loans. And what loans they do make are at very high interest rates. We need to fix that.”
So the Fed puts out word that they want to buy some Treasury debts (Treasury Bills, Notes, Bonds, whatever). Bank C has a Treasury Bond that it would like to liquidate. The Fed says “we’ll pay you $100 for it.” How do they pay for it? They just add $100 to Bank C’s reserve account. They don’t print any greenbacks. They don’t mint any coins. They just go over to a computer terminal, tap a few keys, and declare that Bank C now has $100 more in its reserve account than it had a few minutes ago. Where did this $100 come from? It wasn’t transferred from any other bank’s reserve account. The Fed just created $100 in reserves out of thin air. The Fed is allowed to do that. That $100 is now Bank C’s to keep. It can use it to fund more loans or to settle debts between banks. Other banks are happy to have funds transferred from Bank C’s reserve account to theirs and, as I said, don’t ask questions about where it came from.
So, when Bank C sold the Treasury Bond to the Fed, all of the sudden the total of money in bank reserve accounts increased by $100. If Bank C would like a few greenbacks for some reason, it can call up its Federal Reserve Bank and say “would you send me a $100 bill please?” And the bank will say “Sure, we’ll deduct $100 from your reserve account and send you that $100 bill right away.” But since the balance in the reserve account can be used to electronically settle most of Bank C’s debts, most of the time they won’t bother to ask for a $100 bill.
Usually, the Fed creates reserves by buying up Treasuries. But during the recent economic crisis a lot of banks were stuck with “junk”: bad mortgages and other debts. The Fed made an exception and bought up some of this junk and paid for it as if it were valuable. Again, it did not pay for it with greenbacks. It just magically added money to the banks’ reserve accounts. That money did not come from other banks or their depositors. It was just added with a few taps of the computer keys.
Perhaps it would help you to understand the money-creation issue if you understand that money is not value, and that an increase in money does not result in an increase of net value?
When the bank takes a $100 deposit and issues an $85 loan, there is not net change in value. $85 of Slug’s cash is offset by $85 of Slug’s debt. The bank owes Cecil $100, which is offset by an $85 asset (note receivable) and $15 in reserves.
Net value does not change in this scenario. However, cash/money most certainly does change. $100 has become $185.
When economics are measuring money supply (whether M1 or M2), they don’t net out loans and liabilities. They don’t care about increases in net value. They just add up the money, and the money has unquestionably increased.
The short answer is the Federal Reserve buys US Treasury securities with new electronic money it creates out of thin air. Fractional reserve banking takes care of the rest.
Alley Dweller (and Newme): Okay, this business about the Fed buying stuff up and creating money in reserve accounts out of thin air (in sense) is what I was looking for. I get everything up until the last 3 paragraphs 100% (I think), and the last 3 paragraphs are what I was looking for–I’ll have to think about it a bit to make sure I understand it. Thanks for your replies.
It still seems like either the fed is just handing out free money to bank C, or that C really isn’t gaining anything because it lost $100 in treasury notes that it bought (maybe not for $100, but still… it would’ve been worth $100 eventually). Which is true? If it’s the first, that seems odd, and if it’s the second then it seems like treasuries/bonds are an integral part of this system of creating new money, and I’d have to think more about how that all might fit together.
If bank C does choose to take the “free” $100 and get a $100 bill, then where does that bill come from? Of course the Fed can give C a $100 bill they got in deposits from other banks, but eventually that would get the Fed in holding reserve accounts of a much bigger value than the cash deposits they have. Do they sometimes print a $100 bill to send C?
Dracoi: Hmm… I agree that net value has not changed. But I don’t see how, especially if we agree that net value hasn’t changed, how $100 has become $185, overall. I do understand how this spurs economic growth, and how assets like houses can grow. But my question is how money (specifically currency) is created, because if it isn’t created somehow then if the population doubles everyone could have huge homes and 45 cars, but the amount of (liquid) money in the world would still be the same and each person, on average, would have half as much money. I don’t think that’s the case, so I think there is a system to create money (including adding more currency every year), so that’s what I was asking about.