How much money is there?

Cecil's Columns/Staff Reports
1

Firstly, I feel bad about being one of the first back on this board after Tuesday’s events, but as your President and other leaders said, the world will carry on rather than letting the terrorists win, right?

Initial warning: I think this question may go on a bit…

I am probably way behind the times, being British, but I’ve only recently discovered Cecil’s pages. I’m not happy, mind - as well as showing me to be wrong in many truths I’ve always held (I won’t admit it to anyone I know, though), he’s also shown me to be ignorant about things I hadn’t even considered before.

For instance, I do not understand where new money comes from: the world is getting richer, so money must be being generated somewhere. I know that someone has asked this before, but the thing is, Cecil’s answer ( http://www.straightdope.com/classics/a3_163.html ) has left me more confused.

You see, he explains that banks generate money: if he puts 100 dollars into an account, the bank may loan out 85 of these dollars to Slug. If these are spent at McGinty’s, then he says that “McGinty’s has $85 in folding green and I’ve got $100 in checking that theoretically I can draw out at any time. Behold, the local money supply has bloomed from $100 to $185.”

This is of course true in the sense that the amount of money that can be withdrawn from the bank has increased from 100 dollars to 185 dollars, but the total money supply has not increased: the extra 85 dollars were a loan that must be repaid. The bank still has 100 dollars total credit (let’s say it only has Cecil, McGinty’s and Slug as customers): Cecil’s +100, Slug’s -85, and McGinty’s +85. Eventually, of course, Slug must repay his 85 dollars plus interest (returning his balance to zero), but this he must earn elsewhere, so the bank’s increased holding of 85 dollars plus interest is just money that has moved from somewhere else.

That was perhaps a little long-winded, but it seems to me that banks don’t increase the money supply; they just produce a profit, as does any service-provider.

In my simple world, for someone to make money, someone else has to lose it. But in banking, this is blatantly not true: you don’t hear of big banks making losses (if only…) due to their funds becoming other banks’ profits. So where does the new money come from?

And while I’m on the subject of the answer Cecil gave, the bit about governments issuing new bonds to pay for old ones sounds like a one-man pyramid scheme! Surely old bonds must eventually be considered as being paid off, or the total interest payments would skyrocket. What happens when the number of bonds that need to be issued increase beyond the number of investors able to buy them? Should I start stocking up on tinned meat now?

Man, he’s given me a headache. Sorry, but you all have to suffer by reading this ridiculously long question.

James, Germany (I’m English though!).

2

Actually my macroeconomics book disagreed with Mr. Cecil, but i think his explanation is alot better then my macro books.

My Macro book said their was a finite amount of money and broke it up into 3 categories,1 being spendable cash 2 being savings and a third. And they gave amounts for each (which i remember we had to memorize for a fill in the blank test). But the fact that there was a finite amount of money bothered me, as the money supply would have to grow with the population or the supply of it would decrease per person and money would increase in spending power rather than have inflation. But we do have inflation, I thinx it is like 1% right now.

Banks make more money because they take the original money and lend it out. SO if i have 100 dollars in the bank in my checking account and the bank lends out that money, they have created more money.

TO best understand this, think of the great depression. Alot of people made runs on banks, to get their money, which the bank had lent out. The banks did not expect this so they did not have the money on hand to give to those that wanted their money back because they did not have enough money on hand. Banks actually have about 10% of the money in savings on hand, or something to that effect.

Also, something his article did not point out is that there is an effect, that money spent in a community actually makes more money, because you buy an item from a store, then the store buy an item from someone else, and so. I think it increases the amount of money by a factor of ten, by buying an item and the money circulating.

Also gov bonds create money. Because they have interest on them, gov bonds add more money into circulation.

I think maybe your trying to imagine money as a tangible good, such as currency. Most of the time, especially in todays computer age, money is spent through checks and credit card, eletronic transfers, etc, and is only there because you say it is there and your bank says it is there.

3

Err, is it just me or is this what the US Mint does. Granted most of their production is to make up for what is lost, but it does exist as a way to pump more money into circulation. re the macro textbook, the supply of money is finite but not neccessarily constant.

4

The Mint, which makes coins (yeah, 90% of you are saying, “Duh!”, but 10% of you aren’t), has not had an important role in the money supply since we went off the Gold Standard, and has been even less important since silver was effectively demonetized in the 1960’s.

Bills, of course, continue to have some significance, but nowadays the only important bills are Federal Reserve Notes, which are part of the whole Federal Reserve System system – and bills are being reduced in importance, too, as nothing larger than $100 is being allowed into circulation.

More and more “money” nowadays exists only in the form of electronic records. (If this were not so, the abandonment of larger bills would have been impossible.)

There is also evanescent “money” in the form of outstanding checks.

5

Couple things. One Cecil was wrong about the Government not creating money. The Federal Reserve can increase the money supply by buying back U.S bonds in the secondary market. This is called “monetizing” the debt. This is more than just simply lowering the discount rate at the Fed window. These bond buybacks amount to real profits to private institutions - typically investment banks not plain vanilla lenders. Cecil didnt really define his terms enough to say that he was wrong or right about much of anything. Now, is the US banking system a ponzi scheme?

Absolutely and on a grander scale than you could even imagine. The important thing to keep in mind is that just because this is the case, it doesnt necessarily mean you should listen to the “buy ammunition and bottled water” cranks. While there is much more concrete proof of the over-leveraging of the financial system, this is the one I like to throw out to cocktail party (and even professional) stock market “anal-lysts.” My numbers are a little off because I retired from speculation a few years ago and am numb after witnessing the stupidty of mankind but ill give some rough estimates. The GDP grows at a rate somewhere around 3% (Im being kind there). Yet the stockmarket, which is among other things, a discounting mechanism for on future earnings goes up by over 20% per year. Now when you take into account periods like now where there are massive increases into productivity rather than production itself, concessions can be made. However, in the end either GDP has to catch up to the stock market or the stock market has to catch down to GDP. How long this process is put off depends on consumer/investor confidence and the willingness of politicians to continue to opt for short term happiness over long term stability. In the long run, even politicians are dead, which is why they don;t give a rat’s ass about the long run of anything.