That’s what anti-regulation people often forget. That the free market will typically correct problems by eliminating businesses that engage in unsustainable business practices.
:dubious: And in the course of that correction process, a lot of innocent investors and depositors will lose their shirts and a lot of crooks will get away clean with their loot. There are countless historical examples. It’s best not to leave this to the free market.
I still don’t feel like you answered my question. What regulations did you want put (back) in place, specifically?
For the record, I am not anti-regulation, nor am I pro-Bush, but I need to know what regulations we are talking about.
Thanks,
Rob
Bring back Glass-Steagall, enforce the existing regulations and stop firms being allowed to pick and choose their own regulators. Prevent the Fed and the SEC making private deals with firms to change their capital ratio requirements. And we need new regulations to deal with the shadow banking system. They need to have a clearing house system and an open exchange for their derivatives operations, they also need to hold capital to cover losses in exotic paper. It doesn’t matter that they’re not depository institutions, they need to be regulated like any other bank, QED.
Securities ratings agencies need to be re-regulated with the people paying them being changed back to investors and not sellers, as has become the norm recently, as ratings agencies are noe basically consultants for financial firms advising on how they can get AAA ratings for crap assets (and have seen their profit levels quadruple over the past decade due to the consultancy stuff). Put caps on the size of banks, make them spin off various parts of themselves. (Glass-Steagall will do that.) Bring in a consumer protection agency to stop predatory lending.
Reform executive compensation. If you’re a financial executive and you see an opportunity to make yourself tens/hundreds of millions in a few years from a bubble but the aftermath will be economic meltdown, you’re going to go with the bubble, QED. Reform compensation so that if huge profits turn out to have been bubbleicious after a few years you have to hand the money back. Even keep the cash in escrow for a few years so they don’t even get it if it turns out to be illusory profits.
Neat, glib, and, of course, completely wrong.
Let’s start with the assumption, because if you destroy the assumption, you destroy the argument:
Rilly?
So, pray tell, exactly HOW did money get created before there were central banks, keeping in mind that fractional reserve banking has been around since the earliest stages of the Renaissance, way before anyone had ever thought about having a central bank?
Well, let’s see: money is essential to a commercial society. No money, no commerce, ergo, no commercial activity, and everyone winds up hunting/gathering/dirt farming rather than living in great big cities doing things inconceivable to the folks who conceived them.
So, the private economy had to come up, somehow, with a way of creating money without the assistance of a central bank.
That way is fractional reserve lending.
The money multiplier is a myth. It’s a nice little oversimplification for Economics 101, but it ain’t the real world.
The real world is like this (US version): banks have to report reserves once every two weeks, to the Fed, on a day that is known in the industry as “Fed Wednesday”. I know, stunningly creative.
Somehow, in some way, they find a way to report the proper levels of reserves to the Fed. Thursday morning, everyone stretches, relaxes, and starts lending out money as fast as can be justified by whatever the metrics are that day for what a worthy lender constitutes. Somewhere around the Monday morning prior to the next Fed Wednesday, the Fed Funds traders at your local too-big-to-fail megabank start figuring out their strategies for that coming Wednesday. If the bank has had more in deposits than the bank has received in loans, they start figuring out how to strangle the banks who need that money to report the proper level of reserves for as much vig as they can manage to squeeze. OTOH, if the bank has lent out well more than what would be justified by their deposits, they start trying to find that money right away, so as not to be squeezed on Wednesday afternoon. Wednesday afternoon & evening the various megabanks play all kinds of games with each other, and usually everyone does OK. Thursday morning, everyone forgets about the reserve levels, and the whole two week cycle starts over again.
Banks lend money first, and find the reserves later. What does that mean? That the reserve level “enforced” by the Fed, and the money multiplier, are both myths. Also, that the Fed, contrary to Libertarian and Eco 101 myth, is completely powerless. Also, finally, that the actual real world evidence is that first comes debt, then, lagging behind, comes money, that stack of thousand-dollar bills from the Central Bank.
The economy and its needs decides how much money gets created. It couldn’t be any other way, or you would be arguing that the growth of the private economy is a slave to the Fed, which is just crazy. Also, fractional reserve lending, also known, to the terminally sane, as banking, is as necessary to commerce as breathing is to life. Which, finally, means that there will always be bubbles, and the depressions that come after them.
I’m arguing from experience, having spent years supporting the Fed Funds desk at a super-mega-global bank. Steve Keen, an actual economist, explains this for the economist types (he’s even got actual, like, formulas, hidden in there somewhere on that site, for those who can’t live without 'em): The Roving Cavaliers of Credit.
Care to make an actual argument?
My points are threefold. First, that money does not equal value; they are different concepts, such that you can have lots of value, but not a lot of money. That is correct–and so straightforward as to not require more. Your attack on my “assumption” doesn’t affect it.
Second, the perhaps obvious point that banks can’t lend out money they don’t have. They can’t “create” it out of thin air. The banking system as a whole can create money–individual banks can’t. Again, how someone thinks a bank can magically do things they can’t, without any mechanism to do so, I don’t understand. Ditto as to your “attack” on my assumption.
Third, it was pointing out how the money multiplier works. That is also correct–your post, at best, disputes how effectively enforced the reserve requirements are. That is (remarkably enough) not a repudiation of the point I was making–which was a functional explanation of how the multiplier works, with numbers that are easy to understand.
Well, you’re asking this rhetorically, but I’ll go ahead and answer, since it’s such an easy question. Strong “money” is whatever banks promised to pay depositors in on demand–historically, gold or gold certificates (see old banknotes), silver or silver certificates, specie, or some other form of deposit held in reserve that depositors will accept in satisfaction of their credit with the bank.
As any reader of my post would immediately understand, the fact that it is almost universally central bank money these days is more or less irrelevant to how the system works; it does, however, make it easy to pick an example to show how it works. Replace central bank money with spanish gold dollars, conch shells, or tulip bulbs if it makes you happier. Again, it doesn’t really matter for the purposes of this thread, so I really don’t understand why you make such a big deal over it–especially as there is an easy answer.
As i pointed out.
It may be a simplification–but not an oversimplification. When you’re trying to explain how money creation works in the first place, the multiplier is step one.
If you really want to come in and nitpick my post, get your stuff together. The person to whom a bank lends money is a borrower, not a lender.
If there’s a point in there, I can’t find it. And if there was one, it would be a dispute over the calculation of the money multiplier–how effectively enforced reserve requirements are. It does not repudiate it.
And that real-world “evidence” is…
Again, this is, at the very best, an argument that the neat mathematical equation taught in Econ 101 for the money multiplier doesn’t provide real-world results. This is true; for one thing, it’s a maximum based on a certain level of reserves. However, it is in concept exactly right–it does tell you how much money is created by the lending out of a certain sum of money at a certain reserve ratio (whether set by the fed or commercial banks). It is, also, again, essential to explain the concept. So how you can even claim to “disprove” it is to me, incomprehensible. It’s not designed as an exact proof–but as a demonstration of concept and a theoretical limit.
Argument to personal authority is the weakest kind, especially when your arguments are themselves unconvincing.
Also, your profile says you are a computer programmer. So I have to ask–what do you mean by “supporting” the Fed Funds desk? Were you an economist, a trader, an actuary, or in research?
In the case of single borrower (farmer in this case) this is accurate. And if the bank were willing to accept payment in wheat, that would be great. Banks though want cash back. And where does cash come from? In our current system it is all loaned into existence. When you take all the borrowers in aggregate they all need to repay loans plus interest, and since there is only the loan principals in circulation either the banks will have to constantly up the money supply with ever more loans (inflation) or some of the borrowers will have to default, or the banks will have to accept payment in something other than the currency that they are the only source for.
The only way the value of the farmers crop can be realized is by selling it, and that can only happen if it is bought by others, using even more loaned money. Maybe the wheat buyers didn’t borrow it from a bank, but if you follow the money back far enough it all comes from bank loans.
Another way of looking at it is that the value created by the farmer when he grows his crop can only become liquid if a matching amount of money is somehow created, and in the current system that happens when banks issue more loans. Since the banks charge interest they have to loan out enough to supply the interest plus enough to support the growing economy caused by all the industrious farmers.
Questions: If every single loan, private and public, including any that were defaulted, written off, forgiven, discharged via bankruptcies, etc. were to be paid off with interest tomorrow, and banks issued no more loans, how much cash would remain in circulation? What is the source of that remaining cash?
The… treasuries… of the nations… of the world? And their printing presses?
Sigh. The usual response.
Yes, banks can and do create money out of thin air every day. How do you think economic growth happens?
Actually, I’ll explain: economic growth happens when someone comes up with something that allows his little neck of the woods to either a) make more money, or b) spend less on something it was getting from somewhere else.
The common thread in both is that it then allows the folks in his neck of the woods to c) spend the money they either made or saved on other stuff, with more utility for them, thereby making them richer.
In the real world, the new thing is usually distrusted by your average banker, bankers being the conservative types that they are. This makes getting financing difficult for our clever entrepreneur. So, they have to resort to various schemes to come up with the money, one of the most common being a 2nd mortgage on their house.
This is where the money creation comes in.
Banks are, strange to say, in the business of making money. That is, of making a profit. The way you make a profit, in the real world, is to buy something for less than you can sell it for. Banks buy money from depositors, and sell it to borrowers. They buy it wholesale, and sell it retail, just like your local candy store.
Banks, in the real world, don’t stop to think what their allowed reserves are. Shoot, in the real world, reserves are only enforced against deposits anyway, and banks can raise money in any number of other ways, such as through, to take a simple example, selling commercial paper.
This is actually a very important point, and invalidates the entire money multiplier Eco 101 just-so story you’re so fond of: if a bank needs money, it can get it through the money market, where commercial paper is bought and sold.
That’s the domestic example. As I hope you’re aware, there also exists an international money market, and mega-banks will raise money, as much as they need and can get their hands on, here as well.
All of which means that that reserve requirement that is enforced only against deposits is completely meaningless, even before we get to the fact that if the Fed is only looking at it once every two weeks, it’s obviously a fiction. Well, obviously to anyone who’s actually worked for a business.
That’s my point, plain and simple. There is no money multiplier, because the money multiplier just-so story depends on an enforceable reserve requirement. It is completely unenforceable, once you look at how finance operates in the real world, outside of the textbooks. The amount of money a bank will create out of thin air is dependent on the demand, and the demand is in turn dependent on the economy and on the sheer entrepreneurial and speculative drive of the people who want that money. If it’s entrepreneurial demand, you get, if the ideas are any good, real economic growth. If it’s speculative demand, you get what we just went through: a bubble.
Either way, the hangover is a recession/depression. Booms & busts preceded central banks, and if they were eliminated tomorrow, would outlive them. Your just-so story falls into the Libertarian’s trap of boxing you into talking about money in the context of central banking, after which they can conflate that with fractional reserve banking, and start beating you about the head and shoulders.
That’s because your money multiplier myth makes it seem like if you got rid of fractional reserve banking, you could get rid of speculation, and all would be right with the world. But, to understand the real world, you have to understand the very simple fact that the money multiplier is a myth.
Debt comes first, money comes after. That’s how it happens. In that kind of a world, you have to be prepared for the roller-coaster that is real life. There is no ideal world that you can create where there won’t be crazy booms and busts. The best you can do is mitigate the busts. That was Keynes’ much-misunderstood message. Keynes, and the early Keynesians like Paul Einzig and Hyman Minsky, understood markets. Modern folks like Steve Keen are reviving the understanding of markets that Keynes, Einzig and Minsky had.
Actually they do. When the Fed gives banks money at zero percent, it is hard to imagine them not making money. How incompetent would banks have to be to lose money nowadays. The banks are so proud of their profits today. Yet they get free money from American taxpayers. Heaven forbid if they actually had to compete. Excuse me I have to get out of the way while they give themselves another bonus. It is tough to have a pipeline to tax money.
Is there only one bank left now?
pantom, I’m not going to dispute the broader points of your explanation. But this?
Maybe you were intending a specific context for that last sentence that I somehow missed, but as written, it is complete crap.
The Fed does not have to provide the additional liquidity when banks start bidding up the federal funds rate in their struggle to find the reserves to meet their legal requirements come the day of reckoning. It can choose to let the interest rate rise, and when FOMC changes their interest target, they will even encourage the process by selling bonds to suck even more dollars out of the system to make the scramble for reserves that much more intense. This has been their traditional policy tool for a long damn time, as anyone who’s ever worked at the open market desk should well know.
Nor is the Fed as powerless in the current situation as Steve Keen might like to suggest. They have numerous tools that fall far short of a Zimbabwe situation. They could stop paying interest on excess bank reserves; raise their inflation target; buy up more longer-term government bonds, in order to drive down longer-term interest rates; switch to price level or nominal GDP targeting, or some other method where they overcompensate when they’ve missed a previous period’s target, in order to get their metrics in line with their long term expected growth rates; or any other method which would change the market’s expectations of future inflation, instead of having those expectations “anchored”. Their hesistance to use these powers is not an indication that they don’t have them. (And I’m not saying all of these are good ideas. For example, a higher inflation target would provide short term relief, but it’s still not the right way to go.)
With adequate regulation of the financial sector, we went nearly 50 years without the risk of systemic failure. It was only after the development and maturation of the largely unregulated shadow banking system that the US financial sector has started to mimic the “panic” situations of the 19th and early 20th centuries.
The business cycle will not go away, but the big financial crises can be prevented, at least as long as stringent regulation isn’t eaten away by political pressure from short-sighted bankers.
pantom’s points seem to be an odd mixture of jargon and econ 300 and hyperbole about how the market alters how money creation works; further, even the correct parts are more or less off topic as I have pointed out, when trying to explain money creation to people who don’t have any background in economics.
Also, while his points do show (correctly) that the amount of bank reserves does not define the money supply at any one time, they do not alter the fundamentals of how money creation works.
Again, this has nothing at all to do with the process of money creation. It has to do with the amount of money creation. And I’ve already agreed that the multiplier is an econ 101 explanation of the amount of money creation–but the fact that there is a deeper understanding of how much is created does not mean that there is also a deeper explanation of how money is created by commercial banks.
Money is created when banks borrow money and then lend it out again, they create a credit that can be used as money (a checking account), and a loan that can be used as money (because it is).
Interestingly, this is not true in the money markets–because there, a bank is borrowing by issuing (usually) some kind of commercial paper, which cannot also be used as money (except on a very high-finance level, between giant banks); So there, as to the parts of the money supply that matter to the retail economy, you get a transaction that looks much more like a personal loan–I borrow money from you, and so I get money and you get an IOU that can be traded, can be sold, can be marketed, but cannot practically be used as money. No money creation. Further, when a bank borrows from the money markets, the lender is giving them money it has–not creating it. The whole point of the money market is that you borrow money, not some kind of instrument that cannot be used to satisfy the requests of depositors or borrowers. No money creation because the money already exists–it is just being transferred from lender to borrower, and then lent out again by the borrower.
Demand does drive money creation, although as I have already pointed out empirically, the amount of money creation is less than the figure you’d get by the multiplier. Pantom seems to me to be suggesting that “failure” of the multiplier equals much more money creation than the “myth” would suggest. I contend that that is untrue.
Well, first, I haven’t been beaten about the head and shoulders on this topic in a while, and you don’t seem to be on the way to do so effectively.
More importantly, central banking is not a necessary element of money creation. I’ve pointed that out, and you’ve simply ignored my responses. It is, however, very useful when explaining the concept to people on an econ 101 level, and when we live in a world where M0 is, basically central bank money.
When did I say that?
Not knowing this is kind of a strange omission. Another such omission is the fact that pantom still hasn’t pointed out what he meant by his statement that he spent years “supporting” the “fed funds desk,” including what kind of support he provided, and how he squares that with his profile description as a “computer programmer.”
Since he’s claiming authority based on that experience, I think it’s fair to press the question.
Now, many quant guys are mathematical economists–and are very skilled at modeling and computer programming. They, on the whole, wouldn’t make the kind of errors hellestal points out above (and all the way at the top). Also, I’m getting more of a trader-y vibe from the tone of the statements pantom is making. But how you get from there to computer programming is anyone’s guess.
So again, pantom, what exactly did you do when you were “supporting” the fed funds desk?
I’ve written two long replies that got eaten, so just a quick one this time: I spent two decades living with the Fed Funds traders, and we spent all our time worrying about how the bank’s operations affected liquidity and might cause them to scramble. I wrote many programs to help them with that worry. I never once got a request to write something to track what the Fed was doing. If the Fed’s liquidity operations were that big a deal, believe me, I or one of my colleagues would have been requested to put something together for it. Banking is not an eleemosynary pursuit, so if something was a real problem in the interbank money markets, they’d want a way to track it. Never happened.
I agree with that last paragraph. The reason I’m hitting this money-multiplier idea so hard is that it’s a large part of the intellectual foundation behind the crazy idea that markets will “self-correct”. They won’t, not without someone holding onto them very tightly. Glass-Steagall can and did prevent the nonsense we just went through. The Fed, demonstrably, can’t.
Also, one last point, which you may be aware of but the folks reading this may not be: the actual Fed Funds rate on a given day can vary very considerably from the target that the newspapers and economists pay so much attention to, because the actual level depends a lot on the dynamics of the interbank market. For some reason, I’ve never seen commentary from an economist on this variance. That’s a strange omission.
whorfin: if you can’t figure out what I meant by “supporting” from the above and my profile, I can’t help you. The tradery feel is because I spend my days these days trading index options. How you could feel your way to that but not figure out what I meant is just weird.
Your commentary on the money market is completely wacky and has no relationship whatsoever to reality. I’ll leave it at that, because I’m tired of typing.
You misinterpret me. I think I can figure out what you mean by “supporting” quite well, namely, that you were a tech guy, not a mathematical economist, a researcher, or something similar.
Whatever you did, what I am doing is calling you on whether that experience gives you any notably useful expertise or formal training on the theory behind and function of markets (which you are claiming to rely upon quite heavily in this thread, and which I would generally expect a mathematical economist or a researcher specializing in the field would possess, and which a tech guy instructed by one or more of the latter probably would not); my skepticism is specifically driven by the fact that you seem unwilling to directly answer the question.
Someone should tell the fed; the limited importance of institutional money market accounts and repos to the overall economic picture is why they stopped publishing M3 numbers in 2006–because M3 didn’t provide any real economic information M2 does not, and just plain wasn’t that important to our understanding of the money supply. Now, Ron Paul disagrees with that decision; I’ll let you guess what I think of that endorsement.
(for those readers who aren’t familiar, the money supply can be measured in different ways, depending on how broad a definition of money is used; M0 is the narrowest measure, M1 or M2 are the standard measures of the “multiplied” money supply, and M3 is the broadest measure of “money.” As pointed out above, the federal reserve stopped publishing M3 numbers in 2006. M3 is the first time you see the kind of large-scale institutional money market account or repo agreement pantom is talking about being counted, and it does not include all zero-maturity instruments traded on money markets.)