Banks create money when they make loans. Regular people have to obtain money first, before they can lend it out to someone else. Banks don’t. That’s what separates banks from the rest of us.
Wrong. The money banks lend out is money they got from their depositors. I’m not a bank, but could accept a deposit from you and turn around and lend it to RickJay. The essential difference then between me and a typical “bank” is that your deposit with me won’t be audited or FDIC-insured.
I know little about “MMT economics” (and find it odd you would post an OP about it with no explanation or URL), but if its adherents really imagine that the mechanics of money-creation are pivotal to macro-economic policy, then I’m not impressed.
Yeah, you really have some bad knowledge about the banking system. Banks can not make loans without money on deposit.
Not quite true. It can inflate the currency to any degree. But there is a hard limit on how much it can deflate the currency.
I’m sorry, but this is absolutely false.
If Fifth Third Bank loans you $100,000, they are subtracting $100,000 from their available money and transferring it to you. They are actually taking money from their pocket and placing it into yours. They are not simply willing the money into existence.
I know you’ve gotten this idea from the Internet that banks write money into existence. It’s wrong, a basic misunderstanding of how fractional reserves work.
There’s a pretty good explanation of how banks work at this site: Hummel
I guess the question I’d ask is, if you believe that banks take money from the public, and lend it back to the public: Where does the public get the money from?
No, it can simply tax all money out of existence. Tax rate = 100%. Spending = $0.
Of course, it would never really do that, but I assume we’re talking theoretically here.
Money is a credit and a debit. Every dollar is a credit to someone, and a debit to someone else. Money on deposit in banks is a liability to the banks (a debit). It is an asset to the depositors (a credit).
Similarly currency is a liability to the Federal Reserve Bank, and a credit to whoever owns the note. Federal reserves - which are just bank accounts located at the Fed - are liabilities on the Federal Reserve, and credits to the member banks.
A bank does not subtract anything from its “available money” when it makes a loan. From the bank’s point of view, the bank is simply exchanging a liability on itself (a deposit in the amount of the loan) for a IOU from the borrower. The IOU, of course, is worth more than the deposit (because of interest) which is what makes lending profitable.
Suppose I borrow money from my bank. The bank adds the amount of the loan to my checking balance. Do you imagine there’s boxes in the back of the bank, and that the bank is scooping money out of one box and putting it into another?
All that’s happened is that the numbers have changed when I check my balance. If the loan was for $10, there’s $10 that did not exist before - $10 that is balanced by my promise to pay the bank $10, plus interest, sometime in the future.
Treasury printing presses.
The total amount of US currency circulating in the world: ~ $1 trillion.
Deposit liabilities of US commercial banks: $8.4 trillion. link
Not physically, but this is essentially what happens. In this scenario, there’s essentially three boxes at the bank. Let’s say they are all empty at the beginning. So:
My deposit account = 0
Bank’s reserve money = 0
Your wallet = 0
I bring in ten nice new one dollar bills to the bank and deposit in my account. What we now have is:
My deposit account = $10 (A number written on the bank’s ledger)
Bank’s reserve money = $10 (The actual currency in a drawer)
Your wallet = 0
Now you come in and get a loan for $8. Now we have:
My deposit account = $10 (A number in the bank’s ledger)
Bank’s reserve money = $2 (Two bills in a drawer)
Your wallet account = $8 (eight bills in your wallet)
Now, as you can see, despite your assertion to the contrary, the amount of money the bank has to loan has been reduced. If RickJay walks in asking for a $5 loan, he’s out of luck because the bank doesn’t have it.
And?
It’s also an asset to the bank. Double entry bookkeeping and all that. But never mind that.
Your first sentence in flatly wrong. If the bank loans me $150,000 for a mortgage, they take $150,000 out of their pile of money and give it to me (and in turn to the person I bought the house from.) They absolutely are out $150,000 in honest-to-God money, and in return get an IOU.
In an electronic sense, yes. That is exactly what they are doing. They do not simply create the money. They give you their money. It’s not** currency** being moved around (you appear to be confused as to the difference between currency and money) but they do, in fact, deduct that money from their available assets and put it in your account.
I know you have been told otherwise. You have been lied to. The idea of banks simply inventing money is not only false, but transparently absurd, since if they could do that they would behave completely differently, as you can figure out with just five minutes of critical thought.
If they simply created the money out of thin air, why on earth do they do credit checks? They have nothing to lose. Why would they even charge interest? In fact, if they’re creating the money, why not pay ME to borrow it? Why doesn’t CIBC call me up and offer to loan me a billion dollars with negative ten percent interest on a one week term? They create $1 billion tomorrow, and next Tuesday I pay them $900 million. I get $100 million and they get $900 million. It’s free money. Why the hell would they bother with any other line of business?
If banks actually worked like that - that is, if they borrowed cash from the public, and then lent that same cash back out again - then the amount banks could lend to the public would be no more than the amount the public physically brought to the banks in the first place. In fact, the total amount of currency in existence is about one trillion, and the total amount of bank loans made by US commercial banks is over nine trillion. Banks have lent, in other words, better than nine times as much as all the US currency in existence (most of which circulates outside this country).
Your example - of banks obtaining cash from depositors and then handing that same cash back out again - doesn’t describe how banks actually work.
Have you ever heard of a bank that had stopped making loans because it’d run out of cash? Have you ever heard of a bank telling a customer, “Hey, we’d love to make you that loan, but we have to wait until someone makes a deposit?”
It’s completely accurate, and that’s exactly how it works. How do you think it works? Use the format I did and explain how banks take deposits and lend money.
And banks can easily create more money than the actual physical currency because lent money usually makes it way to a bank account where it is available to lend out.
Sure it happens. Well, what happens is that bank raise interest rates on both loans and deposits until the amount of money they have to loan equals the demand for loans.
Banks do work like that. What you overlook is that your checking account (which is not backed by greenbacks still in the bank’s possession) is included in the total money figures you cite.
Yes. If it weren’t so, why would banks want to waste their money paying interest on the funds you bring to deposit?
(Your over-confidence in these assertions, LinusK, confirms once again the Dunning-Kruger Effect.)
It’s called a run on a bank, and it used to happen not infrequently. Of course a single bank branch does not make loans based on physical money in its coffers mate, it’s aggregated.
“All money is debt” is only true in a fictional accounting sense. In practical terms, it’s complete fantasy.
The monetary base (central bank money) is not debt in any legitimate sense. It shows up as “liabilities” of the central bank only because we’ve been dealing with double-entries in our financial books for so long, we have no other established way of doing things. But there is literally no obligation present for the central bank. Their currency “liabilities” need never be paid back, at any time, for any reason. Those accounting-based liabilities can exist in perpetuity, because the central bank has no legal obligations after issuing the money. No court is going to enforce payment on an obligation that does not exist. To call that kind of money a form of debt is to get so caught up in the accounting definitions that you lose all track of reality.
Monetary base is not debt. It is not an obligation of the central bank.
This is false, because the first step was false. The central bank can create more money by creating fictional obligations that it need never pay back.
No matter what the accounting identity says, the creation of new monetary base can increase the supply of savings available (depending on the productive capacity of the economy as a whole) without creating any new legal obligations for the central bank. Governments universally accept tax payments made with the monetary base, and in that sense the base is an obligation of the government, but even that is shaky, because the tax burden itself can be increased at the government’s own discretion. Calling the monetary base an obligation in any broad sense can be shaky proposition. Calling the base a kind of “debt” is beyond the pale.
This is true only in the most useless definitional sense.
A country that is experiencing hyperinflation is bankrupt in all but name. No, they won’t file Chapter XI, but calling them bankrupt is still a valid description of a government what done printed its way into penury.
Making something true by definition is of no use whatsofuckingever if your resulting equation provides no meaningful description of how the real world works.
These accounting identities lose their usefulness when they’re describing the functions of governments and central banks. This should come as no surprise. They were created for micro purposes, to track a single entity’s accounts. The macro world is, obviously enough, a great deal stranger.
It wouldn’t necessarily be counter-productive to reduce government spending, if the central bank were to pick up the slack. The MMT types would even seem to agree with that, based on the (false) notion that another form of debt is being created by the central bank.
Where they go wrong is in assuming that the new money can be easily destroyed. It can’t be. The creation of new money is easy, because the technocrats just push some buttons on the computational machine to create that new money out of the void. But taking those dollars back out of the system? Well, then they have to have some claim on the dollars. When they’re trying to reduce the money supply, they have to have some way to lure back dollars which they no longer own. They need to have sufficient assets to sell to suck up all those dollars again, or they need to do even more invasive tinkering, like jacking up the reserve requirements of banks to keep dollars from bouncing around so quickly. It’s typically a painful process in the short-run, and that’s why stopping inflation can often be harder than getting it started in the first place.
They cannot “deflate at any rate they want” in any real sense. This is not a finely calibrated machine, it is a lumbering beast that can and will trample the innocent into a bloody pulp if its handlers lose all sense of caution.
This is completely irrelevant.
Yes, banks are not strictly watched 24/7 to make sure they don’t loan past their reserve requirement. Sure, they’ll happily make as many seemingly profitable loans as they can from day to day, without keeping on exact tally of their reserve requirement. But they still need to have cash – monetary base – on hand to pay out the loan. If they ran out of base, they could not pay the loan. Full stop, end of story. And then, when the Fed check-up day rolls around, they absolutely need to scrounge up reserves from somewhere to back up to their required amount.
Those scrounged up reserves don’t necessarily have to come from depositors. They could come from other banks. That is… unless the other banks have already loaned out all of their monetary base as well, and are also in need of reserves. In this case, you’d see upward pressure on the interbank interest rate, and the open market desk at the Fed would respond to that pressure by supplying more base after-the-fact, as it were, to help the banks to meet their reserve requirements on loans they’ve already made. That is… unless the Fed was content with allowing the interbank interest rate to rise. In which case, interest rates go up, and banks are forced to cut their loans because they can longer be assured of being able to have the required reserves to back those loans.
Now, there’s almost always no surprise in the Fed’s decision to raise rates. They offer plenty of advanced warning, to make sure the banks will have a cash cushion ready when things are about to get tighter. The banks generally appreciate that warning, because if the Fed stops supplying the additional dollars, then the banks hit a hard limit of how much they’re able to lend.
They won’t tell you they’re waiting for depositors, though. They’ll just plain tell you fuck off in a time of tightening, but in the nicest possible bankers’ terminology. They’ll still be making loans, but not nearly as many, and only to the best possible candidates. If you don’t get a loan, it’s because the tight times will have increased their lending standards to a point where you no longer make the cut. “Waiting for deposits” has nothing to do with anything. In a credit crunch, only the most reputable borrowers get their hands on some cheese.
I can’t think off the top of my head of any monetary economist who would disagree with the semantic notion that banks “make money” when they make loans. The definitions of the broader “money supplies” such as the M1 and M2 are entirely based on the idea that banks expand the monetary base into the broader money supply with their fractional-reserve lending, and when economists talk about the money supply, it is almost exclusively a reference to the broader bank-magnified money supply, unless otherwise noted. (I will add the caveat that the M1 “broad” money supply is extremely strange right now.)
This is essentially a semantic point, as you say, but there is extremely broad agreement about the definition. Bank loans create money. Bank deposits (bank IOUs) are a negotiable instrument, a medium of exchange, and are therefore money. You remain, of course, completely correct that banks need to have “cash” available (the monetary base) to actually pay the loans that they make. They don’t just hand magical IOUs back and forth forever, as Linus seems to think. The IOUs are always backed by base. That is, in fact, what a bank deposit/IOU is: a promise to pay back monetary base on demand.
A deposit is a liability on a bank. If the deposit is created by making a loan, the other side of the transaction is the value of the loan. If it’s created by a customer bringing in currency, the other side is the currency. In either case, the deposit - which is a bookkeeping entry - is a liability and a liability only, so far as the bank is concerned.
It cannot be any other way.
I’m not sure what you mean by honest-to-God money. There’s three kinds of money: commercial bank deposits, which are bookkeeping entries that represent liabilities on banks; currency, which are promissory notes and represent liabilities on the Fed; and Fed funds, which are bookkeeping entries that represent liabilities on the Fed.
If the seller has an account with the bank that makes the loan, the bank will adjust its bookkeeping entries to reflect an increase in its assets by the value of the loan; and simultaneously, an increase in its liabilities, reflected as an increase in the credit assigned to the seller’s account. The result is that the money supply has increased by the same amount as the amount of the loan.
If the seller has an account at a different bank, the first bank will cut a check. The check is a liability on the bank, just as a deposit account is a liability on the bank. When the seller deposits the check at his own bank, it will be settled, or cleared, through the Federal Reserve system. Thousands (millions?) of checks are cleared through the Fed over any given time period. If at the end of the day, the first bank owes money to the second bank, the Fed adjusts the respective banks’ reserve accounts to reflect the difference. If that means the first bank’s funds fall below some limit set by the Fed, the first bank will have a couple of days to make up the difference by borrowing in the Fed funds market. Ordinarily the interest charged for borrowing those funds is higher than what banks have to pay depositors, which is what gives banks an incentive to obtain deposits.
What’s important, however, is that the bank lends first, and obtains Fed funds (if needed) later, and that the act of lending is what creates the deposits in the first place.
Again, it can be no other way. The public does not have the ability to create money (it’s illegal). If banks do not create it, it does not exist.
Banks are controlled through accounting logic, and accountants are controlled, at least in theory, by the Fed and by the power of the government to put them in jail if they cheat.
So, for example, a bank that makes a loan for X% interest has an asset that has a specific worth. I’m going to simplify here and pretend the amount loaned is $100, at 10%’ for one year, and that the market value of the loan is $105. From the bank’s point of view, it has a new liability ($100) and a new asset ($105). Its profit is five dollars.
Now suppose the bank makes a loan for one year at -10%, for a market value of $85. The bank’s loss is $15. A bank that loses money like that will be shut down by the Fed, because its assets will eventually fall below its liabilities. It will be insolvent.
Of course bank accountants sometimes lie and make stuff up. That’s fraud. If they get caught, the go to jail.
But the money would still theoretically have value, and in practice would have actual value on the black market.