I don’t really like this sentence of mine. It could be too strongly worded.
Well… In the US, the Fed only checks the banks’ reserves every couple weeks. Given this relaxation of reserve requirements, and the ability to borrow reserves from other banks on the interbank market, new loans are going to be made based on a bank’s expectation of being able to find wholesale reserves at a profitable price after the retail loan is made, and before Fed Judgment Day.
That expectation of being able to find relatively inexpensive reserves after loans are made will, in turn, be based on the broader situation, like Fed announcements and the macro picture. Banks still have to be careful, but not in the way the simplified money multiplier story would imply. Here’s the wiki section on the “loans first” picture of the multiplier. It’s not really fleshed out, though. I find some of those theories of endogenous money somewhat silly, because the central bank is still going to have a big fat target (an exogenous target) of where they want things to be. If bank lending is not helping them hit their big target, then the central bank will yank back on the chain. The macroeconomic picture is always there, guiding the process.
The simple answer to the OP is how we want to define money. If you define it as cash in your pocket or a deposit in a bank, it didn’t go anywhere. Even in a depression, money doesn’t vanish out of your pocket, and (assuming no bank failure) your money is still sitting in your account.
Where money “disappears” is when people own assets that fluctuate in value. Your retirement plan that might have been worth $100k five years ago is only worth $80k now. $20k didn’t disappear, it’s just the value of the stocks lowered.
Short answer: You never have money until you have cash. You have an asset that is worth a certain amount of money at that given time. When that value changes, you think of it in terms of lost money, but it was never really there to begin with except in a balance sheet.
You’re right that the value of assets can fluctuate but the total amount of money also fluctuates.
Defining money as bank-account money plus the small amount of cash in the economy, the total of all bank-account money can lower as explained in detail above.
Loan repayments to a financial institute reduces the money supply. This is an important detail.
Is anyone still in doubt that banks directly create money through increasing the borrower’s account without lowering any depositor’s account or their reserve account?
And equally is anyone in doubt that the bank-account money used to repay a loan no longer exists after the debt is settled?
I can try to explain it in a couple of different ways.
If anyone would like to learn more about how the money supply is eroded throughout a recession we recently published a document which describes the process.
The money given to you when you take a loan is decreased from the bank’s holdings. The idea that the bank simply creates the money out of thin air is a very popular myth, I know, but it is false (and is transparently silly, if you consider the logical implications and how banks would behave if they could do this.)
If Bank of America gives you a $100,000 mortgage, they take $100,000 out of a BoA account and put it in yours. They don’t simply type the money into existence.
You’re allowing yourself to be flummoxed by the fractional reserve system, which allows the same money, in theory, to be used to create multiple ledger entries, but it doesn’t allow for banks to create their own money (or else banks would have no reason to charge interest.)
I realize this is a zombie thread, but misconception abounds. The first step in understanding “money” is to think of it as an intangible bookkeeping abstraction that can fluctuate with little effect, but that’s hard to do when Money is capitalized and thought of as the be-all and end-all.
(And, unlike “money,” gold is an exact tangible thing; the number of tons of gold on the surface of the earth does not vary at banker’s whim. I am not a gold-bug, but it is easy to see how gold-nuts derive their philosophy.)
Trivial thought experiment: John and I wake up every morning, pick $5 worth of apples from our respective fruit trees, eat them and go back to sleep. One morning, I’m not hungry and don’t feel like picking so I invite John over to pick my tree as well. “You’ll return the favor some day,” I say, “and to make it official write ‘I owe you $5 of apples’ on a piece of paper.”
Little has changed, but $5 of paper exists that didn’t exist before! If you want to quibble that that IOU isn’t “money”, then let the apple trees belong to central banks. If you want to argue that this $5 isn’t M1 money, nor even M2 or M3 money, but perhaps M9 money(!), I say Don’t be distracted! M2 money becomes M1 money whenever you cash a CD; the distinctions just aren’t that critical.
Wealth and money aren’t synonyms, but these comments are wrong anyway. As a thought experiment, substitute a corporation where the only share sales are just to establish a price (prove the company represents “wealth”), buyers and sellers end up balancing exactly, but company goes bankrupt.
Or, simply note that the value of Kodak’s equipment declined, representing a loss to the total value of equipment on the planet. That two guys were exchanging money at a craps table while this happened is irrelevant.
I’m surprised Mr. Ferguson was attacked for offering a simplified look at the process of money creation. Simplicity is precisely what is needed when clearing up gross misconceptions about things like money. That $10 of a $100 deposit needs to be reserved is just a detail when understanding the basic picture.
No to you. You’re also attaching a sacredness to “money” that only confuses. Recall that John “created $5” when he picked my apple tree above. Whether I charge him interest is irrelevant.
I honestly do not understand your complaint here. Sacredness? Huh?
Your $5 example immediately defaults to the concept of a central bank creating money. It absolutely is true that central banks can create money just by deciding to do so. Paul was referring to commercial banks, the kind a normal person gets a mortgage from. They do will not will money into existence. F they lend you a dollar, that dollar actually is taken from the bank’s available stash of money.
I open a commercial bank, and place $1000 in small bills into the vault. Ignoring the rest of the universe, we have M1 = $1000.
George walks into my bank; I agree to loan him $900; he walks away with a checkbook. We have M1 = $1900 ($1000 in small bills still in my vault, plus $900 demand deposit held by George). Read Money - Wikipedia if this unclear.
$900 of “additional money” has just been created. If it wasn’t created by my commercial bank, I wonder who did “create” it.
I don’t think you’re quite grasping Paul’s claim. What you’re saying is true but is not what a truly astounding number of people believe. The $900 loan is actually promised against your money; yes, you increased the M1 for the moment, but suppose George immediately withdraws the $900 rather than walking away with the checkbook. How much money’s in the vault?
You can’t loan the money out unless you have the money at the time the loan’s made. It would otherwise be in the interest of the bank to agree to simply lend me a hundred million dollars at 0% interest for one hour (and toss me a gift certificate to a restaurant for agreeing to sign the papers) so they could make a quick hundred million bucks.
(And talking about the M1 in a thread about where all the money went in 2008 is missing the point; demand deposit accounts did not shrink during the financial crisis.)
But, in reality and not this simplistic example, that’s the only way the economy works–right now the reserve requirement is, at most, 10% (Federal Reserve Board - Reserve Requirements).
Well, of course. In the example of the Bank of Septimus, he could be reduced to close to the 10% minimum the instant he issues the loan if George decides to take it all out to go to the strip bar. Now the Bank of Septimus has only $100 in cash, and someone out there’s got a $1000 credit in their savings account, and Septimus is hosed if they come in looking for it. Which is, of course, why banks needs oodles or depositors and creditors and lots of confidence in their operations. I get fractional reserve banking.
What’s being claimed by Paul, and it’s becoming a common myth, is that banks don’t actually give you any money, they just create it. That isn’t the case. The Bank of Septimus can’t actually give George $900 unless they have it to give to him. And if you walk in after George heads off to the strip bar with $900 in cash, the Bank of Septimus can’t lend you more than a buck or so because they’re nearing the limits of their reserve requirements. They need another depositor to walk in and give them more money so they can lend you some of it.
Again, we’re talking about a commercial bank. The central bank (it’s kind of unfortunate we call it a “bank,” really; there should be another word for it) CAN create money out of thin air. They can just say “you know what, let’s make another two hundred billion dollars today,” and so it is.
It is the case that if you get a loan from a bank they create the money they lend you. This is why almost every Euro, Dollar etc. has a corresponding debt.
It is also the case that once you repay a loan to a bank the money no longer exists. This is why there’s less money during a recession.
[QUOTE=RickJay]
… commercial banks … do will not will money into existence.
[/QUOTE]
Was that intended to be a true statement, or an oversimplification you’re now retracting?
I’m afraid it’s still you missing the point. If George asks for cash rather than checks, it’s probably because he intends to spend it now, and eventually the banknotes will find their way to someone who places them back into a bank account. They may deposit them at the Bank of RickJay instead of the Bank of Septimus, but either way they remain in the system, adding to M1 or M2.
Your claim that “commercial banks do not create money” is simply false. I’m unclear whether you now acknowledge that or not. Commercial bank loans do tend to increase “money” (M2); you’ll see this by Googling to see bank loans and M2 growth both declining circa 2010.
(Although to say so may increase rather than lessen confusion, the Federal Reserve Banks can be treated as playing a money-creation role similar, in its mechanics, to commercial banks! FRB banknotes are FRB obligations, much like BankAmerica traveler’s checks are BofA obligations. FRB is itself subject to certain reserve rules, although, since its deposits and banknotes can be backed by U.S. Treasury bonds, the “backing” is circular!)
If your point is that money supply will decrease if many or most depositors insist on redeeming their checking accounts for banknotes, then you’re agreeing that the banks create money. Because, on balance, checking accounts do exist, to the tune of hundreds of billions of dollars today. That’s all “money” that was “created” by commercial banks.
Now, you may argue that that “money” needs to be backed, in part by banknotes in bank vaults, and is therefore just an accounting abstraction. But all money (except gold) is just an accounting abstraction – that’s the point consistently ignored, and that’s why I previously wrote “You’re also attaching a sacredness to ‘money’ that only confuses.”
My intention is to educate about the monetary system, ultimately as a means of finding a resolution to the debt crisis. We’ve done months of research into the publication I linked to and, of course, it’s on our website but my intention is not to get hits.
I link to it because it’s such a technical subject and a document like it is a much tidier way to show how the system operates than the various treads that can go off in tangents.
If you’ve any specific issue with my description of how banks create and destroy money I’d be happy to enter debate.
Let’s say I ask my bank for a $100 million loan, for a week. I want 0% interest, but I agree to pay them back in gold bars.
Surely they should accept my proposal. They are simply conjuring money at will, so it doesn’t even matter to them if I can’t pay them back. But if I do, they will have “real” money.
