Creating Money

reply to post by CookieMonster09

If a bank lends $10,000 to a borrower, and over the course of the year, gets repaid $15,000, did the bank just magically create $5,000 out of thin air, or did it just earn a $5,000 profit?

When the bank loans $10,000 it doesn't actually take $10,000 out of it's vault and tranfer it to the customer. The Bank has only $1,000 or $2,000 in actual deposits but it can loan $10,000 from that $1,000 or $2,000. That is called fractional reserve banking.

The differemce between what a bank takes in as deposits and what it loans out is the money that it creates.

The $5,000 interest is the cost of getting the loan, same as the $15,000 is the cost for the truck.

The problem is that the $5K taken by the bank out of the available demand of the economy is out of proportion to the total resources of the economy. That $5K could have been made by building a truck, which would conceivably lead to more manufacturing. Instead that $5K from the loan went to credit expansion which will cause a bubble by enabling too many people to make trucks fro sale at the same time.

reply to post by CookieMonster09

Let''s say I design and manufacture a car, and it costs me $10,000 to do so, all expenses included. I then market this car, and sell it you for $15,000. Did I just create $5,000 out of thin air, or did I just earn $5,000 in profit?

The truck increases the value of all money. Money is only as good as what it can buy. A new truck is one more thing that money can buy.

No money was created by making product for sale to money.

reply to post by Semicollegiate


Actually only the fed can create money that way. Regular banks actually do have the 10000 in their vault. It's just not theirs. It's the customers deposits. Where the money multiplier effect comes in is when the banks loans it out but pretends they still have it.

Like if I deposit 10000. They'll loan that out to someone but my account will stay 10000 but so will the guys account who they loaned it to.

reply to post by tinfoilman

Like if I deposit 10000. They'll loan that out to someone but my account will stay 10000 but so will the guys account who they loaned it to.

That would be a creation of $10,000.

If you spent or withdraw your $10,000 before the first loan payment, then the economy has $20,000 in it where as before your deposit there was only your $10,000.

If you have no intention of withdrawing your money before the loan is payed off, couldn't you loan the money out yourself?

reply to post by CookieMonster09

Doublespeak. You cannot have it both ways. Either banks can or cannot create money out of thin air. If they can create money out of thin air -- as you suggest -- there would be no such thing as a bank failure.

Yes I see the point you are trying to make now, and it is valid. Banks cannot create money out of thin air when ever they want it, obviously it's a bit more complex than that, but the end result is the same. They do create money from thin air, it's just that they only do it when they create new loans. That's the only way they can create money from nothing, by taking advantage of fractional reserve laws (it's allowed to happen because our economy needs the easy credit). They bet on the fact that the debtor will pay that money back to them... that's when it becomes free money for the banks. As I already explained, if a large number of debtors default on those loans, the banks are going to be in huge trouble, because they have to take on that debt.

Banks are businesses, and lend money from their own capital.

Don't make me laugh. That is exactly what they want you to believe, in fact it's what most people believe because they are so naive when it comes to monetary policy. Fractional Reserve Banking revolves around the idea that they can lend out 9 times as much money as they actually have in their reserves (their own capital). If they have $100 in reserves they can lend out $900 and they achieve that by changing some numbers on their computers, that's the only way the money is created, but it's just as valid as any other money because it can be withdrawn from the account and spent in the real world.

reply to post by Semicollegiate


It's not created, it's assumed existence based on the credentials of the institution issuing the loan.

This is the same problem that's been done since the beginning.

People are assuming the existence of many things.

At the deepest level, it seems the problem has less to do with the banking policies in place, rather a collective psychosis within the people who make assumptions not in evidence.

Purge the psychosis via healthy cultural values and beliefs, and the policies no longer wield leverage over the people.

reply to post by Semicollegiate


Yeah it's still a type of money creation. I'm just saying there's more than one kind.

Originally posted by CookieMonster09

Just watch the following video friend. Banks can and do create money from nothing. They collapse when bank runs happen or large amount of debtors default on their loans, that affects the banks in a drastic way because they rely on the debtor to pay off those debts which they have created with no real financial backing.

Doublespeak. You cannot have it both ways. Either banks can or cannot create money out of thin air. If they can create money out of thin air -- as you suggest -- there would be no such thing as a bank failure.

The fact is that banks fail. They cannot magically create money out of thin air. If the could, they would never be taken over by the FDIC. We have had record numbers of bank failures in this country, and yet you and your conspiracy nuts continue to espouse this ludicrous idea that banks can magically create money out of thin air. It's simply untrue.

Banks are businesses, and lend money from their own capital. Banks also have the ability to borrow from the Fed, if needed.

This is no different from any other business that lends money. Manufacturers lend money to their distributors. Car companies lend money to their dealerships. This is basic accounting, folks. Basic business. Manufacturers and car companies don't magically create money out of thin air, and neither do banks.

GE Capital lends money to businesses. They are one of the largest equipment lessors in the country, financing real estate, equipment, airplanes, etc. Are you suggesting that GE Capital, which is not a bank, magically conjures money out of thin air, too? If so, then practically any individual or business that lends money falls into your category of conjuring money out of thin air. It is standard business practice for businesses to lend money to other businesses.

Banks - especially the mega-banks - have trillions of dollars in assets. They have assets such as cash, loans receivables, real estate - bank branches, loan operations centers, etc., equipment - computers, ATM machines, etc., and investments in the stock and bond markets.

The big banks, like Chase, etc., literally have trillions of dollars in assets.

Somehow, people seem to neglect basic accounting. Banks have assets. Just look at the basic financial statement of any publicly-traded bank and you will see the amount of assets that they carry.

You have no idea what you are on about.

reply to post by macaronicaesar


Well what he/she is saying about businesses lending to each other is generally true. However, that poster clearly doesn't understand that banks are different, because they operate under fractional reserve laws, meaning they can loan out much more money than what they actually have - no other company can do that. Fractional reserve banking is only accepted and practiced because if they didn't do it, it would be extremely hard to get a loan. The easy credit helps new businesses get started, but it's also completely unfair if the banks can do that.

reply to post by ChaoticOrder


Fractional reserve banking causes the boom bust cycle. It hides or distorts the amount of demand in an economy, which would be discernable if the amount of money were constsant and spending by consumers was the only guide.

They do create money from thin air, it's just that they only do it when they create new loans. That's the only way they can create money from nothing, by taking advantage of fractional reserve laws (it's allowed to happen because our economy needs the easy credit). They bet on the fact that the debtor will pay that money back to them... that's when it becomes free money for the banks.

Couple of things - First, when a bank writes a legal contract with a borrower, that borrower typically pledges collateral. That signed contact becomes an asset of the bank -- because it represents a stream of interest income for the bank for the next 10, 20, or 30 years - whatever the length of term of repayment.

So, now the bank has a real live asset -- a signed legal contract from a borrower that is legally enforceable for repayment over a set period of time.

This is not the "creation of new money out of thin air", this is a loan with a repayment stream greater than the funds originally invested. The bank is taking a calculated risk that the borrower will repay the loan, based on the borrower's credit history, pay history, historical cash flow, collateral pledged, etc.

A receivable is an asset. This is basic accounting, and used not just by banks, but also by ordinary companies as well.

As far as utilizing deposits on hand, you have to remember that, except in the rare event of a bank run, operating deposits for a typical depositor tend to wax and wane, but rarely to a $0 balance. There is an average balance in that account that the bank can reasonably and predictably expect to "stick". In the case of CD's, deposits are very "sticky" in the sense that the CD holder usually incurs a significant penalty for early withdrawal of funds.

Lastly, banks do have their own cash, and their own investments. After all, they earn interest on loans that are repaid. Your typical mortgage over 30 years repays the original principal balance 2-3 times. A $100,000 loan over 30 years can return a huge amount of interest for the bank. What does the bank do with the interest? It takes these profits and pays its employees, its operating expenses - yes, but also the bank can reinvest these profits into new loans. It doesn't necessarily need to rely on depositor funds to fund loans. It can use profits, or its own cash on hand to make these loans.

reply to post by CookieMonster09


The point is that banks transform a signed contract into real money. Sure, I can loan money to you, and force you to sign a contract saying you will pay me back within a certain time period... but that doesn't mean I have some sort of magical ability to give you money which I don't have. I have to loan you money which I actually have. Banks don't. They can loan out 9 times as much as they actually have. Because they are banks, they have the ability to simply change some numbers of their computers and give a person some money, so it's easy for them to loan out money which they don't really have. So you can get a loan, and even withdraw that money which has been created with a few keystrokes.

reply to post by CookieMonster09


The seller of the house gets the money that the bank created.

When a deposit of central bank money is made at a commercial bank, the central bank money is removed from circulation and added to the commercial banks' reserves (it is no longer counted as part of M1 money supply). Simultaneously, an equal amount of new commercial bank money is created in the form of bank deposits.When a loan is made by the commercial bank (which keeps only a fraction of the central bank money as reserves), using the central bank money from the commercial bank's reserves, the m1 money supply expands by the size of the loan.[5] This process is called "deposit multiplication".

en.wikipedia.org...



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reply to post by CookieMonster09

Couple of things - First, when a bank writes a legal contract with a borrower, that borrower typically pledges collateral.

Yeah I think you're completely missing my point here. Nobody cares what the bank buys. The only question on the table is where the money to buy it with came from.

Nobody denies that banks have their own money but the vast majority of money lent out is fractional reserve cash. Bringing up the banks own money and what they personally invest in is a minority topic. We're only concerned with how fractional reserve banking works.

Like I said only the fed can create true new money that continues to exist. Fractional reserve banking and money creation are two different topics. Regular banks don't do this. They create digital money that doesn't really exist due to the multiplier effect, but it's just an accounting thing. It shrinks and grows with the economy. Or appears to anyway.

They take your money and loan it out, but they tell you, all your money is still there. Say I deposit $100,000 and the bank loans $90,000 of it out to someone to buy a house.

Sure the bank now has the house as an asset, but it's irrelevant. Because if I come by to withdraw my money tomorrow they're not gonna say hey sorry, loaned your money out. But we got this house! No, they're just gonna take $100,000 from other people's accounts and give me my money.

But the previous home owner still has the $90,000 in his pockets. So now you got this $190,000 floating around the economy.

But where did the extra money come from? Well it came from other people's accounts. The only problem is, the bank is still telling all those people that all their money is still in their accounts. But it's not. They just gave it to me so I could make my withdraw.

But digitally the money supply just grew. Digitally everyone's accounts either stayed the same or got larger. But in reality we know that's not true.

However, eventually someone will deposit that $90,000 back in the bank and it will balance again. The borrower will find a way to collect $90,000 from the economy and pay the bank back, like say, working for a couple decades. Or the borrower will default and the bank will sell the asset. When they do, that $90,000 will come back to them from the economy.

See, it all works out in the end. It's not a problem.

But I'm not one of the people that believes there's too much money in the economy. Perhaps that is what's confusing you. Many of the conspiracy theorists believe there's too much cash in the economy and it's gonna cause massive inflation and that's why the system is gonna collapse.

But I'm not one of those people. At least not when it comes to fractional reserve banking. I have the exact opposite view. There's not enough money in the economy because not enough people have jobs where they can borrow. The money just sits in the bank and rots. It's a debt based system which means the wheels don't really spin unless someone's in debt.

After the housing collapse people's credit went to crap and banks stopped loaning causing the money supply to appear to shrink just like it appears to grow when people borrow. Don't believe my theory? Just ask your friends and family if you can borrow $1,000. See how that works out. Then come back and tell me if you think the problem is there's too much money, or not enough money.

Lets just clear up this confusion with one simple concise video which explains the facts. Fractional Reserve Banking explanation starts at around 2:40 but I suggest watching from the start.




reply to post by tinfoilman


That Wikipedia article clearly states the fact that the process expands the money supply:

The process of fractional-reserve banking expands the money supply of the economy but also increases the risk that a bank cannot meet its depositor withdrawals.

reply to post by ChaoticOrder


There's problems with that video though depending on how you look at it. For one he says, paraphrasing, that new money is created regardless of demand for product. But that's not true.

That's exactly why our money system is debt based. The new money isn't backed up by the old money. The new money is backed up by your future labor and credit score. You gotta pay that loan back.

In any fiat system, the question is, how much money do you print? Nobody knows. We decide by how many loans people are willing to take out.

Nobody takes out a loan for their health. So, for the guy in the video to say demand isn't there. That doesn't make any sense. If someone is borrowing money they must be interested in buying something right? There must be some demand right?

Since someone is willing to go into debt to buy it, it's okay to print the money needed to buy it. You'll probably never get hyperinflation in this system because you'll probably never find enough people willing to risk their credit score and take on the massive debt it would require to cause it.

The loans act as the check and balance except in cases where we lower borrowing requirements. Then we get things like sub prime loans and the housing bubble. That's why you shouldn't mess with checks and balances.

Also he says that the new money steals wealth from the old money. GOOD! That's exactly what it's supposed to do. That way you don't stick it under your mattress. Maybe now this way you'll invest it in a new business or something like that that has a higher rate of return than the rate of inflation.

See, it's done on purpose so people don't sit on their money. It encourages investment. But more importantly it doesn't really steal any value from the old dollars because it's fiat. The old dollars never had any value to begin with. They're not supposed to. All fiat money is worth 0. It's just paper.

If you want to stick something under your mattress that holds value just buy silver or gold.

reply to post by ChaoticOrder

The process of fractional-reserve banking expands the money supply of the economy but also increases the risk that a bank cannot meet its depositor withdrawals.

Yes that's what I just said. It expands the money supply.

reply to post by ChaoticOrder


False.

Bonds are purchased at less than face value and redeemed at that face value later. Thus investors (e.g. banks) would want them.

So Uncle Sam says, "Geez! I am out of money, better get a pay-day loan!" and issues a bond at auction. I put in my bid, the Chinese put in theirs, banks and retirement firms put in theirs and the bonds are then sold. Uncle Sam gets cool cash to keep on keeping on, and banks get another financial instrument to put in its assets.

When the Federal Reserve wants to increase the money supply it calls the guys who bought the bonds and says, "Hey! Remember those bonds you bought? I would like to take them off your hands." They then issue money into the economy by their purchase. So I get cash, and the Fed safeguards the bond. They've injected money into the economy paying me more money than I paid for the initial bond.

When the Fed wants to decrease the monetary supply they sell bonds. Thus removing cash and leaving me (the buyer) holding something to be redeem later.

This is called "Open-Market Operations".

Nobody takes out a loan for their health. So, for the guy in the video to say demand isn't there. That doesn't make any sense. If someone is borrowing money they must be interested in buying something right? There must be some demand right?

You are correct, but giving a loan to someone who wants to buy a new car or house doesn't create nearly as much economic growth as providing a loan to a new startup would. Plus the whole thing hinges on the belief that banks are perfect lenders, and they will also make successful investments, and that a large percentage of their loans wont default. But that is certainly far from the truth.

But I agree with you, the inflationary effect of fractional reserve banking probably isn't even half as bad as the inflationary effect caused by the Federal Reserve when they convert debt into new money. It's clear that inflation is a real problem, over the last decade prices has risen so much its ridiculous. And since the Fed was established the dollar has lost something like 98% of its value.

Also he says that the new money steals wealth from the old money. GOOD! That's exactly what it's supposed to do. That way you don't stick it under your mattress.

People should be allowed to save their money if they wish. They only save it so that they can spend it later. Most people put their savings in a bank anyway, and the bank loans it out and puts that money into different investments. There's nothing wrong with banks loaning out what they really have.

reply to post by ChaoticOrder

You are correct, but giving a loan to someone who wants to buy a new car or house doesn't create nearly as much economic growth as providing a loan to a new startup would.

And giving a loan to someone to start a new start up plus giving someone else a loan for a car or house adds even more growth. It's not an either or thing. I don't care what the loan is for. I'm not here to debate what's a good loan versus a bad loan. That's for the bank to figure out.

People should be allowed to save their money if they wish.

They can, it's a free country. Go ahead.

There's nothing wrong with banks loaning out what they really have.

I never said there was?