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Wednesday, August 15, 2012

The IMF on no-reserve banking

Karl Denninger digs up the document:
In a financial system with little or no reserve backing for deposits, and with government-issued cash having a very small role relative to bank deposits, the creation of a nation’s broad monetary aggregates depends almost entirely on banks’ willingness to supply deposits. Because additional bank deposits can only be created through additional bank loans, sudden changes in the willingness of banks to extend credit must therefore not only lead to credit booms or busts, but also to an instant excess or shortage of money, and therefore of nominal aggregate demand. By contrast, under the Chicago Plan the quantity of money and the quantity of credit would become completely independent of each other. This would enable policy to control these two aggregates independently and therefore more effectively. Money growth could be controlled directly via a money growth rule. The control of credit growth would become much more straightforward because banks would no longer be able, as they are today, to generate their own funding, deposits, in the act of lending, an extraordinary privilege that is not enjoyed by any other type of business. Rather, banks would become what many erroneously believe them to be today, pure intermediaries that depend on obtaining outside funding before being able to lend. Having to obtain outside funding rather than being able to create it themselves would much reduce the ability of banks to cause business cycles due to potentially capricious changes in their attitude towards credit risk.

Read that however many times you need to until it sinks in folks, because this is what I and a few others have been saying now for a long time -- and our ideas are not only not really new, they're also factually correct.

The "extraordinarily privilege" referenced above, were you or I to engage in it, would be called what it is -- counterfeiting. "Generating their own funding, deposits", is exactly that -- creating money out of "thin air" though the unbacked emissions of credit. It is exactly identical in form and effect to you running off $100 bills on your office copier. And for every other entity other than a bank, it is a felony.

But it is Congress that has this power according to our Constitution. A commercial institution that operates for profit should never have the right to literally steal from you at its whim, but that is exactly what unbacked credit creation empowers a bank with -- the ability to take everything you have by debasing your purchasing power to the point that you are forced to hock, or even sell and abandon, any asset you possess.
This is important if you want to understand the financial crisis and the inflation/deflation issue. Contra what you've been taught, loans don't come from deposits. The loans come first. This is the "credit money" of which Mises wrote and is the reason that the mainstream economists are so confused by their continual focus on M1/M2, which are just a small fraction of the real money supply, which is Z1+M1/M2.

So, the inflationistas are correct in one sense. Inflation has been worse than is reported by the CPI-U. Vastly worse. However, this also shows why the central bank has been talking about the need to fight off deflation via "quantitative easing" despite the fact that M1/M2 have continued to increase; Z1 has been flat for four years despite the heroic efforts on the part of Washington to prop up spending by taking on a larger share of it.

As I showed in RGD, the USA is closer to a no-reserve banking system than the textbook ten percent fractional-reserve one. The credit money is pure digital counterfeiting, but it spends as readily as legal tender.

Labels:

99 Comments:

Anonymous A.Handle August 15, 2012 8:13 AM  

North has a deflationist rebuttal up on Mises. Vox hasn't gotten close enough to land the intellectual equivalent of the hook punch yet. But the sizing up and circling continues...

Anonymous Poli_Mis August 15, 2012 8:21 AM  

Yes, do let the debate continue. I cannot wait to see which will be our fate ... the Sword of Damocles or the dreaded Iron Maiden.

Anonymous GmBH August 15, 2012 8:21 AM  

I soured on North when he advised people to start buying up single family homes with debt and having the inflation pay it off. Gee, what could go wrong?

Blogger Dan Hewitt August 15, 2012 8:28 AM  

For some reason, I thought you were a free banker (no central bank, no 100% reserve mandate). The Chicago plan is pretty much the opposite (central bank, 100% reserve mandate). Out of curiousity, which do you support?

Blogger Dan Hewitt August 15, 2012 8:30 AM  

I read North's article this morning, and he did such a good job of discrediting himself, you shouldn't even bother responding to him.

Anonymous dh August 15, 2012 8:30 AM  

When a bank emits credit, in the form of a loan or revolving debt instrument, where exactly do those electronic dollars come from?

Blogger Kentucky Packrat August 15, 2012 9:05 AM  

IMHO, this is the disconnect happening between consumer price increases and the money supply. In the US, we are suffering from significant consumer price increases, especially in food, gas, and other essentials. At the same time, the money supply is essentially flat to shrinking.

The consumer price issues are a trailing effect of the inflation of the last credit bubble. That's why Shadowstats inflation numbers have exploded: they are measuring consumer price costs as a proxy for inflation, and its trailing the actual inflation by years. It also explains why "regular people" in the US hurt. GDP may have been positive some over the last 30 years, but matched against the cost of necessities, people have been losing purchasing power for almost 30 years.

Eventually, consumer prices will resync with inflation. It just won't be fun when it happens.

Anonymous FUBAR Nation (Ben) August 15, 2012 9:13 AM  

Denninger is right, but why does he think Congress would do a better job, or a law would make it all right. There are a massive amount of laws and all they do is protect the big firms from competition.

It's ridiculous that schools still teach the garbage that banks lend from reserves. That's what I learned and it's wrong. Banks lend whatever they can as long as it doesn't exceed capital limits, and they do it by creating credit as Denninger points out.

I think this whole inflation/deflation debate comes down to the political question. Would the government rather see a deflationary collapse of Z1 or a huge printing of money by buying up tons of assets in the tens of trilions?

That's why I think it's a good idea to keep half your money in cash and half in precious metals. Don't play the stock market if you can't take losses and don't give your money to brokerages because once they take the money they can steal it and you have no recourse.

Anonymous Athor Pel August 15, 2012 9:25 AM  

I brought some pre-1964 silver quarters to work this morning. I like to do show and tells every so often. I also hand them some more recently created coinage, post 1964. I show them how they feel different in the hand, sound different when made to spin down on a table top or rubbed together, the difference in metal lustre. Once you know what to look for the differences stick out like a sore thumb.

I then go on to show and explain all the other methods of debasement other than mere metal swapping, the depth of the design that was stamped on the faces of the coin, the thickness of the edges in both the horizontal and vertical dimensions, the depth of the grooves on the edge.

Then I tell them the actual metal value of the silver on a quarter, about $5 right now. Many get an obvious calculating look on their face. For those folks that get what I'm telling them it starts them down the rabbit hole. And they don't even know they just took a red pill.


Anonymous Josh August 15, 2012 9:25 AM  

When a bank emits credit, in the form of a loan or revolving debt instrument, where exactly do those electronic dollars come from?

Supposedly, bank reserves, but in reality, they just create them in the ledger. Then the fed pumps money into the banks reserves.

Anonymous Josh August 15, 2012 9:28 AM  

Denninger is right, but why does he think Congress would do a better job, or a law would make it all right. 

Because, at some level, he's still an idiot who thinks that "if the right people were I'm charge" and "if we just enforced the black letter law" everything would be better, even though hundreds of years of history stand to refute his theory.

Blogger vandelay August 15, 2012 9:32 AM  

O/T
Over 80 per cent of studies published in peer reviewed science journals cannot be replicated.
http://slate.me/OvyFma

Anonymous Josh August 15, 2012 9:32 AM  

The consumer price issues are a trailing effect of the inflation of the last credit bubble.

Not all of it is. The massive increase in corn ethanol production has greatly distorted prices (virtually everything people eat comes from corn). And China and to a smaller extent India have increased the global demand for commodities as a result of their credit fueled booms. So it's not enough to say, "look, inflation!"

Blogger Rahul August 15, 2012 9:33 AM  

I wonder what's better: 100% reserve banking system that Rothbard recommends or the One dollar of Capital that Denninger talks about.

Anonymous Josh August 15, 2012 9:41 AM  

A free banking system would likely lead to a "one dollar of capital" system. Ideally you would have both a free banking system and a free monetary system, with the supply of money and credit both determined by the market, not by guns and badges.

Blogger Titus Quinctius Cincinnatus August 15, 2012 9:44 AM  

Booooooring! C'mon Vox, less talk about economics stuff, and more talk about what Michelle Malkin will be wearing to the Republican National Convention!

/

Blogger Joshua_D August 15, 2012 9:46 AM  

Josh August 15, 2012 9:28 AM

Denninger is right, but why does he think Congress would do a better job, or a law would make it all right.

Because, at some level, he's still an idiot who thinks that "if the right people were I'm charge" and "if we just enforced the black letter law" everything would be better, even though hundreds of years of history stand to refute his theory.


I don't think Denninger has ever said Congress would do a better job. Well all need to try to read what is written. If he has said that, then I'm wrong, and I'll be happy to admit it.

KD always points to the Constitution that clearly states that Congress has the power to coin money, not banks.

I personally don't think today's Congress would be much better, since our politicians are bought and paid for by the banks, but that's beside the point. Of course, I also disagree with KD when he moves from pointing to the Constitution to claiming that Congress should issue fiat currency, but that's another story.

Blogger Joshua_D August 15, 2012 9:48 AM  

Josh August 15, 2012 9:41 AM

... not by guns and badges.


Somebody has to have a gun, Josh.

Anonymous Stilicho August 15, 2012 9:50 AM  

Indeed, this is not a new idea:

I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.
Thomas Jefferson

Like Newton said, we stand on the shoulders of giants.

Blogger Joshua_D August 15, 2012 9:52 AM  

OT but related, it seems that Mark Grant is a PROTECTIONISTA!

"Any scheme such as Eurobonds or any other artifice that produces a unified Europe where national boundaries fade away will result in an average rating for all of Europe at “A” or maybe “BBB+” and the cost of funding and standards of living will also revert to a mean for all of Europe. This is why Germany is in such a perilous state because they know this. You may disregard all of the rhetoric and the jargon; the people in Berlin do not wish to live like the people in Athens and that would be the certain outcome, over time, of blending the national debts. The nations with the money would be forced to disgorge and the nations without money would be the recipients and you would get a harmonized Europe but at a huge price to the wealthier nations who would no longer be wealthy." - Mark Grant via Zerohedge

http://www.zerohedge.com/news/some-simple-answers-requested

Anonymous Stilicho August 15, 2012 9:55 AM  

not by guns and badges.

But it's not guns and badges now so much as it is the use of guns and badges to enforce a monopoly in favor of one group at the expense of everyone else.

Anonymous Vidad August 15, 2012 10:04 AM  

@Athor Pel

It's a remarkable object lesson. I tend to do the same sort of thing with teens and kids that visit us. "This is real money..." I also ask questions like "Do you have any idea why the dime is smaller than the nickel?"

I paid a babysitter in silver dollars just a week or so ago. She was thrilled.

Holding real value in your hand is eye-opening.

Anonymous Stilicho August 15, 2012 10:06 AM  


I don't think Denninger has ever said Congress would do a better job. Well all need to try to read what is written. If he has said that, then I'm wrong, and I'll be happy to admit it.

KD always points to the Constitution that clearly states that Congress has the power to coin money, not banks.

I personally don't think today's Congress would be much better, since our politicians are bought and paid for by the banks, but that's beside the point. Of course, I also disagree with KD when he moves from pointing to the Constitution to claiming that Congress should issue fiat currency, but that's another story.


I have read him endorsing Bill Still's plan to do just that (direct emission of currency by Congress). But I think it was more of the "they can't be any worse than the banksters" variety than anything else. Ben is correct, though, that his proposed one dollar of capital rule, while correct in theory, would be violated before the ink dried on the bill. It could only work if enforced and I would be more comfortable if a gold standard were added to it along with regular public audits of the vaults. In other words, a 100% gold reserve system. It isn't a panacea, but it would be far better than the current system.

On a side note, I've been against the Fed (and central banks in general) for a while now on theoretical grounds (thank you Murray Rothbard), but I just started reading The Creature From Jekyll Island and, if even half of what's in that book is true, banksters and politicians should be hanging from every available tree branch in the country. Vidkun Quisling, Benedict Arnold, those guys were patriots compared to the treasonous thieves that have gone unpunished and largely unnoticed in our banking system.

Blogger tz August 15, 2012 10:09 AM  

This is how the Mississippi scheme was possible and created a boom and bust on a "gold standard" - It worked until one of the investors arrived one day with a wagon to redeem the notes in Gold. It was easy to issue more paper until them.

The 50+ trillion in mortgage backed securities which is evaporating wasn't "printed".

Blogger Vox August 15, 2012 10:13 AM  

North has a deflationist rebuttal up on Mises. Vox hasn't gotten close enough to land the intellectual equivalent of the hook punch yet.

I already took this one apart. It's a repeat of the one that was on Rockwell before.

Anonymous Roundtine August 15, 2012 10:15 AM  

There is far more demand for easy money than hard money because the debtors always outnumber the savers. Hard money systems don't last long and an easy money system can have a long-life on a human timescale. Ron Paul's policy recommendation is the best: allow gold and silver to assume their natural monetary role (take taxes off them) and let them compete in the market. Have a hard money system for savers alongside an easy credit system for debtors. I don't even think most gold bugs would actually want to borrow gold. Much better to borrow and spend fiat, while saving in gold.

So, the inflationistas are correct in one sense. Inflation has been worse than is reported by the CPI-U. Vastly worse.

Has been the key part. Objects in the rear view mirror may be closer than they appear, but they are still in the rear view mirror.

Blogger Nate August 15, 2012 10:28 AM  

The Zero Reserve Banking option is a nuke that I have been expecting to see for some time. I've brought it up several times here... and though Vox takes it seriously... many didn't.

Hopefully seeing it discussed will open some eyes.

Anonymous Stilicho August 15, 2012 10:43 AM  

Hopefully seeing it discussed will open some eyes.

You're a funny man, Nate. A regular freakin' comedian. There are none so blind as he who will not see. Even those who are capable of understanding the issue often cannot discuss it without their eyes glazing over 'cause thinking be hard or dismissing the facts out of hand due to their indoctrination and normalcy bias. Among those who do understand the full implications of it, well, I'll leave you with a quote:

The few who understand the system, will either be so interested from it's profits or so dependent on it's favors, that there will be no opposition from that class. - Mayer Amschel Rothschild

Anonymous Noah B. August 15, 2012 10:47 AM  

"Contra what you've been taught, loans don't come from deposits. The loans come first."

If the loans come first, and lending is independent of deposits, what is it that limits banks' ability to lend? The notion that banks loan out some multiple of deposits seems to be implicit in the definition of the reserve requirement.

Anonymous Mr. Nightstick August 15, 2012 10:50 AM  

There might be hope for us after all. Even Canadians are getting on our bad side.

Blogger Vox August 15, 2012 10:52 AM  

If the loans come first, and lending is independent of deposits, what is it that limits banks' ability to lend?

The limit of credit money is the banks' ability to find borrowers deemed capable of keeping up on their payments.

Anonymous Salt August 15, 2012 11:06 AM  

I wonder when people and small businesses will cease to feed the beast, at least in the direct way they do.

STOP PAYING INCOME TAXES.

Blogger IM2L844 August 15, 2012 11:06 AM  

I find it suspicious that the IMF would support the Chicago plan unless the bankers are really starting to get worried about bank runs. You can't trust any of these bankster bastards any further than you can hang them. They're all in cahoots with one another. I found it odd that the IMF paper didn't mention reserves on savings while the original Chicago Plan only called for 5% reserves on savings. I see some potential wiggle room for some kind of technical bait and switch that will restore superficial confidence in the banking system while sill allowing them to rape and pillage at their own discretion through redefining the legal meaning of "savings".

I don't know. Maybe, I'm missing some critical point here.

Anonymous Starbuck August 15, 2012 11:12 AM  

I wonder when people and small businesses will cease to feed the beast, at least in the direct way they do.

STOP PAYING INCOME TAXES.-Salt


yea, good luck with that. Even if everyone agreed to stop paying taxes in rebellion, 98% of the people would continue to pay them. The 2% would be arrested and put in jail.

Do you want to be the first?

Blogger Dad29 August 15, 2012 11:16 AM  

So my payroll-check-deposit is from a loan the Bank made to me?

The deposits made from retail stores are all a result of loans?

Really!!

Anonymous Josh August 15, 2012 11:17 AM  

The Zero Reserve Banking option is a nuke that I have been expecting to see for some time. I've brought it up several times here... and though Vox takes it seriously... many didn't.

Dude, it doesn't freaking matter what the reserve policy is, because they don't have any bearing on when banks lend or don't lend.

How do you propose that banks will lend money to borrowers who cannot repay them?

Blogger tz August 15, 2012 11:28 AM  

The fraud is technical. Mutual funds can invest, but can also suspend resumptions if cash gets low. There would be little or no need for FDIC insuring deposits. But except for the bulk and security why would I need to? In the S&L crisis, Vernon Savings and others had tables encouraging "widows and orphans" to move their money out of the FSLIC insured accounts into an investment account (that was part of the ponzi scheme).

I don't have problems with having a mutual fund with ATMs and drive-through or regular tellers as long as the investors know their cash is locked up for years, some loans aren't callable, and if the free cash available is used up they won't be able to get their funds. (They might be able to use the funds as collateral to get a loan from a more liquid institution with only a little usury).

Ah, Usury, one of the great sins, handmaid of avarice, that the modern world is awash in, worse than pornography and the free and open sex. There might be a place for actual time preference and risk based "loans" where the creditor and debtor collaborate. Islam has some ideas because they haven't changed their doctrine. Neither does the Catholic church, (google "Catechism Usury" for 2 articles), but it tends to ignore the teaching or accepts as "science" what the economists tell them, especially because they say it will help the poor. Student Loan debt is exposing that lie.

Here is where my christian and libertarian leanings need to resolve the paradox, but bankruptcy in all such cases is an answer. A contract for debt can only take the property of the person beyond that needed for him to live, and no more, the rest must be written down. The debtor's life and liberty cannot be abridged, though this might make both the creditor and debtor unhappy. But I'm open to ideas, unfortunately there are few who try to integrate it.

I'm not sure what happens to people like Gary North and Thomas E. Woods - they manage to have cognitive dissonance keeping scripture or church teaching or even the catechism in one box, and Libertarianism and economics in a different one and don't credibly try to reconcile them.

I would also note Libertarianism and Austrian economics are different things, the latter tries to describe what WILL happen in different circumstances when real human beings, including when they include government, act in their own perceived interest. Even Mises wrote "Bureaucracy" to indicate not everything ought to be subject to the market (e.g. are trials in court supposed to be based on truth or should the decision go to the highest bidder?).

Anonymous Noah B. August 15, 2012 11:30 AM  

"The limit of credit money is the banks' ability to find borrowers deemed capable of keeping up on their payments."

If the banks are able to just create the money from thin air, rather than taking it out of deposits, why not lend to everyone and hope that they pay back the money? Why go through all the trouble of checking borrowers' credit?

Anonymous Vidad August 15, 2012 11:34 AM  

@Salt

I haven't paid income taxes for years. S Corp FTW. They pay me to exist.

Actually, if you really want to starve the beast, go all the way and sign up for every welfare program you can find. And take all the free literature in every gov't office.

Blogger ajw308 August 15, 2012 11:35 AM  

Athor, about 6 months ago, I received some change in a store and it just sounded different. When I looked at the change (since almost no tellers count it out to you anymore) I noted that a dime was silver.

The silver coins do sound prettier. Modern coins clink, the older silver coins almost ring.

Blogger Nate August 15, 2012 11:43 AM  

" S Corp FTW"

sure yeah...

but what about those of us that actually have money?

Anonymous Salt August 15, 2012 11:55 AM  

but what about those of us that actually have money?

You'll have less come April 15th.

Anonymous Supernaut August 15, 2012 12:01 PM  

So my payroll-check-deposit is from a loan the Bank made to me?

The deposits made from retail stores are all a result of loans?

Really!!


All of it.

Basically there are two kinds of money - actual cash printed up by the Fed...but this money is backed by the Fed selling T-bills on the open market. So every dirty dollar in your wallet or in a cash register, is money printed up by the Fed, based on the promise of paying it back with interest to the holder of the T-bill.

The second kind of money is the debt money created by Federal Reserve Cartel members (any bank that is a member of the FDIC).

The deliberate misdirection that gets promulgated is the idea that Fractional Reserve Banking means a bank takes a deposit, and is allowed to lend out 90% of that deposit and keep 10% as it's reserve requirement.

This is not how it really works.

This is precisely how the Dallas Federal Reserve website describes it in their PDF file describing what the Fed does:

How Banks Create Money

Banks actually create money when they lend it. Here’s how it works: Most of a bank’s loans are made to its own customers and are deposited in their checking accounts. Because the loan becomes a new deposit, just like a paycheck does, the bank once again holds a small percentage of that new amount in reserve and again lends the remainder to someone else, repeating the money-creation process many times.


In other words...The banks can create "$1000" out of a deposit of $100.

The misunderstanding occurs because most people understand that the bank lends out $90 of a $100 deposit with a reserve ratio of 10%.

What most do not understand is that that is not how it actually works. The bank accepts your $100 deposit, and treats that $100 as the 10% to be kept on reserve.

Since the bank has $100 in reserves, it uses it to create the other $900 (i.e., 90%)...

Blogger Giraffe August 15, 2012 12:04 PM  

but what about those of us that actually have money?

I dunno, ask your wife.

Blogger James Dixon August 15, 2012 12:12 PM  

> So my payroll-check-deposit is from a loan the Bank made to me? ... The deposits made from retail stores are all a result of loans? ... Really!!

Whoosh.

Anonymous Noah B. August 15, 2012 12:13 PM  

@Supernaut

Yes, that's exactly introductory macroeconomics teaches. I would consider that to be "lending from deposits" as I've always understood the term.

Anonymous CaptDMO August 15, 2012 12:18 PM  

"Booooooring! C'mon Vox, less talk about economics stuff,..."

Yeah, Let's talk about Hollywood opiate of the masses,
like what Jimmy Stuart explained in "It's A Wonderful
Life" and how gross incompitance, without "back-up" cash, results in a run on "the bank" and a potential "housing crisis" unless folks are willing to "go along" with Socialist "New Order" (at that time)economics.

Anonymous Josh August 15, 2012 12:27 PM  

I dunno, ask your wife.

Nice

Anonymous Roundtine August 15, 2012 12:30 PM  

Here is how banks really create money, in actuality.

The bank has no deposits. Joe Blow asks for a $500,000 loan to buy a house. He's good for it, so the bank lends him the money. Now, in order to comply with regulations, they need $50,000 in deposits (assuming 10% RR). They can borrow $50,000 from the interbank market overnight to be in compliance and repay it in the morning (the reserve requirements take effect at close of business, not during business hours). They could attract deposits with higher CD rates if they got desperate. They can (now) borrow from the Fed (before they usually only took U.S. Treasuries as collateral).

Canada has reserve requirements of 0%. There's really no need for reserves in the system, not the way it functions today.

Anonymous Mr. Nightstick August 15, 2012 12:35 PM  

Come on guys, He's not a househusband, he's a farmer.

Anonymous TheVillageIdiotRet August 15, 2012 12:37 PM  

Putting on an adjusting tin foil hat.

It's the white commie jews,
and their fictional reserve banking
that's making our money sound all funny.


DannyR

Blogger Joshua_D August 15, 2012 12:38 PM  

tz August 15, 2012 11:28 AM

Here is where my christian and libertarian leanings need to resolve the paradox, but bankruptcy in all such cases is an answer. A contract for debt can only take the property of the person beyond that needed for him to live, and no more, the rest must be written down. The debtor's life and liberty cannot be abridged, though this might make both the creditor and debtor unhappy. But I'm open to ideas, unfortunately there are few who try to integrate it.


As far as I'm aware, we really only have two kinds of loans - secured and unsecured. A secured debt come with collateral. The majority of risk in the situation falls on the borrower. If the borrower defaults, the lender gets the collateral and likely takes a small less relative to the deal.

An unsecured debt comes without collateral. The majority of the risk falls on the lender. If the borrower defaults, the lender takes the loss.

Now, if lenders refused to make unsecured loans, then a lot of this nonsense would stop. But, easy money and greed have infected the system. Lenders want easy money, borrowers want easy money and nobody wants to take the loss. But Reality will do what people don't want to do in a harsh and cold manner.

Anonymous Silmarillion August 15, 2012 12:40 PM  

I've seen explanations of modern fractional reserver banking say that banks can only lend out a percentage of their deposits. I've seen others say that they can lend out a multiple of their deposits. Does anyone have a link to an authoritative explanation/definition?

The difference would be huge. If it's a percentage, say 10%, then a bank with a billion dollars in cash/gold/assets could loan out $900 million, and would have to keep $100 million in reserve. If it's a multiple, say 10x, then the bank with a billion dollars could loan out $10 billion and would need to keep the billion in reserve.

If it is the multiple, then what stops the bank from loaning out like crazy to anyone, and then just writing off the bad loans? They didn't loose any thing. Even if every single dollar that they loan out is defaulted on, they still have their billion dollars. Rinse and repeat.

At least, under the percentage scheme, if the loans go bad then the banks actually loose something. If all of their loans go bad, then all they have left is the $100 million, they woud have lost most of their initial bank roll.

Also, if it is the multiple, then do all banks have that ability, or just the central banks?

Anonymous Vidad August 15, 2012 12:46 PM  

Giraffe... you crack me up.

Anonymous Vidad August 15, 2012 12:48 PM  

Personally, I killed all my debt and sunk extra cash into tangibles. My accountant keeps my salary really low (not like that's hard) and then I write off a lot of other things.

I'm long fruit trees right now.

Anonymous dh August 15, 2012 12:48 PM  

> I wonder what's better: 100% reserve banking system that Rothbard recommends or the One dollar of
> Capital that Denninger talks about.

100% reserve can be determinental because it in effect makes you double pay for everything. If you borrow $100,000 against a house worth $130,000, the 100% reserve system has tied up the $100k in reserves to back your loan, plus the $100k in equity of the house - $200k in capital (100k cash, 100k asset). In KD's proposed 1 dollar of capital, you offset the cash requirement against the firesale cash value of the collateral. If the house has a firesale, cash value of $30k (meaning, you could sell the house today for $30k in cash), then that is $30k cash value you don't need to hold in reserve.

My two cents is that this invites more "mark-to-market" problems - once the average homeowner gets dispensation for finding the cash value of something, then we have even more problems than we have now.

Anonymous Supernaut August 15, 2012 1:02 PM  

Silmarillion, see my post above. I quote the Dallas Federal Reserve Branch website directly.

That quote used to be available on a webpage, but they've since converted that page into a downloadable PDF file so you can no longer hyperlink the actual quote. Go to the Dallas Federal Reserves website and look for a PDF document entitled "Money, Banking & Monetary Policy." The quote I copy and pasted is on page 11 of that document.

Also, if it is the multiple, then do all banks have that ability, or just the central banks?


All Federal Reserve member banks have the ability to create fiat currency based on the fractional reserve system. Any bank, National or local that displays the FDIC Insured sign on the premise is a cartel member given the legal right to create fiat currency.

Anonymous Mr. Nightstick August 15, 2012 1:03 PM  

@Vidad,

What's your ROI on fruit trees?

Blogger Vox August 15, 2012 1:10 PM  

I've seen explanations of modern fractional reserver banking say that banks can only lend out a percentage of their deposits. I've seen others say that they can lend out a multiple of their deposits. Does anyone have a link to an authoritative explanation/definition?

The deposits are the loans. All you have to do is look at the Fed's statistics as of Mar 2012:

Total Bank Deposits: $7,031
Total Loans and Leases in Bank Credit, All Commercial Banks: $7,114 billion

Anonymous The One August 15, 2012 1:17 PM  

The more complex the system, the faster the death spiral. Going to be bad unless the hail mary end times one world currency happens

Anonymous LES August 15, 2012 1:19 PM  

Deuteronomy 23:20

20 To a foreigner you may charge interest, but to your brother you shall not charge interest, that the LORD your God may bless you in all to which you set your hand in the land which you are entering to possess. 

Deuteronomy 15:6

6 For the LORD your God will bless you just as He promised you; you shall lend to many nations, but you shall not borrow; you shall reign over many nations, but they shall not reign over you.

Proverbs 22:7

7 The rich rules over the poor, 
      And the borrower is servant to the lender.

Blogger Res Ipsa August 15, 2012 1:19 PM  

"Having to obtain outside funding rather than being able to create it themselves would much reduce the ability of banks to cause business cycles due to potentially capricious changes in their attitude towards credit risk."

This is in place now. ALL Fannie Freddie based MTG lending comes from the gov. Banks are program backed brokers and servicers, very few banks underwrite for themselves anymore.

Anonymous Silmarillion August 15, 2012 1:25 PM  

Supernaut:

"Banks actually create money when they lend it. Here’s how it works: Most of a bank’s loans are made to its own customers and are deposited in their checking accounts. Because the loan becomes a new deposit, just like a paycheck does, the bank once again holds a small percentage of that new amount in reserve and again lends the remainder to someone else, repeating the money-creation process many times.

In other words...The banks can create "$1000" out of a deposit of $100."

This is where it always breaks down for me.

The Dallas Fed describes what I referred to a percentage based scheme. They have $1000, they loan out $900, and keep $100. The customers spend most of that $900, but keep some, say $200, in their accounts. The bank can now take that $200 and loan out $180 and keep $20 in reserve. Again, most of the $180 is spent, but say that the customers keep $40 in their accounts. The bank can now loan out another $36 and keep $4 in reserve.

Stopping there, the banks started with $1000 and ends with $1116 loaned out and $124 in reserve. They turned $1000 into $1240.

That's bad, but that's not the same as saying that they took the $1000 and loaned out $10 000.

So which is it.

Blogger Vox August 15, 2012 1:42 PM  

So which is it.

We've already told you the answer. You are failing to note the obvious, so I will point it out for you. Where did the original $1000 come from?

Anonymous Tom B August 15, 2012 1:43 PM  

Les, these verses might be more relevant, given the notion of the creation of credit by fiat - i.e. "cashless" money.

(Rev 13:16-18 KJV) And he causeth all, both small and great, rich and poor, free and bond, to receive a mark in their right hand, or in their foreheads:

And that no man might buy or sell, save he that had the mark, or the name of the beast, or the number of his name.

Here is wisdom. Let him that hath understanding count the number of the beast: for it is the number of a man; and his number is Six hundred threescore and six.

Blogger James Dixon August 15, 2012 1:47 PM  

> They have $1000, they loan out $900, and keep $100.

No. They create the money they loan out from thin air. The $900 isn't pulled from their deposits. That seems to be the point you're missing.

Blogger James Dixon August 15, 2012 1:50 PM  

And I should point out that, save those pesky ethics and fiduciary conflict of interest rules, nothing prevents the bank board members from borrowing the money themselves and redepositing it in the bank, thus giving them 10 times the original amount to loan out. Repeat ad infinitum.

Anonymous Supernaut August 15, 2012 1:52 PM  

You're confusing yourself by trying to play with the numbers.

Stopping there, the banks started with $1000 and ends with $1116 loaned out and $124 in reserve. They turned $1000 into $1240.

You're missing the main point. Why would they stop there?

Because the loan becomes a new deposit, just like a paycheck does, the bank once again holds a small percentage of that new amount in reserve and again lends the remainder to someone else, repeating the money-creation process many times.

Every deposit gets treated as a new reserve allowing them to create a new loan....a new deposit, which in turn allows them to create a new loan...ad infinitum. The only thing that keeps it in check is the reserve requirement.

Ergo, if the RR is 10%, any cartel member bank need only have $10 on deposit in their Federal Reserve Bank Branch account to create $100 of "ledger money" or loans.

In other words, when banks "create" money, they are not printing up new cash. They're simply typing numbers on their keyboard and creating a new account in their database under the name of the person recieving the loan.

When you take out a $1000 loan, only $100 of physical cash needs to exist, while $900 of it is just "created" as a ledger entry.

Anonymous Salt August 15, 2012 1:59 PM  

@ Silmarillion

The operative word is account. Most people keep their money in bank accounts.

Want to screw the bank? Pull it all out in cash.

Anonymous Noah B. August 15, 2012 2:02 PM  

"The deposits are the loans. All you have to do is look at the Fed's statistics as of Mar 2012:

Total Bank Deposits: $7,031
Total Loans and Leases in Bank Credit, All Commercial Banks: $7,114 billion"

Ok, so we're using different language to describe the same thing. I would say that these loans did come from deposits, although it is probably more accurate to say that bank loans are based on deposits.

Whatever name you put to it, it's a fraudulent system that can only end in failure.

Anonymous Salt August 15, 2012 2:07 PM  

Every dollar, cash or digital, has interest due on it to its originator, the FED. It's all funny money.

Blogger Rahul August 15, 2012 2:09 PM  

Let's see. Based on fractional reserve banking, banks should be leveraged 10:1. IF you put derviatives into the picture, what is that? 50:1.......100:1 or what

Anonymous VD August 15, 2012 2:24 PM  

I would say that these loans did come from deposits, although it is probably more accurate to say that bank loans are based on deposits.

You're wrong. You have it backwards.

Anonymous The Anti-Gnostic August 15, 2012 3:05 PM  

Ergo, if the RR is 10%, any cartel member bank need only have $10 on deposit in their Federal Reserve Bank Branch account to create $100 of "ledger money" or loans.

In other words, when banks "create" money, they are not printing up new cash. They're simply typing numbers on their keyboard and creating a new account in their database under the name of the person recieving the loan.


That's a pretty good gig: loan out dollars you ginned up out of thin air, get repaid in real goods and services.

Anonymous Azimus August 15, 2012 3:26 PM  

So this Chicago plan would essentially force banks to compete for available capital and actually pay real interest on their deposits? Would've worked real nice in 1981, but today? Who saves money anymore?

I expect this would be the death of most but not all small banks and credit unions who couldn't keep up with WellsFargo BofA, and so forth. Or maybe this rule just wouldn't apply to them.

Anonymous Noah B. August 15, 2012 4:10 PM  

"You're wrong. You have it backwards."

I don't see how, but I suppose it's possible. Supernaut's explanation of how banking works is completely in agreement with my understanding, which is that banks lend out a multiple of the deposits they hold, with that multiplier being determined by the reserve requirement. If you've got a credible source to contradict that, I'd be interested to see it.

Anonymous Stilicho August 15, 2012 4:11 PM  

The deposits are the loans. All you have to do is look at the Fed's statistics as of Mar 2012:

Total Bank Deposits: $7,031
Total Loans and Leases in Bank Credit, All Commercial Banks: $7,114 billion


I've never looked at it quite that way, although it is laid out in Keen's "Roving Cavaliers of Credit". Another way of viewing it is the 10.4 trillion in treasury debt which created an equal amount of credit money is the base for 43 trillion in private debt. But, even that base isn't necessary for the commercial banks to create new money.

Anonymous Stilicho August 15, 2012 4:19 PM  

If you've got a credible source to contradict that, I'd be interested to see it.

The Roving Cavaliers of Credit

Anonymous Noah B. August 15, 2012 4:42 PM  

Thanks Stilicho, this looks promising.

Blogger El Borak August 15, 2012 5:30 PM  

Vox: then you'll love this one:

Duluth, MN (Northland's NewsCenter) --- Cheering for the St. Scholastica football team in 2011 simply wasn't enough for Cloquet native Laura Bakken, so this year she decided to become one of the players...

But at least she's realistic: "Eventually in my career, I'd really like to play in a game," Bakken said.

Anonymous FUBAR Nation (Ben) August 15, 2012 6:23 PM  

Vox, are you sure banks can create unlimited amounts of credit money? Don't they have capital requirements to one degree or another? Obviously, banks won't lend to people who can't pay back unless they can sell the junk paper to government agencies like fannie and freddie.

I completely agree with you that lending comes first and then reserves.

Banks are very afraid to make loans now because the economy is in the ditch and there aren't very many credit worthy borrowers. The result is going to be stagflation to deflation unless the fed does something insane like buy up tens of trillions of assets.

Anonymous Noah B. August 15, 2012 7:11 PM  

"I completely agree with you that lending comes first and then reserves."

This was a new concept to me before today and contradicts what I learned in macroeconomics, but it makes sense and seems to have solid empirical evidence to back it up. Do you know where this idea originated? Thanks.

Anonymous ridip August 15, 2012 8:34 PM  

You're wrong. You have it backwards

Slow day for me. You had to say that before it really registered. It looked odd that the loans exceeded the deposits.

The deposits are the loans. All you have to do is look at the Fed's statistics as of Mar 2012:

Total Bank Deposits: $7,031
Total Loans and Leases in Bank Credit, All Commercial Banks: $7,114 billion


In other words out of $7,117 billion, only $83 billion in cash is out there some where.

*long slow whistle*

And the greedy bastards keep changing the bills to force that little bit back into the system.

The hatred grows.

Anonymous Noah B. August 15, 2012 8:48 PM  

"Slow day for me. You had to say that before it really registered. It looked odd that the loans exceeded the deposits."

It was hard for me to fathom too. It goes against everything I ever learned about how banks work. It was as though someone casually said that the sky was green.

Anonymous Silmarillion August 15, 2012 8:55 PM  

Supernaut:

I know what you're saying, I see it all the time. The the problem is that every formal description that is provided, such as the Dallas Fed one that you mentioned, doesn't match what you describe.

In your scenario a bank starts with $1000, and then loans out $9000 (using a 9:1 reserve). Instantly creating $9000 in new money. The bank now has essentially $10 000 in assets, $1000 in reserve and $9000 in outstanding loans.

In the scenario described by the Dallas Fed, the bank starts out with $1000, then loans out $900 of it to customers and keeps $100 in reserve. If you end there, no new money is created, and the bank still only has $1000; $100 in reserve and $900 in outstanding loans.

If you play out the Dallas Fed's description, and even if say that the customers don't spend any of the loan and keep it all in their bank accounts, then the bank can now take the $900 and loan out $810, keeping $90 in reserve. Again, if the customers keep it all in their accounts, then the bank can now loan out $729 and keeps $81 in reserve.

Stopping there, the bank now has $271 in reserve and $2439 in outstanding loans.

Now, in three steps the bank has turned $1000 into $2710 (reserves and outstanding loans).

Even if you take away the assumption of the customers keeping most of their borrowed money in their accounts, this scheme is unsustainable. And of course the banks don't stop at three steps, they keep going and going and going.

But that is NOT the same as saying that the bank starts with $1000 and it able to just loan out $10 000. The Dallas Fed is not saying that the bank can start with $1000 and loan out $10 000, and that's not a description I've been able to find from any authoritative source.

If it is true that banks can loan out a multiple of their reserve, can anyone provide an link to a good source?

Anonymous FUBAR Nation (Ben) August 15, 2012 9:21 PM  

Noah B. August 15, 2012 7:11 PM

"I completely agree with you that lending comes first and then reserves."

This was a new concept to me before today and contradicts what I learned in macroeconomics, but it makes sense and seems to have solid empirical evidence to back it up. Do you know where this idea originated? Thanks.


I learned the concept from Steve Keen.


"If it is true that banks can loan out a multiple of their reserve, can anyone provide an link to a good source?"

Reserves have no impact at all on how much money banks create. It all depends on their available capital and credit worthy lenders unless they can sell trash to the government or other clueless parties.

Someone correct me if I'm wrong.

Anonymous Aeoli Pera August 16, 2012 12:34 AM  

Why am I finding it so hard to predict the future of the financial system when the actors and their motivations are so obvious?

You know, aside from the obvious.

Anonymous Aeoli Pera August 16, 2012 12:52 AM  

To be more specific, something feels qualitatively different about the financial masters of today. I suspect Satan is directly involved, but what's his angle?

If we assumed, for instance, that he had a controlling stake in the minds of the Fed, IMF, et al, what would he use them for?

Anonymous Noah B. August 16, 2012 1:35 AM  

Zerohedge reports that Japan has been responsible for a huge portion of the T-bond purchases lately.

Anonymous Stilicho August 16, 2012 6:26 AM  

This was a new concept to me before today and contradicts what I learned in macroeconomics, but it makes sense and seems to have solid empirical evidence to back it up. Do you know where this idea originated? Thanks.

Keen credits Basil Moore:

This first major paper on this approach, “The Endogenous Money Stock” by the non-orthodox economist Basil Moore, was published almost thirty years ago.[4] Basil’s essential point was quite simple. The standard money multiplier model’s assumption that banks wait passively for deposits before starting to lend is false. Rather than bankers sitting back passively, waiting for depositors to give them excess reserves that they can then on-lend,

“In the real world, banks extend credit, creating deposits in the process, and look for reserves later”

Blogger LP 999/Eliza August 16, 2012 8:14 AM  

And this is what makes the inflation v deflation debates so darn entertaining. If that is all they understand what do they really know beyond that? All this while nearing a collapse...

Anonymous Silmarillion August 16, 2012 1:54 PM  

Vox:
"We've already told you the answer. You are failing to note the obvious, so I will point it out for you. Where did the original $1000 come from?"

Thanks Vox. Yes, I realize that it's a ponzi scheme and that one bank's loan is another bank's deposit, and that there is essentially no requirement for any reserves anyways.

But, how is it supposed to work? How do the banks claim it works?

If some entity wanted to start a bank, say Apple with $50 billion. And say that the reserve requirement is 10%. Could they initially loan out $500 billion, keeping the $50 billion in reserve, and instantly creating $500 billion in new money? (scenario 1)

Or could they only loan out $45 billion, needing to keep $50 billion in reserve. (scenario 2)

Even the second scenario would lead to borrowed money being deposited (either with Apple Bank or some other bank) and then a new loans for 90% of the deposited (borrowed) money being loaned out again, and again and again and again and again (each time with 90% of the deposited borrowed money). Eventually leading to trillions of dollars of money being borrowed and only backed by the original $50 billion. Definitely a house of cards. Definitely a ponzi scheme.

That being said, there is a big difference.

One obvious difference would be that under scenario 1, Apple could loan out the $500 billion to their closest friends, convince them all to default, seize no assets, collect no interest, and they would still end up having lost nothing. And their friends would be $500 billion richer.

There would basically be no such thing as a bad loan.

Anonymous Silmarillion August 16, 2012 2:04 PM  

Sorry, second scenario "Or could they only loan out $45 billion, needing to keep $50 billion in reserve. (scenario 2)", should have read:

Or could they only loan out $45 billion, needing to keep $5 billion in reserve. (scenario 2),

Anonymous Noah B. August 16, 2012 2:23 PM  

"Keen credits Basil Moore..."

I did read that in the link you gave me, and thanks again. I should have been more specific in my question. I haven't read Basil Moore's paper, so I couldn't tell if the idea had been around before Moore's paper and Moore was the first to test the idea that loans precede deposits, or if Moore also developed this idea himself.

In any case, it's quite a revelation.

Blogger James Dixon August 16, 2012 2:51 PM  

> (scenario 1) ... (scenario 2)

Scenario one is how banks operate today. I can't honestly speak for the historical case.

Anonymous Noah B. August 16, 2012 5:09 PM  

According to my understanding, I would say that banks operate under scenario 2.

Apple Bank starts with $50 billion in deposits (or Fed loans), and let's say all of that is in its Federal Reserve account.

When Apple Bank makes a loan of $45 billion to an individual, it makes two accounts for that individual: a deposit account and a loan account. Apple Bank charges interest on the loan account. At this point, nothing has happened to Apple Bank's Federal Reserve account.

When the loan recipient wants to use the loan money, and make a payment to someone using Wells Fargo, Apple Bank has to make a transfer from its Federal Reserve account to Wells Fargo's Federal Reserve account.

Apple Bank is not creating money from thin air, it is just spreading it around so that it is used many times over. Again, according to my understanding.

Anonymous Silmarillion August 16, 2012 5:56 PM  

Noah B

That's my understanding as well.

To keep it simply, the borrower buys equipment from a large corporation, and they deposit into their account at Facebook Bank. Even if FB Bank had no reserves yet, they would now have $45 billion, of which they can loan out $40.5 billion, but would need to keep $4.5 billion in their reserve account.

Two loans and you are already at $85.5 billion in loans and $9.5 billion in reserves.

Cut the middlemen (the customers) out, with the banks loaning to each other, and repeat a couple of dozen of times, and you end up hundreds of billions of dollars created from just the initial $50 billion. (I think that this is call the 'multiplier')

That's bad.

Then reduce the reserve requirement.

That's really bad.

Then, eliminate the reserve requirement.

That's the end of the road.

However, even without a reserve requirement, Apple Bank, starting out with $50 billion, could only initially loan out $50 billion. They could NOT loan out $500 billion. (they could however loan->deposit->loan->deposit…. a few time and you might end up with $500 billion)

Bailouts aside, the idea of a 'zero risk loan', where the bank loses nothing, even if all of their outstanding loans were to completely default with no collateral seized and never having collected any interest, just seems a little far fetched. But it seems like a lot of people think that fractional reserve banking operates like that though (i.e. banks loan out a multiple of their reserves).

I suspect that it may be because the term 'multiplier' is used.

Anonymous Noah B. August 16, 2012 10:19 PM  

"Bailouts aside, the idea of a 'zero risk loan', where the bank loses nothing, even if all of their outstanding loans were to completely default with no collateral seized and never having collected any interest, just seems a little far fetched. But it seems like a lot of people think that fractional reserve banking operates like that though (i.e. banks loan out a multiple of their reserves).

I suspect that it may be because the term 'multiplier' is used."

Well, if banking does work according to your scenario 2, then I can't understand why we wouldn't have immediate hyperinflation. And although I've never worked in banking, I do work with CEOs of a few local banks, and it definitely does hurt them when people default on loans.

Anonymous Noah B. August 16, 2012 10:47 PM  

Sorry... I meant scenario 1 in that last post.

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