Austin Powers Money Mystery (how is money created?)

[eric_cartman]

The Question:

In this clip from the second Austin Powers movie, the year is 1969 and Dr. Evil threatens to destroy Washington D.C. and other major cities unless he is paid $100 Billion.

https://www.youtube.com/watch?v=1z-AxgueBRk

The President laughs at him and says "that amount of money doesn't even exist".

In modern times, $100 billion is a lot of money, but that amount of money clearly exists today. The total money supply is in the trillions.

Between 1969 and today, a lot of money has been created. So what exactly is the process that allowed this money to be created and enter into circulation?

This seems like it should be a simple question to answer. And it seems like most people should know the answer. However, I suspect that even people studying economics in University (and maybe even the Professors teaching the subject) will have trouble explaining the correct answer.

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The Answer? : (this is my best attempt at an answer, to please correct me where I'm wrong and expand upon what i've written)

I think 99.9% of the general population is not able to answer this question.

The most common answer would be that the government prints/creates the money. This is somewhat true in the sense that there is more physical paper money in circulation than there used to be, and this money was printed by the Treasury ... but I think that something like only 2% of the money supply exists in physical paper (the majority is numbers in computers at the banks). But if the government did just print and spend money, then why do they collect taxes or go into debt? So this answer is clearly not correct.

More informed people might say that the Federal Reserve prints the money. But this answer isn't really correct either. The Fed expands the base money supply through open market operations with the primary dealers (banks). They can set short term interest rates which influences the money supply. Through Quantitative Easing, they create money out of thin air and use this money to buy US government debt and Mortgage debt. However, this is not how the majority of money comes into existence.

I think that the correct answer is that it's created out of debt through the banking system and fractional reserve banking system.

If the banks have a 10% reserve requirement, and someone deposits $100, then the bank can lend out $90. Then that $90 gets deposited back into the banking system, and then another $81 can be loaned out, etc.

So when a business or an individual takes out a loan from the bank, new money is created out of thin air. This is responsible for the majority of the increase in the money supply. So as debt increases, money supply increases. As debt is repaid, the money supply contracts as the banks destroy the newly created money and keeping the interset as profits.

But most companies don't take out bank loans, they sell corporate bonds instead. So if a corporation is selling $1 million in corporate bonds, then people will give the corporation $1 million in real money, and in return, they get an IOU. After some time has passed, the corporation will earn real money, that money is paid back to the holder of the corporate bond, and when all the money has been paid, the bond is destroyed.

This IOU (corporate or government bond) isn't really money, but the holder of the IOU sort of believes they have money. If you ask someone their net worth, they might say that they have $1,000,000. But really, they don't have $1,000,000 in real money, they've got $1,000,000 worth of IOUs (made up of bonds, bank deposits, etc.).

So in summary:

The Central Bank creates the base money through open market operations with the primary dealers. The Central Bank will create money out of thin air and use that money to buy government securities (debt) from the balance sheets of the banks. The banks now have more money to lend to the public through fractional reserve lending which increases the money supply.

The Central Bank also sets the discount rate. If they lower the discount rate, banks will borrow more money directly from the Fed's "discount window". So the Fed creates money out of thin air, loans it to the banks, then the banks loan that money to the public.

The Central Bank can also lower the reserve requirement that banks are forced to hold in reserve for the loans they make. Therefore, if the reserve requirement is lowered, the banks can loan out more "checkbook money" that they create out of thin air.

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Anyways... that's my best attempt at an answer to his question. If you can help me arrive at a more accurate answer, that would be very appreciated.

 

[Zippyjuan]

The Central Bank also sets the discount rate. If they lower the discount rate, banks will borrow more money directly from the Fed's "discount window". So the Fed creates money out of thin air, loans it to the banks, then the banks loan that money to the public.

Borrowing from the Discount Window is to meet short-term needs- overnight loans to cover shortages of deposits relative to loans outstanding- their reserve requirements. Banks rarely use this option.

The Central Bank can also lower the reserve requirement that banks are forced to hold in reserve for the loans they make. Therefore, if the reserve requirement is lowered, the banks can loan out more "checkbook money" that they create out of thin air.

It is true that if the reserve requirement is lowered that banks can theoretically make more loans. The money they loan out doesn't come from "thin air" but from money already deposited at the bank.

 

[eric_cartman]

Borrowing from the Discount Window is to meet short-term needs- overnight loans to cover shortages of deposits relative to loans outstanding- their reserve requirements. Banks rarely use this option.


It is true that if the reserve requirement is lowered that banks can theoretically make more loans. The money they loan out doesn't come from "thin air" but from money already deposited at the bank.

gotcha... so the discount window isn't really a source of money creation... it's just there to keep interest rates from fluctuating outside the limit of the band overnight by acting as either the buyer or the seller.

and i see what you mean. it's not really correct for me to say that banks create money out of thin air. they just loan most of what you deposit. and you're left with an IOU. and we treat these IOUs as "money" even when it technically is not.

 

[thoughtomator]

I have people flee in literal panic from me when I ask them the simple question "Do you know how dollars are created?" There is intense behavioral programming that has been done to the masses to instill in them a very urgent and desperate desire not to know that information.

 

[thoughtomator]

To the OP - your explanation of how money is created is not correct.

In our monetary system, new dollars are created by the act of lending them to a borrower. The completion of the loan agreement itself, combined with the privilege of legal counterfeiting granted to fractional reserve banks, is what actually brings the new dollars into existence.

 

[roho76]

Social Security Numbers? The more in existence the more money they can create. Our money is not backed by a commodity anymore but is now backed by labor, more specifically future labor. When you have kids they can borrow against their future because they will one day be a tax payer.

 

[eric_cartman]

To the OP - your explanation of how money is created is not correct.

In our monetary system, new dollars are created by the act of lending them to a borrower. The completion of the loan agreement itself, combined with the privilege of legal counterfeiting granted to fractional reserve banks, is what actually brings the new dollars into existence.

that's a good point. it's the whole legal and government system that enables this whole process to work.

because the banks don't really create money out of thin air. they just have the legal authority to loan out 90%+ of someone's deposit. the real money is loaned out into the economy and the only thing backing the depositer's account is someone elses IOU. However, the FDIC has promised to turn that IOU into cash if it's $100,000 or less. And then we assume the Federal Government will bail out the FDIC. And the Fed will bail out the Federal Government. The Government also guarenteed all the money market accounts in the 2008 financial crisis. So we've allowed debt to basically function as money because that's the way the system is set up. And the more debt that is accumulated, the more debt-money/currency comes into circulation.

 

[thoughtomator]

So we've allowed debt to basically function as money because that's the way the system is set up. And the more debt that is accumulated, the more debt-money/currency comes into circulation.

Close but not quite. Our "money" is debt. Pull out a dollar bill and read it - it's a promissory note. Then go pull a dollar from the pre-fiat era, and read it - those earlier dollars were explicit that they were an instrument representing real silver or gold, and could be redeemed in the indicated metal by the bearer upon demand.

US dollars today are literally nothing more than a claim on someone's future labor.

The moral problem here is that the people writing these promises are not the people whose labor is intended to fulfill them.

If you keep adding the 2's of the financial system, it's hard to avoid the conclusion that the system was designed - in 1913 - to enslave the future - which is now.

 

[eric_cartman]

Close but not quite. Our "money" is debt. Pull out a dollar bill and read it - it's a promissory note. Then go pull a dollar from the pre-fiat era, and read it - those earlier dollars were explicit that they were an instrument representing real silver or gold, and could be redeemed in the indicated metal by the bearer upon demand.

US dollars today are literally nothing more than a claim on someone's future labor.

The moral problem here is that the people writing these promises are not the people whose labor is intended to fulfill them.

If you keep adding the 2's of the financial system, it's hard to avoid the conclusion that the system was designed - in 1913 - to enslave the future - which is now.

I understand what you're saying. But if I have a $20 bill in my pocket... I don't own a piece of debt... I own a piece of paper with the number $20 on it. By holding this paper, it doesn't give me a claim on anyone's labor, but my hope is that I can make a voluntary exchange with this $20 for someone else's labour or property. What gives the piece of paper with the number twenty on it value, is that people have the confidence that this piece of paper can be used in the future in exchange for primarily barrels of oil (since oil is only sold in exchange for US dollars)...for money to pay the various taxes... and to purchase other goods and services.

I would say that a government bond is debt backed by the labor of its future citizens.

It used to be that the paper dollars were really just an IOU for gold. Now they're not an IOU for anything... they're just pieces of paper with numbers on them, but they remain valueable because they function as the medium of exchange.

 

[Carson]

To the OP - your explanation of how money is created is not correct.

In our monetary system, new dollars are created by the act of lending them to a borrower. The completion of the loan agreement itself, combined with the privilege of legal counterfeiting granted to fractional reserve banks, is what actually brings the new dollars into existence.

Which happens when someone prints a bond out of thin air to trade with a central banks pulling a dollar out of somewhere.

It allows them to shift the property line that divides the Haves over to the side of the Have-not's.

What they are doing used to be punishable by drawing and quartering.

 

[Carson]

Lets not over look the fact that when the people that, don't know what they are doing, are allowed to counterfeit the money supply, they are stealing away the power from the people that do know what they are doing.

The people that do know what they are doing used to have a voice with their dollar. They in turn were able to drag us into the future and into prosperity along with them.

Many of us used to count on them for leadership.

 

[Durendal]

Lets not over look the fact that when the people that, don't know what they are doing, are allowed to counterfeit the money supply, they are stealing away the power from the people that do know what they are doing.

The people that do know what they are doing used to have a voice with their dollar. They in turn were able to drag us into the future and into prosperity along with them.

Many of us used to count on them for leadership.

Please expand upon this statement as I am ignorant, and would like to be informed.