Educate me about Fractional Reserve System

[thoughtomator]

Educate me about Fractional Reserve System

OK bend over, this might hurt a little bit.

 

[Mogambo Guru]

In this video too, at around 04:15, the narrator is saying that out of 10billion, 1 billion is kept as reserve and 9 billion is given out as loan,
when that 9b is deposited in someone's account - 900k reserve is kept and 8.1 billion "new money" is created ?
why call it new money, since it is already there - left from the original 9b ?
that is confusing.
and then he says around 05:04, that from the original 10B, from this deposit-money creation-debt cycle - new 90B has been created ?
explain this plz !

1. i have not watched your video
2. someone please correct me if i am wrong, but from what i see in your question and zippys response is that he seems to be leaving out some details.(or presenting them in such a way that it throws people off)

All money is debt.. so debt=money

I earn or otherwise get $!0,000

Where does this 10000 come from? Isnt it just previously created debt that he got and held as an asset but in reality is just a creation of someone elses deposit from the example he goes on to explain?

I have no money but am owed $10,000.
The bank has $1000 but owes me $10,000.
Bill has $9000 and owes the bank $9,000. Money supply is still $10,000.


yadda yadda yadda

&

This is the current money status:
I have no money but am owed $10,000.
Bill has no money but owes and is owed $9,000.
Carl has $8100 and the bank has $1,900. Total money is still $10,000. Debt has grown but the money supply hasn't.

When he breaks it down he says he has no money and bill and carl have no money.. guess what. debt=money and from what i understand all of them "have" that money as an asset in their account. So as i see it, between those 3 people there is 10000 + 9000 + 8100 = 27100 of money. They can go out and spend that money. He says debt has grown but money supply hasnt... but in our system, debt is money. Everyone along that chain of depositing and lending lays claim to that "money" and uses it as an asset and considers it "theirs." In this way the money supply increases, along with debt. He mentions that once you deposit you get an IOU.. Isnt that what dollars are?

All money is debt and all debt is money.

The system works as long as everyone keeps money in banks, and overall debt keeps expanding.

When debt is created, money is created and when debt is paid off money is destroyed.

so you asked:

In this video too, at around 04:15, the narrator is saying that out of 10billion, 1 billion is kept as reserve and 9 billion is given out as loan,
when that 9b is deposited in someone's account - 900k reserve is kept and 8.1 billion "new money" is created ?
why call it new money, since it is already there - left from the original 9b ?
that is confusing.

Because the different people that deposited the 10 billion, and 9 billion, and 8.1 billion and so one down the line all assume they are "saving" their "money" in a bank. The way zippy explained it one gets the idea that they have no money, they are just owed money. But in reality the original guy thinks has 10b, the next guy thinks he has 9b and the next guy thinks he has 8.1b and so on.


Someone please correct me if i am wrong i am no expert, just trying to learn and am lacking sleep too.

 

[Zippyjuan]

Repeat the same lending exercise but with friends. I have $20. I loan it to Bill. Now he owes me $20. I have no money, Bill has $20. Chip comes along and needs lunch money. Bill says he has $20 and can loan him $10 of that. Ok. Now I have nothing, Bill has $10 and Chip has $10. Chip owes Bill $10 and Bill owes me $20. Debt is up to $30. Money is still just $20. Chip's girlfriend wans him to buy her some lunch too. He says "I won't buy it for you but I can loan you five to buy your own!" (he is a cheap boyfriend). Diane now has $5. Chip has $5, Bill has $10 and I have nothing. Diane ows Chip $5 (yeah- like she intends to pay him back!). Chip owes Bill $10 and Bill ows me $20. (we have a zero dollar reserve requirement). Total money is still $20 but debt has grown to $35. Have we multiplied the supply of money through all of this lending? Not at all. All of us together can't spend more than $20.

 

[Crystallas]

Debt is debt. Money is not debt, it's a medium of exchange(you could say that a specific money transfer was debt at some time, that is why its purpose exists). Fiat currency might be better equipped to make the money = debt correlation, but even then, you kind of stretch what it means. We already have too many words with specific meanings in our dictionary that are hijacked to mean whatever, no need to blur this term as well.

 

[Mogambo Guru]

Debt is debt. Money is not debt, it's a medium of exchange(you could say that a specific money transfer was debt at some time, that is why its purpose exists). Fiat currency might be better equipped to make the money = debt correlation, but even then, you kind of stretch what it means. We already have too many words with specific meanings in our dictionary that are hijacked to mean whatever, no need to blur this term as well.

I agree and disagree. I agree that money should NOT be debt, but i also disagree because under our current monetary system money IS debt. Every dollar in existance only exists because it was created through debt. I dont like it or agree with it, but it is what it is...

If all debts were paid off, there would literally be no money left, and actually there would still be debt because of interest. This is why the debt level must continue to grow over the long term and why deflation is so hated by central banks.

Is it not??

 

[agitator]

If you deposit $10,000 into a bank, they can loan out up to 90% of that...or $9,000, but they have to keep the other 10% of that ($1,000) on reserve at the bank. This is called the Reserve Ratio, and it is set by the Federal Reserve. The Fed rarely changes the Reserve Ratio requirement, and it currently sits at 10% for major financial institutions.

http://www.federalreserve.gov/monetarypolicy/reservereq.htm

Look up two Federal Reserve Publications: Two Faces of Debt, and Modern Money Mechanics.

They can loan out $90,000 with that $10,000 making up their reserve requirements. Money is created with debt.

 

[Zippyjuan]

Look up two Federal Reserve Publications: Two Faces of Debt, and Modern Money Mechanics.

They can loan out $90,000 with that $10,000 making up their reserve requirements. Money is created with debt.

Assuming that that the money lent out keeps getting re-deposited at the bank. Stops growing if it gets spent.

 

[Crystallas]

I agree and disagree. I agree that money should NOT be debt, but i also disagree because under our current monetary system money IS debt. Every dollar in existance only exists because it was created through debt. I dont like it or agree with it, but it is what it is...

If all debts were paid off, there would literally be no money left, and actually there would still be debt because of interest. This is why the debt level must continue to grow over the long term and why deflation is so hated by central banks.

Is it not??

I pretty much covered this all in my short and sweet post. Debt is debt. If you pay in full, there was no debt. Thus why the terminologies are very concise. I can use A for B, that doesn't mean A = B

 

[Zippyjuan]

I agree and disagree. I agree that money should NOT be debt, but i also disagree because under our current monetary system money IS debt. Every dollar in existance only exists because it was created through debt. I dont like it or agree with it, but it is what it is...

If all debts were paid off, there would literally be no money left, and actually there would still be debt because of interest. This is why the debt level must continue to grow over the long term and why deflation is so hated by central banks.

Is it not??

Money is a medium of exchange- traded for goods and services. I trade my labor for my employer for pieces of paper (or now mostly digital bits) which I can use to trade for other goods and services I want or need. It has no value until it is exchanged for something- money in a bank account is not really money. Money under my mattress isn't really money. All those "excess reserves" the banks have at the Fed aren't really money. Yet. Not until they are actually used.

Why hasn't all that money the Fed "printed" not caused price inflation? Because it isn't being used for anything. It isn't out there competing with other dollars for goods and services- bidding up their prices.

Debt is changing time preferences for money. I got paid this week but don't need the money right now- I prefer to wait to spend it. So I put it into a bank account. Since I don't seem to need it, the bank turns arround and loans it out (minus their reserve requirement). That person has a time preference for money now. So much preference, that they want more money today than they actually have and are willing to give up money in the future for the ability to spend now. In the future, they will have to surrender money they could be spending then to pay back the money they are spending today (plus interest). If I don't decide to forego my spending today, he can't borrow money and spend extra today because he would not be able to borrow.

Debt is the exchange of time preference. Money still exists even in the absence of debt- it won't go to zero if everybody pays off their debts today. What changes is not the money itself but who spends it.

 

[J_White]

so you asked:
Because the different people that deposited the 10 billion, and 9 billion, and 8.1 billion and so one down the line all assume they are "saving" their "money" in a bank. The way zippy explained it one gets the idea that they have no money, they are just owed money. But in reality the original guy thinks has 10b, the next guy thinks he has 9b and the next guy thinks he has 8.1b and so on.

ok, that was a good point.
when someone deposits 10B in his account, the bank keeps 10% of that and lends 9B out.
But in this guy's bank account - it will still show 10B and not 1B (the actual reserve kept), isnt that correct ?
secondly, if this guy now requires to take out 2B out of his 10B, but the bank has only 1B in reserves - so the bank will have to call the guy they lent the 9B to get their money back ? or call the Fed to send in some money.
that part is a bit confusing.

Maybe I am mixing up 2 different things -
first is how much of deposited money can the banks lend out in a fractional reserve system - that is 90% of deposits.
and this process is shown in both the videos i posted. - which could expand if people keep taking a loan and depositing it in banks as Juan said, but it would stop if some takes a loan and spends it (but what happens to the spent money - whoever got that money would probably deposit it in a bank, or spend it himself ! )

second thing is - if a new bank is given the license to operate and it has its own capital seed money of 1 billion, and no deposits from any customers - then how much money can it loan out to people ? is it only 1 Billion (the money it has), or is it 1+9 billion (and creates 9 billion on top of its own 1 billion) ?

 

[thoughtomator]

Assuming that that the money lent out keeps getting re-deposited at the bank. Stops growing if it gets spent.

No it doesn't. When money gets spent, the recipient almost always deposits it in their own bank account. As long as that money is put into any bank, the system recycles it. If you want to stop that money from being recycled into new loans, taking money out and stuffing it in the mattress is the only real option.

 

[thoughtomator]

OK I was hoping someone would take care of explaining how this works, because it's really not that hard, but I see confusion reigns even here.

Here's the system explained in the clearest manner that I have seen to date: http://www.peakprosperity.com/category/tags/crash-course

You'll want to watch chapters 7 and 8 and then you will fully understand the basics of how the system works.

 

[Bossobass]

Let's run through an example of what happens with money in a fractional reserve form of banking.

I earn or otherwise get $!0,000. I don't need to spend this money right now but may want it later so I loan it to the bank (open an account and deposit the money with them). The bank has a reserve requirement where they are requilred to keep ten percent of their deposits on hand- this is the "fractional reserve" they are required to keep and where the term comes from. That means they can loan out up to $9000 of that money.

Sorry, Zip. The banks have zero reserve requirement since the 2008 Emergency Economic Stabilization Act.

"... changed to 'which may be zero'...".

Not only could they lend 100%, they could lend more than that after The Bernanke "gave" them hundreds of billions in cash in addition to their deposits on hand and bought trillions of their shit mortgage paper.

With zero reserve requirement, a bank may refuse to hand over your demand deposit and there's nothing you can do about it. Your money then would not be covered by FDIC if the bank is not declared insolvent.

 

[hazek]

I am trying to understand the fractional reserve system.
This is one video which seems to depict it clearly.

The video is accurate in illustrating how FRB actually works but the narrative is inaccurate.

No new money is created in FRB. None.

What is created is debt. Highly liquid - that most people confuse as money - debt. For example after the initial $10,000 gets deposited and $9,000 is lent out, that depositor who deposited the $10,000, is now holding IOUs for $10,000 (while thinking, foolishly, that he's holding money) and the bank holds $1,000 in money and $9,000 in IOUs and the borrower now actually holds $9,000 of the original $10,000 real money deposit.

The thing is that this can repeat until theoretically all loans redeposited and again a fraction of them lent out can balloon the debt to $90,000.

So it basically means that banks are running at a profit of about 900+ % ?
At reserve rate of 10%, if they have assets or deposits of 1m, then they can lend out another 9m, just out of thin air and earn interest on all of it ?
I also read somewhere that since the reserve rate is even lower, say 3%, then the effect is much larger ?
why is this considered a fair system ? why not have higher reserve ratios ?

No. It does not mean that they can loan out $9million if they receive a deposit of $1million, it means that they can loan out $9 hundred thousand. And if that money happens to get redeposited they can again loan out $810,000.

And the bank's profit is the margin between the interest they pay to demand deposit accounts and the interest that the borrowers pay them.

 

[Zippyjuan]

Sorry, Zip. The banks have zero reserve requirement since the 2008 Emergency Economic Stabilization Act.

"... changed to 'which may be zero'...".

Not only could they lend 100%, they could lend more than that after The Bernanke "gave" them hundreds of billions in cash in addition to their deposits on hand and bought trillions of their shit mortgage paper.

With zero reserve requirement, a bank may refuse to hand over your demand deposit and there's nothing you can do about it. Your money then would not be covered by FDIC if the bank is not declared insolvent.

That was an example of how it would work but as for actual reserve requirements- as of 12/27/12, if a bank has net transactions of $0 to $12 million, their reserve is zero percent. If it is $12.4 to $79.5 milllion it is three percent and over $79.5 million the reserve requirement is ten percent. "Non- personal time deposits" also have a zero percent requirement.
http://www.federalreserve.gov/monetarypolicy/reservereq.htm

Reserve requirements are the amount of funds that a depository institution must hold in reserve against specified deposit liabilities. Within limits specified by law, the Board of Governors has sole authority over changes in reserve requirements. Depository institutions must hold reserves in the form of vault cash or deposits with Federal Reserve Banks.
The dollar amount of a depository institution's reserve requirement is determined by applying the reserve ratios specified in the Federal Reserve Board's Regulation D to an institution's reservable liabilities (see table of reserve requirements). Reservable liabilities consist of net transaction accounts, nonpersonal time deposits, and eurocurrency liabilities. Since December 27, 1990, nonpersonal time deposits and eurocurrency liabilities have had a reserve ratio of zero.

The reserve ratio on net transactions accounts depends on the amount of net transactions accounts at the depository institution. The Garn-St Germain Act of 1982 exempted the first $2 million of reservable liabilities from reserve requirements. This "exemption amount" is adjusted each year according to a formula specified by the act. The amount of net transaction accounts subject to a reserve requirement ratio of 3 percent was set under the Monetary Control Act of 1980 at $25 million. This "low-reserve tranche" is also adjusted each year (see table of low-reserve tranche amounts and exemption amounts since 1982). Net transaction accounts in excess of the low-reserve tranche are currently reservable at 10 percent.

 

[J_White]

if a new bank is given the license to operate and it has its own capital seed money of 1 billion, and no deposits from any customers - then how much money can it loan out to people ? is it only 1 Billion (the money it has), or is it 1+9 billion (and creates 9 billion on top of its own 1 billion, considering the original 1 billion as reserve) ?

 

[J_White]

OK I was hoping someone would take care of explaining how this works, because it's really not that hard, but I see confusion reigns even here.
Here's the system explained in the clearest manner that I have seen to date: http://www.peakprosperity.com/category/tags/crash-course
You'll want to watch chapters 7 and 8 and then you will fully understand the basics of how the system works.

the crash course 7 basically says the same thing as the vids in the previous posts. how does it clarify things ?

 

[Zippyjuan]

if a new bank is given the license to operate and it has its own capital seed money of 1 billion, and no deposits from any customers - then how much money can it loan out to people ? is it only 1 Billion (the money it has), or is it 1+9 billion (and creates 9 billion on top of its own 1 billion, considering the original 1 billion as reserve) ?

They can't loan out more than they have. If they attract more deposits, they can loan out more money but again, not more than their total deposits.

 

[eric_cartman]

if a new bank is given the license to operate and it has its own capital seed money of 1 billion, and no deposits from any customers - then how much money can it loan out to people ? is it only 1 Billion (the money it has), or is it 1+9 billion (and creates 9 billion on top of its own 1 billion, considering the original 1 billion as reserve) ?

with a 10% reserve requirement, they can lend out $900 million. but then if that $900 million gets deposited back into that same bank, then they can hold 10% of that in reserve and lend out $810 million.

 

[Mogambo Guru]

i thought this was good

Is Our Money Based on Debt?
http://mises.org/daily/4631