Fractional Reserve Banking And Fiat Money Questions

[Banana]

AceNZ & Scooter, thanks so much for the informative posts! Just one more question.

The Fed can't just print money to hold off a bank run. The bank would have to acquire new reserves first in some way. Exactly how depends on things like what assets the bank holds and whether other banks are willing to lend through the Fed Funds system.

....


The Fed can only issue printed money into circulation (actually, it becomes vault cash before it goes into circulation) in exchange for reserves. Issuing new FRNs does not result in credit expansion or inflation.

Not sure if I'm understanding you. Let's see if I get this....

In order for bank to receive more FRNs, it has to somehow create new reserves. Therefore, the credit expansion only occur with the bank's loaning out money, but never with FRN, as there is a 1:1 correlation between reserve to FRN... right?

 

[shocker315]

Yes...thanks to everyone for the informative thread. It seems that everyone essentially agrees the banking system does "create" more money than is in reserve through the lending process. Although there are some disagreement on the mechanics of the process. However I think one aspect being somewhat lost in the mix and various disscussions is.....the banks are charging INTEREST on this money they have just created....interest on nothing. No one worked for this money, no one saved it, no one sacrificed its use, it was just created. Right?

And... if you can't pay back the interest on the nothing money they just created ...the banks ends up owning "something"...the collateral on the loan, (your house, car, boat, etc). Is it honest/moral or whatever, to charge interest on a loan of money you essentially just created out of the blue in an accounting trick. Or am I missing something?

 

[SilentBull]

When a bank places an order for FRNs with the Fed, money in their reserve account (which is held by the Fed) is exchanged for the FRNs at face value, and they are shipped to the bank. When a bank receives FRNs, they become "vault cash", and can be exchanged by the bank for checkbook money of their customers.

FRNs are not created or used for any other purpose. They are not used for lending, nor are they used by the government to pay bills, etc.

Maybe I still don't 100% get it, but what I'm seeing is that new federal reserve notes are NOT created? When you say "money in their reserve account" it's a little confusing. Isn't the money in a bank's reserve account backed 100% by federal reserve notes? Isn't a bank's reserve account made up of federal reserve notes?

So if a bank can only ask for federal reserve notes if it has that money in their reserve... isn't that money in their reserve federal reserve notes?

So am I wrong in stating that the amount of federal reserve notes in circulation is ALWAYS THE SAME? No new notes are printed anymore??

 

[AceNZ]

Yes, individual banks create money when they make loans from their reserves, but this is credit money. It is money that is given to a person or business with the promise from that person/business that the money will be paid back in the future. Eventually the money gets erased as the loans are paid back.

The only new money (actual money, not credit-based loan money) that can be introduced is done so by the Federal Reserve.

I think I see what you're saying, although I would use different words: Only the Fed can create new money by creating bank reserves. Banks create money through loans. Both mechanisms are "actual money", in that the resulting funds can be spent into the economy to buy things. And both mechanisms allow the money to be "erased" -- either when a treasury security is purchased by the Fed for reserves, or when a loan is paid off at a bank. The difference is that reserves form the foundation for new loans. The proceeds from a loan are not used (in the banking system as a whole) to create additional loans.

In a free market, I should be able to choose between banks that has different policies; full reserve for maximum liquidity, fractional reserve with an explicit agreement that not all of my money will be available, or collecting interest off non-liquid deposit, or any combination. But we're under a monopoly here, so we all swim or sink together. Not good, IMHO.

Am I mistaken?

That's basically right. However, the risk of bank runs isn't the only issue. Even if there was a free market with different banks that have different policies, as a net saver you would still be damaged by fractional reserve banks, because they would be inflating the money supply.

In order for bank to receive more FRNs, it has to somehow create new reserves. Therefore, the credit expansion only occur with the bank's loaning out money, but never with FRN, as there is a 1:1 correlation between reserve to FRN... right?

Right.

No one worked for this money, no one saved it, no one sacrificed its use, it was just created. Right?

Right.

Is it honest/moral or whatever, to charge interest on a loan of money you essentially just created out of the blue in an accounting trick. Or am I missing something?

No, it's not moral. And to make matters worse, banks aren't just charging interest in money they created from thin air. They are also facilitating a hidden transfer of wealth from net savers to net debtors through the inflation they introduce.

Maybe I still don't 100% get it, but what I'm seeing is that new federal reserve notes are NOT created? When you say "money in their reserve account" it's a little confusing. Isn't the money in a bank's reserve account backed 100% by federal reserve notes? Isn't a bank's reserve account made up of federal reserve notes?

New money is not created by printing FRNs.

A bank's reserve account is a special account at the Fed. Banks are required to keep all of their reserves in that account. It's all digital. When the Fed clears checks, it deducts the amount of the check from the originating bank's reserve account, and adds it to the destination bank's reserve account. If the originating bank is the Fed itself (such as when the payment for the purchase of a treasury bond by the Fed is processed), then new reserves are added to the system.

So am I wrong in stating that the amount of federal reserve notes in circulation is ALWAYS THE SAME? No new notes are printed anymore??

New notes are printed all the time. In the same way that you exchange checkbook money for FRNs when you cash a check, the Fed exchanges money in a bank's reserve account for newly printed FRNs. Money is created as checkbook money, and then exchanged for FRNs.

 

[scooter]

Yes...thanks to everyone for the informative thread. It seems that everyone essentially agrees the banking system does "create" more money than is in reserve through the lending process. Although there are some disagreement on the mechanics of the process. However I think one aspect being somewhat lost in the mix and various disscussions is.....the banks are charging INTEREST on this money they have just created....interest on nothing. No one worked for this money, no one saved it, no one sacrificed its use, it was just created. Right?

Of course someone worked for the money. The depositors did. This is the point of my posts, so you don't think that the bank just created money for nothing and then charged interest on it.

The banks use depositors' money to make loans. They get paid interest on money that they hold for others in the bank. As a depositor, you should know that the bank is going to use your money to try to make a profit. If you don't like this, then you have the choice to pull your money out. Most people won't do this because the banks are considered a safe place to store your money and they generally offer basic services for free. Also, if you are smart with your money, you will put it in savings accounts that will pass some of the interest they make back to you.

 

[Banana]

So, when if FRN is 1:1 to the reserve, exactly how does they print more FRN when a loan is made, creating money out of thin air? Is that when the loan get deposited into the bank's reserve, then bank gets more FRNs, right?

If that's right- with multipier effect, the more re-investment we see with the loan, the more money is created without an accompanying FRN, so there isn't any correlation between money supply and number of FRNs in circulation... it's totally lost. Right?

If that's right, that's.... scary.

 

[AceNZ]

So, when if FRN is 1:1 to the reserve, exactly how does they print more FRN when a loan is made, creating money out of thin air? Is that when the loan get deposited into the bank's reserve, then bank gets more FRNs, right?

If that's right- with multipier effect, the more re-investment we see with the loan, the more money is created without an accompanying FRN, so there isn't any correlation between money supply and number of FRNs in circulation... it's totally lost. Right?

If that's right, that's.... scary.

If I'm decoding your question correctly, what you said is basically right: there's only a weak correlation between the money supply and FRNs in circulation. There are a lot more FRNs in circulation around the holidays, for example, whereas the money supply doesn't change much.

 

[shocker315]

Of course someone worked for the money. The depositors did. This is the point of my posts, so you don't think that the bank just created money for nothing and then charged interest on it.

The banks use depositors' money to make loans. They get paid interest on money that they hold for others in the bank. As a depositor, you should know that the bank is going to use your money to try to make a profit. If you don't like this, then you have the choice to pull your money out. Most people won't do this because the banks are considered a safe place to store your money and they generally offer basic services for free. Also, if you are smart with your money, you will put it in savings accounts that will pass some of the interest they make back to you.

So what you saying is the total amount of outstanding loans (minus interest) from the banking system is no more than the total deposits put into it. Since the amount loaned out is the same money recently deposited. No new money is created. Correct?

Here is a interesting and head scratching quote from the Fed itself…Modern Money Mechanics. Page 6

“Of course, they (banks) do not really pay out loans from the money they receive as deposits. If they did this no additional money would be created.”



Here is my understanding of the issue based on a 10% reserve ratio (allowing the bank to loan out 90% of the deposit amount). Explain to me where I am wrong. I admit I am not an expert. Just going off what I've read. I am open minded to your explaination, not trying to antagonize you. :o

The "banking system" (not a single bank), loans more money than has been deposited by creating it:

For an initial $1,000 deposit into the first bank... 90% ($900) of it is loaned...then that borrower eventually redeposits it into a new account at the same or 2nd bank...and 90% ($810) of that deposit is reloaned... and deposited into the same or third bank ....then 90% ($729) of that is reloaned...etc...etc (through the revolving door of fractional reserve banking) .

At the end of this process the bottom line is.... the "banking system" has loaned $9,000 through this process (based off the initial $1,000 deposit). The original deposit of $1,000 becomes the 10% on reserve in the "banking system" out of a total of $10,000 ($9,000+$1,000). Therefore that additional $9,000 that they are charging interest on came from (????) .

The argument goes....that the $9,000 was newly created money out of nothing...and the banks are charging interest on it.

Explain where that is wrong for my own clarity.

 

[AceNZ]

@shocker -- your understanding is exactly right.

 

[Banana]

If I'm decoding your question correctly, what you said is basically right: there's only a weak correlation between the money supply and FRNs in circulation. There are a lot more FRNs in circulation around the holidays, for example, whereas the money supply doesn't change much.

For an initial $1,000 deposit into the first bank... 90% ($900) of it is loaned...then eventually redeposited into a new account at the same or 2nd bank...and 90% ($810) of that deposit is reloaned... and deposited into the same or third bank ....then 90% ($729) of that is reloaned...etc...etc (through the revolving door of fractional reserve banking) .

At the end of this process the bottom line is.... the "banking system" has loaned $9,000 through this process (based off the initial $1,000 deposit). The original deposit of $1,000 becomes the 10% on reserve in the "banking system" out of a total of $10,000 ($9,000+$1,000). Therefore that additional $9,000 that they are charging interest on came from (????) .

I want to see if I can tie this to FRNs... If shocker's example is correct, it means that when the bank gets $1,000 as a deposit, it gets $100 in FRNs (10% reserve). When it loans out $900, the bank that receives the loan as a deposit then gets $90 FRN and so on toward the total of $900 FRNs?

*head scratching*

 

[AceNZ]

I want to see if I can tie this to FRNs... If shocker's example is correct, it means that when the bank gets $1,000 as a deposit, it gets $100 in FRNs (10% reserve). When it loans out $900, the bank that receives the loan as a deposit then gets $90 FRN and so on toward the total of $900 FRNs?

If you want to restate the example using FRNs, it would work like this: An initial deposit of $1,000 in FRNs is made -- meaning that the FRNs are exchanged by the bank for checkbook money. Those FRNs become vault cash, which are bank reserves.

So the bank now has $1,000 in vault cash reserves.

With $1,000 in reserves, the bank has $900 in excess reserves (90%), so it can create a loan for $900, which would be in the form of new checkbook money (not FRNs). At this point the original account would still have $1,000 in it, and the borrower's account would have $900 in it. Now the borrower goes to the bank and withdraws the $900 loan proceeds in cash. The bank pays out the FRNs they have in vault cash by exchanging them for the $900 in checkbook money.

Now the $900 in FRNs gets deposited into a second bank, and the process repeats. Another loan for $810 (90% of $900) can then be created in new money, etc.

 

[shocker315]

I want to see if I can tie this to FRNs... If shocker's example is correct, it means that when the bank gets $1,000 as a deposit, it gets $100 in FRNs (10% reserve). When it loans out $900, the bank that receives the loan as a deposit then gets $90 FRN and so on toward the total of $900 FRNs?

*head scratching*

The actual amount of actual FRN's banks deal with seems meaningless to me. The majority of our monetary system operates as checkbook ledger transactions or electronic transfers. Our current system doesn't have to be tied to gold or the actual amount of currency (FRNs). They just have to have enough FRN's around in cash and in the vault to allow people to have faith in the system as a whole and give it the appearance of legitimacy. But when you get a home loan they don't give it to you in cash. Its just some electronic digits and a transfer between accounts. We assume it all balances out in the end... and is legit. Because they say it does....right! But how do you really know? What happens when we all try to get our cash at once?....oops!!... things don't balance.

We are mostly a cashless society that operates with debit cards, ccards, IOU's, electronic accounts. Seems to leave open the very easy possibility of monetary deception and lending money you don't really have. Or even more sinister.... erasing your electronic assets with a keystroke. Some think that's the whole reason for the break from the gold backed currency and a move toward a completely cashless society in the first place. It creates a lack of transparency and allows for easier manipulation of the money supply by those who have been given sole power to set the monetary rules and operate our banking system (FED).

 

[SilentBull]

New notes are printed all the time. In the same way that you exchange checkbook money for FRNs when you cash a check, the Fed exchanges money in a bank's reserve account for newly printed FRNs. Money is created as checkbook money, and then exchanged for FRNs.

This is where I'm confused then. If a bank has reserves in its account it's because it has FRNs in its vault, right? So why do they need to print new FRNs??

 

[AceNZ]

This is where I'm confused then. If a bank has reserves in its account it's because it has FRNs in its vault, right?

No. A bank's reserves are split between two locations: FRNs in the vault ("vault cash") AND as digits in a computer at the Fed (their "reserve account"). The majority of a banks reserves, by far, are kept in their reserve account.

So why do they need to print new FRNs??

If a bank uses up all of the FRNs in their vault, they can exchange some of the money in their reserve account at the Fed for more. Those new FRNs would have to be printed...

When the Fed creates new reserves (new money) by buying treasury securities, or when banks create new money through loans -- the money that's created is all digital -- no FRNs. The FRNs are only created in anticipation of that money being withdrawn from a bank as cash.

 

[Banana]

No. A bank's reserves are split between two locations: FRNs in the vault ("vault cash") AND as digits in a computer at the Fed (their "reserve account"). The majority of a banks reserves, by far, are kept in their reserve account.

If a bank uses up all of the FRNs in their vault, they can exchange some of the money in their reserve account at the Fed for more. Those new FRNs would have to be printed...

When the Fed creates new reserves (new money) by buying treasury securities, or when banks create new money through loans -- the money that's created is all digital -- no FRNs. The FRNs are only created in anticipation of that money being withdrawn from a bank as cash.

From your previous post:

If you want to restate the example using FRNs, it would work like this: An initial deposit of $1,000 in FRNs is made -- meaning that the FRNs are exchanged by the bank for checkbook money. Those FRNs become vault cash, which are bank reserves.

So the bank now has $1,000 in vault cash reserves.

With $1,000 in reserves, the bank has $900 in excess reserves (90%), so it can create a loan for $900, which would be in the form of new checkbook money (not FRNs). At this point the original account would still have $1,000 in it, and the borrower's account would have $900 in it. Now the borrower goes to the bank and withdraws the $900 loan proceeds in cash. The bank pays out the FRNs they have in vault cash by exchanging them for the $900 in checkbook money.

Now the $900 in FRNs gets deposited into a second bank, and the process repeats. Another loan for $810 (90% of $900) can then be created in new money, etc.

So let's see if I have it down...


I have $1,000 FRNs. I make a deposit in the bank.

Bank records this as a vault cash. This doesn't count toward reserve and isn't available for loan (not yet.

The bank decide it wants more reserve. So it exchanges with Fed FRNs into reserve money (digital). It now has $1,000 in reserve and $0 in vault.

It can now make a loan of $900, keeping $100 in reserve. This is deducted from the reserve account. The vault is still $0.

The borrower takes the loan and cash it to his bank. Bank then converts the loan into FRNs by transferring the first bank's $900 in reserve to the second bank's vault cash.

Right?

 

[SilentBull]

From your previous post:
So let's see if I have it down...


I have $1,000 FRNs. I make a deposit in the bank.

Bank records this as a vault cash. This doesn't count toward reserve and isn't available for loan (not yet.

The bank decide it wants more reserve. So it exchanges with Fed FRNs into reserve money (digital). It now has $1,000 in reserve and $0 in vault.

It can now make a loan of $900, keeping $100 in reserve. This is deducted from the reserve account. The vault is still $0.

The borrower takes the loan and cash it to his bank. Bank then converts the loan into FRNs by transferring the first bank's $900 in reserve to the second bank's vault cash.

Right?

If the above example is correct, what happens to the initial $1000 in FRNs? If they become digital, what happens to the physical notes? If a bank can only add to its reserve by sending actual FRNs to the fed, then it seems to me that when they exchange their reserve back to FRNs, the fed can just give them the same notes that they sent earlier. Unless checkbook/digital money can also be used as reserve. Is this right?

 

[SilentBull]

If a bank uses up all of the FRNs in their vault, they can exchange some of the money in their reserve account at the Fed for more. Those new FRNs would have to be printed...

When the Fed creates new reserves (new money) by buying treasury securities, or when banks create new money through loans -- the money that's created is all digital -- no FRNs. The FRNs are only created in anticipation of that money being withdrawn from a bank as cash.

Thanks for all your help so far. Here's an example to see if I get it...

A bank initially has the following in his vault/reserve:

BANK:
- $1000 (cash)

It lends 90% and it gets deposited back. Now it looks like this:

BANK:
- $1000 (cash)
- $900 (digital)

Then it lends 90% and it gets deposited back. Now it looks like this:

BANK:
- $1000 (cash)
- $900 (digital)
- $810 (digital)

Are you saying that when it comes time for the bank to pay, for example, $1900, it will ask the Fed to exchange the $900 digital into FRNs??

If my example is correct, that brings me to my other question, how can the bank get to a point where it has no more FRNs? If my example is correct, they can infinitely change their digital money for FRNs. How would a bank run hurt the bank in this case when they can always exchange their digital money for paper?

Let's see if I can answer my own question:

When they "exchange" their digital money for FRNs are they putting up a collateral (another loan)? So they are not getting their FRNs for free, right? They have to give up something. They have to pay it back when someone pays them a loan back with real money. Is this correct? Is that why they cannot do it infinitely? Because at some point they will owe as much as is owed to them?

 

[Deborah K]

Money is debt, and in a finite world such as that in which we live, we are headed for disaster. This tutorial explains our whole monetary system and how it works and why it will eventually ruin us as a nation. It also gives alternatives. It's very well done in layman's terms and I highly recommend it.

http://video.google.com/videoplay?docid=-9050474362583451279

 

[Banana]

Anon- I had took it to understand that vault cash and reserves are a separate accounts.... Will see what others can clear up.


Deborah- Thanks for movie. Too bad it's not captioned... :\

 

[Deborah K]

Anon- I had took it to understand that vault cash and reserves are a separate accounts.... Will see what others can clear up.


Deborah- Thanks for movie. Too bad it's not captioned... :\

Why do you need it to be captioned?