patrick.net

Superficially, it looks like fraud to me. If I did it, I could be prosecuted.

The problem is that all financial systems, with our without fractional-reserve banking, are unstable, so it's hard to make the case that fractional-reserve lending is good or bad.

Would there be grotesque liquidity and investment issues if we god rid of it? What's magical about economic growth that we need it, anyway?

HydroCabron says

Would there be grotesque liquidity and investment issues if we god rid of it? What's magical about economic growth that we need it, anyway?

Suddenly, and yes, one would think so. It is basically money printing, but at the bank level.

One problem that I see is the following.

1.) Whee, I can print money, I will print some and put it into my account. - Even today, it is likely that this behavior would land bankers in jail.

2.) Whee, I can print money, I will pump up my bonuses and compensation by creating bogus financial instruments with this created money. - This behavior does not land anyone in jail.

Criminal behavior should lead to a forfeiture of the ability to create money out of thin air.

Blurtman says

Is fractional reserve lending a negative contributor to economic stability?

Yes, the system is leveraged from the get go. It is why inflation is necessary, for every 1 on deposit they lend out 9 more, conversely for every loan that is paid off they lose 9 for every 1 that is no longer an asset.

Blurtman says

Is fractional reserve lending a negative contributor to economic stability?

Long term or short term? I learned about that 10% ( lower in some parts of the world ) several years ago myself and thought it was insane. Upon further reading I found that it's supposed to help growth / increase the velocity of money. That in some way related to the US war for independence if I recall correctly. ( We couldn't print our own dough and couldn't grow quickly )

I really have no opinion because I'm too ignorant on the topic. I do have a healthy paranoia about it though and that is why I have so much cash on the sidelines. Lately I've even been putting about 0.1% under the mattress.

"the Bank of America writes a check that it can only back with 10% of the check's amount, and no problema."

That's not how fractional reserve lending works!

They get $2,000 in deposits, they lend out $1800, leaving 10% as the "reserve".

That $1800 gets deposited somewhere, and a further $1620 is lent again on that deposit ( 90% x $1800)

So after two rounds there's $5420 in deposits in the system and $5420 in debt (the bank owes the original depositor $2000 and two borrowers owe their banks the other $3420).

Nothing particularly criminal going on here.

shows the fractional reserve lending thing isn't really happening now anyway, now that the Fed is paying money on excess reserves.

The key thing about fractional reserve lending is that the same dollar exists in two separate checking ("demand") accounts.

Asset-based lending requires loans to come out of the bank's capital or locked-up customer money e.g. CDs.

Bellingham Bill says

So after two rounds there's $5420 in deposits in the system and $5420 in debt (the bank owes the original depositor $2000 and two borrowers owe their banks the other $3420).

So $2,000 of deposited money results in the lending of $5420 after only two rounds. Additional rounds of lending will only increase the amount lent on the original $2,000 deposit.

I am not saying fractional reserve lending is a crime, but that it is money printing. And criminals should not be allowed the privilege of creating money.

Blurtman says

I am not saying fractional reserve lending is a crime, but that it is money printing.

Some people can't get over the weirdness of declaring that these people over here can create money, but if those over there do it, it's fraud.

It's the same as with drugs: if you sell opiates on the sidewalk in front of the pharmacy, you are going to jail.

Bellingham Bill says

That's not how fractional reserve lending works!

When you consider that the original $2,000 becomes $20,000 under a 10% capital reserve requirement, that is how it works. You have to look at Bank of America's transactions in the aggregate. In your example, consider that the money is re-lent internally in the large Bank of America. So that BAC does lend out $20,000 on a deposit of $2,000, and in the aggregate, writes a check for $20,000 that is only backed by $2,000.

HydroCabron says

Some people can't get over the weirdness of declaring that these people over here can create money, but if those over there do it, it's fraud.

Yes, it is a privilege that should not be granted to criminals. And yes, folks who are granted this privilege can grow wealthy due to their ability to print money.

And criminals should not be allowed the privilege of creating money.

They're not creating money though. Their job is to put depositors' money back to work in the economy, creating more wealth.

Money in a coffee can buried in the back yard is just rotting, it's not supporting new investment.

As long as the banks' loans are going to capital-building endeavors -- farm plantings, business capital investment, somebody's dental work, a new car -- the modern financial system is perfectly sustainable.

The problem comes from when outright consumption is being funded from this debt take-on, like someone borrowing $5,000 to pay for their honeymoon. If the borrower defaults on that debt, the lender has a huge problem, and so does the wider economy if it has become reliant on consumers being able to borrow to buy unsecured fluffy stuff with no salvage value as collateral for the lender.

(real per-capita (age 16+) annual consumer debt take-on) shows how consumer borrowing rose unsustainably in the last decade

and also shows how dangerous real estate bubbles are to the entire system, as so much of RE's valuation is not the value of the sticks and bricks but rather what the most lax bank is willing to lend against the collateral.

(And of course in the previous bubble there really wasn't fractional reserve lending going on, banks had plenty of capital to lend thanks to CDOs being packaged by Wall Street, plus the GSEs lending the actual 15-20% down payment money to home buyers, making loans zero down instead of the traditional 10-20% down.)

Blurtman says

So that BAC does lend out $20,000 on a deposit of $2,000, and in the aggregate, writes a check for $20,000 that is only backed by $2,000.

The $20,000 is just as real as the original $2,000. All money is debt-based at the end of the day.

THIS NOTE IS LEGAL TENDER FOR ALL DEBTS, PUBLIC AND PRIVATE

With banks sitting on $2T of cash deposits they could lend out, clearly we're not seeing fractional reserve banking going out of control now.

And like I said, it wasn't the cause of the 2008 crash. That crash was mainly the systemic fraud in the real estate and bond writing sectors, from appraisers to branch loan officers to Wall Street firms that made the CDOs of individual loans, cleverly "tranching" them to hide the crap, and, most critically, the cheap, underpriced CDS insurance that AIG etc were writing that insured CDO buyers against loss, and also the credit ratings agencies that let all this happen, along with the Feds that utterly failed to police the system 2002-2008.

Whether loans are paid out of customer CDs ("full reserve") or checking account money ("fractional reserve") isn't that big a deal in the scheme of things, compared to all that.

Bellingham Bill says

They're not creating money though.

Incorrect.They are lending what they do not have, thereby creating money

Money creation by the commercial banks
Most money is in the form of bank deposits in the contemporary economic system. The main way in which those bank deposits are created, is through loans made by commercial banks. When a bank makes a loan, a deposit is created at the same time in the bank account held by the borrower. In that way, new money is created.
http://en.wikipedia.org/wiki/Money_creation

Bellingham Bill says

Wall Street firms that made the CDOs

Like JPM which is the country's largest bank, and therefore a criminal organization creates money. HSBC, Citi - criminal institutions that create money

I wouldn't argue against the proposition that TBTF firms are all criminals. But the bank where my money is at -- a county federal credit union -- does the same thing as JPM.

Was Jimmy Stewart in "It's a Wonderful Life" a criminal?

https://www.youtube.com/embed/EOzMdEwYmDU

Bellingham Bill says

a county federal credit union -- does the same thing as JPM.

I rather doubt that. Just look up the crimes that JPM committed. And again, you seem to be confusing money printing for crime. No one has said that. What I have said is that criminals should not be given the privilege of printing money.

Blurtman says

rather doubt that. Just look up the crimes that JPM committed. And again, you seem to be confusing money printing for crime. No one has said that. What I have said is that criminals should not be given the privilege of printing money.

Strictly speaking, they aren't printing money. They are lending out their depositors' money.

If depositors think all their money is being held in a safe for them 24/7, they are mistaken. The bank only holds 10% of that money.

The practice was started by gold smiths way back.

You do realize that the reserve rate is 10%?

Yup it would make for a more stable economy, if we did away with it.

indigenous says

Yup it would make for a more stable economy, if we did away with it.

The economy probably would be more stable. Much crappier, but very consistently crappy so it would be stable.

tatupu70 says

The economy probably would be more stable. Much crappier, but very consistently crappy so it would be stable.

That is what the Fed is supposed to do...

indigenous says

That is what the Fed is supposed to do...

The Fed's charter is to keep the US economy crappy? Interesting. Please tell me more.

tatupu70 says

The Fed's charter is to keep the US economy crappy? Interesting. Please tell me more.

Once again with the "Socratic" method...

The Fed did not create more stability in banking, 20 years after it's institution we had the the great depression, that lasted for 10 years, In the past 20 years we have had one Fed created bubble after another.

indigenous says

Once again with the "Socratic" method...

The Fed did not create more stability in banking, 20 years after it's institution we had the the great depression, that lasted for 10 years, In the past 20 years we have had one Fed created bubble after another.

I forgot--it's always the Fed.

tatupu70 says

I forgot--it's always the Fed.

Yup, you do realize that before the Fed the currency's value went from a value of a dollar to a dollar and eleven cents, after the Fed the value went from 1 dollar to 4 cents?

tatupu70 says

Strictly speaking, they aren't printing money. They are lending out their depositors' money.

A reserve ratio of 10% means that $2,000 becomes $20,000. That is money creation, also known as money printing. And yes, the banks are not literally operating printing presses, but they are creating money by lending what they do not have.

The Soviet Ruble was a hard currency.

The 10x multiplier is not 10x on every dollar lent, only the total dollars in circulation, plus some other liabilities on the Fed balance sheet. From a high level, the excess reserves above is calculated as such:

Excess Reserves = FRN in circulation * 10 - money supply.

No one ever answers the question: In a growing population with increasing productivity, why should a dollar earned by my grandfather for a days labor 50 years ago be worth more than a days labor today, simply because he by delaying its consumption he is taking advantage of its scarcity under a hard money system? Delayed consumption is not investment in itself.

Blurtman says

A reserve ratio of 10% means that $2,000 becomes $20,000. That is money creation, also known as money printing. And yes, the banks are not literally operating printing presses, but they are creating money by lending what they do not have.

No, it's not creating any money. It's putting saved money back into circulation. They do have what they lend. They just don't keep all deposits on hand at the bank.

When you put money in the bank--it becomes the bank's money, which they then lend out.

control point says

No one ever answers the question: In a growing population with increasing productivity, why should a dollar earned by my grandfather for a days labor 50 years ago be worth more than a days labor today, simply because he by delaying its consumption he is taking advantage of its scarcity under a hard money system?

One of the cornerstones of a culture, country is reliable money. It has been the downfall of almost all countries in history more than any other.

So you think that going from a dollar to 4 cents makes sense?

“It is well that the people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.”
Henry Ford

tatupu70 says

No, it's not creating any money.

Incorrect.They are lending what they do not have, thereby creating money

Money creation by the commercial banks
Most money is in the form of bank deposits in the contemporary economic system. The main way in which those bank deposits are created, is through loans made by commercial banks. When a bank makes a loan, a deposit is created at the same time in the bank account held by the borrower. In that way, new money is created.
http://en.wikipedia.org/wiki/Money_creation

Blurtman says

Incorrect.They are lending what they do not have, thereby creating money

OK--let's take a step back. If you deposit $2K and the bank lends out $1.8K of it, the bank clearly HAS the money. Are you arguing that the demand deposit isn't the bank's money?

indigenous says

So you think that going from a dollar to 4 cents makes sense?

Money is a medium of exchange. It does not matter what its value is relative to itself historically. It only matters that I can immediately exchange my work for it, then exchange it for something I want.

As long as, basically, something I want cost $1 in 1900 when my daily wage was $1, then why should I complain that the same thing cost $25 today, when my daily wage is $35?

tatupu70 says

If you deposit $2K and the bank lends out $1.8K of it, the bank clearly HAS the money. Are you arguing that the demand deposit isn't the bank's money?

I'm going back to the moment in economics 101 when my jaw dropped to the floor - off in the distance, there was an ice cream truck, but that was all you could hear.

When I deposit $2K, it's still my money: I can withdraw it at any time. The bank, in lending $1.8K to someone else, which will go into another account at some bank, has effectively turned my $2K in bank deposits into $3.8K of bank deposits.

But wait: there's more! The second bank, receiving $1.8K in new deposits, lends out (0.9)*(1800) = $1620, which goes into yet another bank. So now the $2K in deposits is actually $2000+$1800+$1620 = $5420.

This chain continues, until there is $2000*[1 + 0.9 + (0.9)^2 + (0.9)^3 + ... ] = $2000*[1 / (1 - 0.9)] = $2000*10 = $20,000 in bank deposits.

In one sense, you are correct, because the moment I withdraw my $2K, the bank must restrict its lending, and the effect then manifests in reverse.

Also, if that $2K I received my have come from a drawdown of someone else's bank account - say, a check, instead of a loan, or instead of me depositing cash from my mattress - then the net effect of money creation is zero, because there is a chain of banks on the other end of that transaction which must tighten up their lending, which kills of $20,000 in deposits going the other way.

tatupu70 says

OK--let's take a step back. If you deposit $2K and the bank lends out $1.8K of it, the bank clearly HAS the money. Are you arguing that the demand deposit isn't the bank's money?

Sure, let's take a step back. And I offer the following analogy, and it is only an analogy and I am not a gold bug, BTW.

You have 10 $200 gold pieces, or $2,000. You write your nephew a check for $2,000, and keep one of the gold pieces, and pass the remaining 9 to your nephew. Your nephew writes a check to his friend Bobo for $2,000, keeps one of the gold pieces, and passes the remaining 8 to his sweetie, Tootsie. Tootsie writes her aunt Mildred a check for $2,000, keeps one of the gold pieces, and passes the remaining 7 to pastor Phil, who then writes a check for $2,0000,.....etc.until the last check writer has the last gold piece. On the basis of the original $2,000, $20,000 in checks have been written, but yet each check writer has only one $200 gold piece. So no, each check writer does not have $2,000, but only $200.

Can you imagine if banks could only lend out actual deposits on-hand? Wonder what that would do to inflation and prices of goods?

jvolstad says

Can you imagine if banks could only lend out actual deposits on-hand? Wonder what that would do to inflation and prices of goods?

What happens to inflation and the price of goods in the reverse, i.e., when you switch from a sound money policy to a fractional reserve policy?

control point says

Money is a medium of exchange. It does not matter what its value is relative to itself historically. It only matters that I can immediately exchange my work for it, then exchange it for something I want.

Because it gives an unfair advantage to investors, and the corollary to wage slaves.

Also the dept is eroded in this manner, since TARP a trillion dollars has been taken away from the 4 trillion in Fed spending during that time just by inflation.

Because it gives an unfair advantage to investors, and the corollary to wage slaves.

Also the dept is eroded in this manner, since TARP a trillion dollars has been taken away from the 4 trillion in Fed spending during that time just by inflation.

Huh?

So should Buddy, the child pornography dealer, be allowed to create money to fund child porn movies that he then resells at great profit?

Should Ratso the swindler be allowed to create money to fund the creation of bogus securities which he then resells at great profit?

Blurtman says

I am not saying fractional reserve lending is a crime, but that it is money printing. And criminals should not be allowed the privilege of creating money.

The alternative is the government could simply print the money. When you consider what you've written, then the economy is really on the banks, therefore we know who to blame.

I personally fail to see the difference between a few hundred bureaucrats in DC controlling the money supply, and a few hundred bank execs in NYC controlling the money supply, except the former is subject to democratic pressure and the latter is unelected and unaccountable.

Blurtman says

You have 10 $200 gold pieces, or $2,000. You write your nephew a check for $2,000, and keep one of the gold pieces, and pass the remaining 9 to your nephew. Your nephew writes a check to his friend Bobo for $2,000, keeps one of the gold pieces, and passes the remaining 8 to his sweetie, Tootsie. Tootsie writes her aunt Mildred a check for $2,000, keeps one of the gold pieces, and passes the remaining 7 to pastor Phil, who then writes a check for $2,0000,.....etc.until the last check writer has the last gold piece. On the basis of the original $2,000, $20,000 in checks have been written, but yet each check writer has only one $200 gold piece. So no, each check writer does not have $2,000, but only $200.

That's a poor analogy. A better one would be you get $2000 from the lottery. You keep $200 and loan $1800 to your nephew. He keeps $180 and loans $1620 to his girlfriend. She keeps $162 and loans $1458 to her out of work Dad. He keeps $146 and loans $1312 to his son. And so on.... Each person who took out the loan only has 10% of the loan value.

In effect, when you deposit in a bank, you are loaning them the money at a specified interest rate for any term you choose.