Money Creation and Money Destruction.

[Harry_Felker]

@filc

@Harry Felker

You are assuming that Bank A and B never communicate…

I did not mean it in a condescending sense, I meant it in a matter of the question…

@filc

With that said though, and offering no evidence of my own, I find that claim extremely hard to believe. Do you have any citations or references which I could read up on? Considering the assumed hundreds of thousands of deposits which occur between thousands of banks nationwide such an accounting system to keep track of this seems impossible from a cost efficiency standpoint.

I have reality, when I write a check, it comes back to me, do you honestly believe the bank does not have the same mechanism for its loans that it has for my checks?

This is the reason the bank issues a loan check, and not cash, it is traceable, and it is really not impossible, considering now we have electronic transfer where the banks in question will have a computer record of the source and nature of every non cash transaction…

@filc

Perhaps they have some built in system with Checks but every deposit I’ve made has only had 2 sets of numbers. 1 account number, 2 routing number. Had there been some other serial code on a check that the depositing bank could reference that may make sense. However to my knowledge there is no open standard used. However I am not very knowledgeable in the banking field.

Realize that a bank check from a teller and a bank check from a loan agent has different numbers on it, the pool of money they issue these checks off of is different so it requires a sub division in the bank… I know from my father’s mortgage, there is a Willshire bank, one that takes deposits, issues check cards and that jazz, and then there is the division of the Willshire group that handles mortgages, another that handles small loans (auto home improvement loans), so on and so forth…

@filc

Additionally many loans to individuals are deposited directly into their checking accounts. The individual may use his normal checks to spend some of his new money. How does BankB know where this money came from? It seems far fetched that there is a transaction police department watching every single transaction that takes place nationwide in a single bank.

No the bank gaining the deposit watches where its money comes from, it is the burden of proof against bad checks and legal requirement for making loans in the Federal Reserve system, by law the bank has to prove the check is no good, not the other way around, and trust me, they have a system set up to do just that. Further if you are a bank you abide by the FRS rules or you are not a bank in this country any longer…

@filc

One of my clients happens to be a bank and I know that they have no technician subsystem or staffing to perform such a task. I know this because I do their IT. Unfortunately I cannot share the details.

The thing you can share is generalities, do you do IT for the Loans Subdivision? Besides the numerical difference on the check the payee for the check is the subdivision that does the loans, when you get a mortgage from bank A, you get a check from Bank A Credit or Mortgage, not from Bank A…

@filc

Now as I said I could be wrong. My rebuttal is made in complete ignorance and shock that such live auditing of the banking system is even fathomable. It would be good for me to get some more information regarding FRB and it’s mechanics.

This is not only fathomable, but very simply done… Just by sub dividing into departments…

@filc

For that matter it may be beneficial to the original poster if the mechanics of FRB were summarized here as an answer. Explaining how $1000 of reserves can be expanded to create new money and how paying that off retracts the original expansion.

I believe we have done this already with my example and other people’s expantions on such…

@filc

I have heard some make the argument that while paying off massive amounts of dept does retract the money supply there is still a residual amount of new money that is created from the process. It would be nice if any one knowledgeable can expand on this.

The issue is one loan in the chain that goes into default makes the credit a permanent entity so to speak…

@filc

Thanks for your response Harry, I appreciate your intellect and time.

Anytime, I am here to help out where I can and learn where I am deficient…

[filc]

Well stated.

What about Loans like Pay-Day loans where the check is written directly to you then deposited into your personal checking account. That new money then goes to pay for general goods like grocieries or bills sometimes in the form of cash. The recipient of that new money then deposits into their bank. How does “their” bank know the money came originally from credit?

One other thing I am confused on however is most of the Austrian literature I have read has made the argument that FRB is bad and inflationary. From the information you simply provided in a few posts you have contridicted the reasons why I believed FRB to be bad from an Austrian perspective. Am I misinterpreting something? Are you saying that FRB can function without any real harm?

I realize that youtube video’s are often subject to extreme error. A friend of mine pointed out this video to me. According to the information your providing this series of videos appears to be inacurate. They state that the pyramid of increased money does not work the same way in reverse and that the same amount of money isn’t destroyed that was created.

http://www.youtube.com/watch?v=oguCNqCE0Kc

What are your thoughts on this video? Is it inacurate?

Thanks again for helping me understand this.

[Harry_Felker]

@filc

What about Loans like Pay-Day loans where the check is written directly to you then deposited into your personal checking account. That new money then goes to pay for general goods like grocieries or bills sometimes in the form of cash. The recipient of that new money then deposits into their bank. How does “their” bank know the money came originally from credit?

A Payday Loan is not a bank loan, different animal…

Payday loans are backed by money, the payday lender does not issue credit, but rather gives you cash on a promise to pay, much like the old S&L business, where they would not lend out more than a % that they had in their possession, and it was contracted that the depositors could not freely withdraw funds…

@filc

One other thing I am confused on however is most of the Austrian literature I have read has made the argument that FRB is bad and inflationary. From the information you simply provided in a few posts you have contridicted the reasons why I believed FRB to be bad from an Austrian perspective. Am I misinterpreting something? Are you saying that FRB can function without any real harm?

It can, but it is unlikely to, it is not a matter of should it be a banned practice, but a bad business move in a free market…

The thing I think you are missing is that the FRB set up can work, but if there is a bank run, or the money supply is not free market, or the bankers are bad, or any number of other factors occur, it is very bad for borrowers who lose real property and depositors who lose real money, the fact is that today we have many such factors in the US, so FRB should not be encouraged.

In a free market, those with High Time Preference will not frequent FRB banks as their money will be in jeopardy, and may be contracted as inaccessible in regard to S&L type scenarios, as they will want access to their money at all times. Conversely those with Low Time Preference, people saving for retirement, might frequent these places as they will offer decent interest to depositors, therefore better prepare them for when they need the money in the future…

@filc

I realize that youtube video’s are often subject to extreme error. A friend of mine pointed out this video to me. According to the information your providing this series of videos appears to be inacurate. They state that the pyramid of increased money does not work the same way in reverse and that the same amount of money isn’t destroyed that was created.

You have to realize that I use the term allegedly to describe money destruction, because I would need to see a bank audit for me to believe it, and I have no authority to see such…

I know the series, I explain how the $1111 becomes $98889 in credit, since the last M1 put credit at about 95% of the money supply in the US, some of this credit does get destroyed, I am certain though it is not all of it, or even most of it, I just cannot quantify this claim without seeing an audit I have no legal way to see…

If you take all the sensationalism quotes out of the video and get to brass tacks, you would cut the series to 10 minutes, unfortunately the video can only go as far as I can with fact and has to rely on the best answer from the facts, with the gap of the real numbers that are no longer reported and we do not have free access to…

[filc]

Harry,

Thanks for your time and clarification. I nominated a previous post of yours as the suggested answer. Thanks again.

[Harry_Felker]

@filc

Harry,

Thanks for your time and clarification. I nominated a previous post of yours as the suggested answer. Thanks again.

Thank you, If I can help I am glad to…

[Erickk]

@Harry Felker

@filc

You are assuming that Bank A and B never communicate…

The loan check is a check from Bank A, so Bank A will let Bank B know that it is “credit”, in the US system, that allows “B” to lend out 90% of the checks value ($9000). Once the loan is paid off with real money (in the future of the loan) the 10K comes off Bank “A”'s sheet (theoretically), the interest is paid to the bank, and from the bank to costs, deposit interest and profit. IF, and this is a big IF, handled properly, FRB is not in and of itself a bad thing, it is the hazard for immoral practices that makes it bad…

If I wiretransfer 100k to your account, the same thing as you just explained is going to happen, am I correct?

[Harry_Felker]

@Erickk

@Harry Felker

@filc

You are assuming that Bank A and B never communicate…

The loan check is a check from Bank A, so Bank A will let Bank B know that it is “credit”, in the US system, that allows “B” to lend out 90% of the checks value ($9000). Once the loan is paid off with real money (in the future of the loan) the 10K comes off Bank “A”'s sheet (theoretically), the interest is paid to the bank, and from the bank to costs, deposit interest and profit. IF, and this is a big IF, handled properly, FRB is not in and of itself a bad thing, it is the hazard for immoral practices that makes it bad…

If I wiretransfer 100k to your account, the same thing as you just explained is going to happen, am I correct?

No, that would be treated as real cash, like a direct deposit, as if you wire money you have to pay the amount of the wire plus a service fee…

You can only give unbacked loans through FRB as a Bank that is a member of the Federal Reserve, or you are breaking the law in this country (LT Laws that Scineram does not understand), sort of the same thing with a payday loan…

[Erickk]

@Erickk

@Harry Felker

@filc

You are assuming that Bank A and B never communicate…

The loan check is a check from Bank A, so Bank A will let Bank B know that it is “credit”, in the US system, that allows “B” to lend out 90% of the checks value ($9000). Once the loan is paid off with real money (in the future of the loan) the 10K comes off Bank “A”'s sheet (theoretically), the interest is paid to the bank, and from the bank to costs, deposit interest and profit. IF, and this is a big IF, handled properly, FRB is not in and of itself a bad thing, it is the hazard for immoral practices that makes it bad…

But if I wire my money from my account in Bank A to your account in, say, Bank B, then the Bank B can create money in accordance with the fractional reserve ratio on top of the increase of money in your account (which is transfered out of my account), am I correct??

Moreover, in your explanation, if the man defaulted on his loan taken from Bank A, Bank B will not be affected, rite??

[Harry_Felker]

@Erickk

But if I wire my money from my account in Bank A to your account in, say, Bank B, then the Bank B can create money in accordance with the fractional reserve ratio on top of the increase of money in your account (which is transfered out of my account), am I correct??

If you wire $100k into my account, you are transferring to my name $100k of currency, not a loan that is back partly by currency…

When you do this, My Bank has an increase of 100K in thier reserves, which opens them up to write a ~810k Loan, now when that loan is deposited, as it MUST BE before it can be spent, it is split 90%/10%, the 10% is taken as reserve by the bank for loan purpose, multiplied by 9 and made into a loan(s) ($729k) wash rinse repeat…

At the end of the ability to loan, each of the $1’s you lent me will be supporting ~$100 of currency (real and electronic), until all of the loans in the process are paid off in total my $1 will have varying degrees of supprot to electronic money, as well as supporting its own value, this is the cause of the inflationary effect due to money creation. When these loans are being paid, the electronic money is destroyed (allegedly), but I am sure you understand that $900k loans are not paid off in short runs…

The other issue is that the money created on your $100K (before you wire it to me) is still in play…

@Erickk

Moreover, in your explanation, if the man defaulted on his loan taken from Bank A, Bank B will not be affected, rite??

Well of course, Bank “B” is given real currency to represent the electronic money when it is needed by the bank, from the federal reserve, even if the debtor to Bank “A” has defaulted…

[Erickk]

@Harry Felker

When you do this, My Bank has an increase of 100K in thier reserves, which opens them up to write a ~810k Loan, now when that loan is deposited, as it MUST BE before it can be spent, it is split 90%/10%, the 10% is taken as reserve by the bank for loan purpose, multiplied by 9 and made into a loan(s) ($729k) wash rinse repeat…

THANK YOU SO MUCH~!!

I somehow do not understand how reserve ratio works. For example, if your account increases by 100k, and provided the ratio is 90%, then the maximum of money the bank is allowed to create based on this increase is 100k times 90% = 90 k. I know I might be wrong, but could you please tell me why and where I am wrong??

[Harry_Felker]

@Erickk

I somehow do not understand how reserve ratio works.

Because the original $ is real, it is yours, when you transfer it to me the bank treats it as a cash deposit, allowing it to make a loan, the original loan is 9 times 90% of the cash, approximately ($810k), every other subsequent loan is made from banks at 9 times 10%, making the 10% responsible for the Loan written off of loaned currency. If you were a bank loaning me that money, then you would be correct, but your money pool to give the 100K loan would come from a cash deposit of (100,000/9 = 11111.11) $11,111.11…

Does that help? There are different rules depending on where the money comes from…

[Erickk]

@Harry Felker

when you transfer it to me the bank treats it as a cash deposit, allowing it to make a loan, the original loan is 9 times 90% of the cash, approximately ($810k),

So actually if I wiretransfer to your account 100k, the money supply accordingly increased is 810k. It doesnt matter if it is being operated in the same bank right? If we the account the wiretransfered money come from and the recipient account are both in the same bank, the increase in money supply is also 810k???

[Harry_Felker]

@Erickk

So actually if I wiretransfer to your account 100k, the money supply accordingly increased is 810k.

When you wire the money to me, it allows my bank to write a loan for $810k…

This money is an increase based on future money…

So yes it brings money into existence that does not exist…

@Erickk

It doesnt matter if it is being operated in the same bank right?

I believe that would make a difference, it would not surprise me if it did not, but I am sure the loans are written off the total pool not the individual account balances…

But the issue there is when you transfer the money to me, you bank already has loans based on that money, and now so does mine…

[Erickk]

@Harry Felker

you bank already has loans based on that money, and now so does mine…

Sorry but I still did not get this, do you mean that this sort of wiretransfer still potentially create money?

Additionally, the new $810k lent out based on the newly received money in your account is actually to be added to the lendee’s accounts in that bank, right?? So can the Bank continue to create money out of this “credit”??

[hayekianxyz]

@Harry Felker

But the issue there is when you transfer the money to me, you bank already has loans based on that money, and now so does mine…

It doesn’t really work like that, banks don’t keep track of every transfer they make on the second they make it.

@Harry Felker

So yes it brings money into existence that does not exist…

No shit.

[Harry_Felker]

@Erickk

Sorry but I still did not get this, do you mean that this sort of wiretransfer still potentially create money?

Your money starts in a bank, your bank made loans off that money, those loans are not automatically paid off when your money is removed from the bank. So, when it goes into my bank, and it starts writing loans off this money, both banks had the opportunity to write $810k in loans…

@Erickk

Additionally, the new $810k lent out based on the newly received money in your account is actually to be added to the lendee’s accounts in that bank, right?? So can the Bank continue to create money out of this “credit”??

Lets say I am at Bank A, and someone gets a loan from Bank A’ Loan Department for $810k to purchase a home, and the home seller belongs to Bank A as well, once the $810k loan check is deposited, Bank A now gets the oppotunity to loan (810000/10 = 81000*9 = 729000) $729K. And this can theoretically continue… lets do a table…

Deposit(Amount and Type) = (Loan Size)

$100000 cash = $810K Loan

$810K Loan = $729K Loan

$729K Loan = $656.1K Loan

$656.1K Loan = $590.49K Loan

$590.49K Loan = $531.441K Loan

$531.441K Loan = $478K Loan

$478K Loan = $430.2K Loan

$430.2K Loan = $387.2K Loan

$387.2K Loan = $348.5K Loan

$348.5K Loan = $313.65 Loan

$313.65 Loan = $282.3K Loan

$282.3K Loan = $254K Loan

$254K Loan = $228.6K Loan

$228.6K Loan = $205.7K Loan

$205.7K Loan = $185.13K Loan

$185.13K Loan = $166.6K Loan

$166.6K Loan = $150K Loan

$150K Loan = $135K Loan

$135K Loan = $121.5K Loan

$121.5K Loan = $109.35K Loan

$109.35K Loan = $98.4K Loan

Let us stop here, though this goes on until there is 0 $ (about $10M in total loans generated)

The $100K in real physical Cash that you transferred to my account has blossomed into $7.21 M (Yes that is Million) in loans so if you add the $100K that is responsible for supporting its own value, the $100K you wired to me is now responsible for $7.3M in currency, and this goes on to almost $10M. Some money destruction happens, but the last M1 (the one before they stopped reporting it) had the physical cash at 5% of the money supply in the US, so some money destruction happens, if it did not it would be 1%, but it is not anywhere near enough money destruction to curb inflation. The other thing to remember, most of these are 30 year loan amounts, so it will take 30 years for this money to be destroyed, so that $100k has a large albatross hanging from it for a long time…

[Harry_Felker]

@GilesStratton

@Harry Felker

But the issue there is when you transfer the money to me, you bank already has loans based on that money, and now so does mine…

It doesn’t really work like that, banks don’t keep track of every transfer they make on the second they make it.

Giles, really, the second they get the money they do not automatically write the loans, holy crap I never knew!!!

Are you really that much of an ___?

I am pretty sure Erikk understands that it is not instantaneous, that there are other factors involved, I am giving him the basic knowledge on how this works

1. I could withdraw the $100k right away
2. The banks could not have anyone to lend to
3. The federal government could seize the money under the RICO Act

Who pissed in your cornfalkes?

[hayekianxyz]

My point was that the transfer is unlikely to result in any sort of credit expansion. If you transfer the money to him, you’re taking money out of your own bank account, meaning your bank has less credit with which they can expand. At the end of the business day is when the two banks check their reserves and evaluate them. Also, you missed out the fact that banks can’t generate loans unless there are people willing to take them. Let’s assume away this last point for the sake of the argument and say that banks can simply expand credit provided their reserves are above the required ratio. Now, imagine that Bank A (yours) loses $100 in reserves due to your transfer, consequently Bank B gains $100. Now, if both are above their reserves at the end of the day, both will expand credit, yours to a lesser extent than would have otherwise been and his to a great extent than would have otherwise been. Now, imagine your bank ends up being below the reserve ratio and his above it. Either Bank A can call in loans (contracting the money supply) or it can take a loan from another bank (meaning the other bank can’t expand to the extent it would have otherwise been able to with the $100). The simplify the example, it could just be said that the $100 ends up right back where it started in Bank A, even if both of your respective accounts have a new balance.

If we relax the aforementioned assumption, nothing changes. Unless you wish to stipulate for some reason Bank B has a large number of customers who wish to take loans but insufficient reserves, with the opposite holding true for Bank A. Now, you can carry on your analysis as if this is the case, if you wish, but it’s contradicted in both theory and reality.

[Harry_Felker]

@GilesStratton

My point was that the transfer is unlikely to result in any sort of credit expansion. If you transfer the money to him, you’re taking money out of your own bank account, meaning your bank has less credit with which they can expand.

Unless of course his bank (Bank A) has no available credit due to loans, and my bank (Bank B) has no available credit due to loans, this is one of the reasons the M1 stopped being reported (it is theorized)

@GilesStratton

At the end of the business day is when the two banks check their reserves and evaluate them. Also, you missed out the fact that banks can’t generate loans unless there are people willing to take them. Let’s assume away this last point for the sake of the argument and say that banks can simply expand credit provided their reserves are above the required ratio. Now, imagine that Bank A (yours) loses $100 in reserves due to your transfer, consequently Bank B gains $100. Now, if both are above their reserves at the end of the day, both will expand credit, yours to a lesser extent than would have otherwise been and his to a great extent than would have otherwise been. Now, imagine your bank ends up being below the reserve ratio and his above it. Either Bank A can call in loans (contracting the money supply) or it can take a loan from another bank (meaning the other bank can’t expand to the extent it would have otherwise been able to with the $100). The simplify the example, it could just be said that the $100 ends up right back where it started in Bank A, even if both of your respective accounts have a new balance.

This mess is dealt with in light of the situation we are in right now in America, “credit crunch”, there is little available credit, one must really question why, FRB is the main reason…

This is because when My bank and his bank at the end of the day have their book making done, despite that he transferred the money to me, the loans written on the money he had (During a “credit crunch” this is almost assuredly spoken for, at least partially), will not just go away, they need to be paid, and they are payable under contracted terms of time. It is not like his bank will send a message to my bank claiming they cannot write loans on the money because there are loans written on it already…

@GilesStratton

If we relax the aforementioned assumption, nothing changes. Unless you wish to stipulate for some reason Bank B has a large number of customers who wish to take loans but insufficient reserves, with the opposite holding true for Bank A. Now, you can carry on your analysis as if this is the case, if you wish, but it’s contradicted in both theory and reality.

I am not making such an assumption, the assumption I am making is that both banks have borrowers in abundance, such was the case in the mid to late 90’s in America and the direct cause of the credit issues we have right now, this would be dealing in reality. In the 90’s Bill Clinton removed Glass-Steagall and the banks needed then to worry about discriminating based on ability to pay, so when the customers flooded for loans, they had to write them, for fear of legal action, this is dealing with reality…

What you are discussing is a healthy system that does not exist…

[hayekianxyz]

@Harry Felker

Unless of course his bank (Bank A) has no available credit due to loans, and my bank (Bank B) has no available credit due to loans, this is one of the reasons the M1 stopped being reported (it is theorized)

In which case, neither bank would expand credit. I don’t understand what your point is, if you would wish to elaborate, go ahead. Perhaps there’s nothing I’m missing, but as I see it what you’re saying is that a transfer of money between two individuals will cause the money supply to increase. How is this possible if they don’t currently meet their reserve requirements.

@Harry Felker

This mess is dealt with in light of the situation we are in right now in America, “credit crunch”, there is little available credit, one must really question why, FRB is the main reason…

This is because when My bank and his bank at the end of the day have their book making done, despite that he transferred the money to me, the loans written on the money he had (During a “credit crunch” this is almost assuredly spoken for, at least partially), will not just go away, they need to be paid, and they are payable under contracted terms of time. It is not like his bank will send a message to my bank claiming they cannot write loans on themoney because there are loans written on it already…

Of course I agree FRB is to blame for the “credit crunch” (although, the ultimate cause is the cartelized banking system), but that doesn’t make your argument fit. At the end of the day once book making has been done the bank that received the loan has more money to expand, and that bank which lost availability of the money has less money on which in can pile credit. Now, bank A (the bank that “lost” the money) is below their reserve ratio and does not call in loans (which would cause the money supply to collapse) can simply borrow money from other banks.

@Harry Felker

I am not making such an assumption, the assumption I am making is that both banks have borrowers in abundance, such was the case in the mid to late 90’s in America and the direct cause of the credit issues we have right now, this would be dealing in reality. In the 90’s Bill Clinton removed Glass-Steagall and the banks needed then to worry about discriminating based on ability to pay, so when the customers flooded for loans, they had to write them, for fear of legal action, this is dealing with reality…

What you are discussing is a healthy system that does not exist…

The assumption was to make the analysis more simple, nothing more. Even if banks do have extremely high demand for customers, I don’t see what your point is. When Bank B (the bank that received the money) obtains the additional $100, they expand credit to the extent that the $100 will allow them to, Bank A is unable to expand credit to the extent that the $100 would have enabled them to do so. There’s simply nothing more to it than that, and I don’t see what you’re not understanding.