For those who think Fractional Reserve Banking is evil incarnate...

You work for the bank in what area? mortgage? When a man signs the mortgage application form, does bank then deposit that signed mortgage application form, monetise it, and turn the table around claiming the bank is now lending the money while in fact it is that signature that creates the new money? If I supposedly "borrow" $1million, how much does it actually cost the bank to "lend" me? Freaking nothing! well, other than copying the papers to be signed.

 

That is FRB. Read my other posts and think about it! Read the wikipedia FRB entry which explains it.

Sorry, your delusions of banks creating money from thin air are just that, delusions.

So let's hear one of these solutions. I'm still waiting.

 

Jekyll Island explains 3 instances in history where full reserve banking has occurred. In full reserve banking, the bank charges fees to depositors for holding their money and facilitating a payment system. It does not pay interest to depositors.

All revenue and thus expenses come from fees paid by depositors. Full reserve banks do not lend money out.

 

So where does the money that people can borrow come from? Or can't people borrow money in this world?

 

borrow money? If enough people go to the bank and withdraw their own money they deposited the banks would collapse!

 

Yes you can still borrow money, it is just that the lender has to lock it out to you for a set period, ie it isn't on call.

The real issue is not so much fractional reserve banking, but maturity transformation (fractional reserve banking being a form of maturity transformation). These are essential reading on this matter:

http://unqualified-reservations.blogspot.com/2008/09/maturity-transformation-considered.html
http://econlog.econlib.org/archives/2008/10/monetary_instit.html

"Maturity transformation might also be called monetary time travel. It is an accounting structure which permits a financial institution to pretend that it can teleport dinero from the future into the present. High-tech modern finance can do many cool things, but this is not one of them.

The price we pay for this illusion is a fundamental instability in the lending market. To most economists, this instability is a Diamond-Dybvig dual equilibrium. To Austrian economists, it's the Misesian theory of the business cycle. And in plain English, it's your common or garden bank run.

...

You may know maturity transformation as "fractional-reserve banking," which is one common case of the practice. A financial institution practices MT whenever it "borrows short and lends long," ie, promises to deliver money in the short term based on the fact that it is owed money in the long term. For example, in a classic fractional-reserve bank which takes checking deposits and uses them to fund mortgages, the bank's promises have a term of zero (your money is available whenever you want it), and its mortgages are repaid across, say, 30 years.

But few of us have operated a bank. I want to explain intuitively why maturity transformation is a basically corrupt practice"

 

full reserve banks can lend your money out if your account is a term deposit, that is, you agree that you will not draw it back out before a set period. funds in term deposits are a pool for loans in a full reserve system. the interest is not just fees, it's compensation for the money that you can't spend now, which is worth more, than the money when you get it repaid. and since also there is the issue of defaults on loans, there needs to be an actuarial percentage tacked on to cover those losses. as far as profits go, when you take out that virtual insurance premium, the interest paid to the term depositors, and the costs of maintaining the bank premises, security, paying the tellers and managers, the scope for profits is actually quite thin.

it's a misconception about business in general that it's all about profits. profits you take when you can get them, if people will borrow at the percentage that gives you 5% profit on the loan on top of the maintenance costs, you'd be doing pretty well but it's not that difficult to achieve. short term loans have higher rates of interest and somewhat higher rates of defaults, profits are all in seizing an unrecognised market segment before anyone else notices it.

and fractional reserve bankers really do make money out of thin air. you can word the description so it sounds otherwise but it's still a fraud, they hold 10% of the money and issue up to 10x as much in certificates of deposit. if everyone wants their money now, only 10% of these demands can be satisfied. if these accounts were on term deposits and you agreed to having to wait until some period later, that would be honest. that's how bank lending would work. muddling the simple savings account which you rightly should expect to pay for and the term deposit, which you rightly should expect to get paid for as you can't have the money right away, together, is a scam.

interest and fractional reserve banking are not intrinsically linked concepts at all. there really is a value to anyone to have the money now or save it for later. money now = more expensive. money later = cheaper. therefore he who gives the loan gets that differential, the getter of the loan pays it.

oh, one more point. with fiat currency, which has no contracted convertibility to a commodity, is able to have the supply very quickly expanded, in the deflation pattern it is no different however, it is possible with commodity money to lock a large amount of money out of a market quickly if a lot of people all at the same time save rather than spend. but this is an equilibrium because at the same time all that saving can go into term deposits and because of the larger pool of available funds for lending, the interest rates can be lowered. with inflating fiat currency, however, savings are worthless, they get diminished as the supply of money increases. lenders are also disadvantaged with inflation, the borrower effectively gets an inflation driven discount on their interest payments. of course banks can always up their interest rates to compensate for this but that would then drive demand for loans down.

the main thing though is that this hot money flooding into the market distorts the real profits on the books of a business. inflation, which diminishes value as time goes forward, makes a break even look like a profit that matches the inflation of the prices between the time of initial purchase of capital resources and the end point of the sale of the product to the consumer. so then when a bank looks at a company's books, it looks better than it really is, and thus they are more likely to grant a loan. this disjoint between true profit and inflationary fake profit causes what is known as 'malinvestment' which basically means that businesses expand production into areas which it would not expand them if inflation wasn't making it look like there was profit potential due to the underlying rise of prices that unevenly distributes in a marketplace.

 

My answer abolish banks......... many yrs ago people only bought things when they could afford it.

 

Yep, I understand what it is. Let's call the system you are talking about above "matching maturities", ie. if someone borrows the money for say a year, the person lending the money cannot access it for a year. Fair?

My issue is, how many people are going to put their money in the bank knowing that they can't access it for a year? Or far, far worse considering the average mortgage term.

I never said FRB is perfect. It's not. Far from it. But no human system is. Properly risk managed it works reasonably well in transferring capital around the economy. I guess the problem is that govt's push the system beyond it's limits.

But personally, I don't think matching maturities is practical. People need access to their money immediately to be able to spend it.

I'd welcome your response.

 

Incorrect. What they do is record who owes who what. You are confusing credit with money. Credit can circulate in the economy as if it is money but all it is transferring the debt that bank owes someone to someone else. If we all had term deposits, no-one would have access to much money at any one time. It's just impractical.

What you're not getting is the time factor of money. You are applying 2 Dimensional concepts to a 3 Dimensional world. That's why you think money is being created out of thin air, when in fact it's not. Bankers are middle men.

eg. imagine 3 people in the room and one $20 note.
A buys something from B for $20
B buys something from C for $20

$40 worth of goods have been sold, yet there is only physically $20 in existence. Fraud?

 

Also, sorry one more thing. A bank may not have the all the cash on hand, but it can sell it's debts to others to get cash if need be. This is in a world with a reasonable level of leverage of course, not in one with a gigantic housing bubble. I maintain that the manipulation of IR's and printing money and preventing the liquidation of malinvestments are the problem, not FRB.

 

Your better off explaining this as the money supply. M0, M1 are actual money supplies (currency notes). M2 are loans from the Fed to the operating banks. M3 are the credit balances that have been created into existence when people take out loans.

So in effect, when you borrow to buy a house, the M3 credit balance would have been created for the borrower. The borrower buys the house, the person selling now has 500k worth of credit in his bank account. Its perceived as good as money because that person can use a bank card and buy things with it, withdraw small sums in cash or settle other debts with this electronic balance.

By no means is M3 real hard currency, because if everyone withdrew their money there won't be enough M0/M1 notes to cover for it. Because these days no one deals with large amounts of cash, banks can get away shifting these IOU balances around.

The powers of fractional reserve banking allow this M3 scam to carry on, so the problems in the US are caused by the contraction of M3 (people paying down debts). Which means theres less IOU balances around, hence property prices need to fall to be in balance. Here in Australia this has not happened yet, it will soon as people are paying down debt and less people are taking out loans. This is what deflation means (nothing to do with price deflation). Deflation / Inflation is contraction / expansion in money supply. People mix it up with price-inflation/deflation. Inflation/deflation does effect price in the end, but takes time to filter down.

Hope this makes sense.

Slam

 

Ok quick question hawk......

I go to the bank and get a 10k loan to buy a car..... now when the bank gives me the 10k where do they get it from?

 

In a fractional reserve system, the 10k is written into the books of the bank as a liability. So they give you 10k credit on the spot into your bank account. The collateral for it will be the car (well its depreciating). Its created into existence by you signing the loan. At long as the bank has that 10k in reserves, because someone else has 11k as a deposit.

So basically a deposit of 11k, they take out 1k and loan out the other 10k. The seller of the car now deposits 10k into same or another bank. That bank can put 900 aside and loan out 9.1k to the next person that wants to buy something on credit.

Note, no currency is created in this process (no bank notes nothing). Just digital balances of IOU, ie. The bank owes you 10k credit because your balance says so, but you also owe the bank 10k now as a loan.

If your a freshman, depositing 1k cash into the bank account. The bank owes you 1k, you owe the bank nothing.

Hope this helps.

Slam

 

So Basically Slam techincally they have really created that 10k out of nothing eh? since that money isnt backed by anything other than their bullshit they serve to people on a daily basis?

 

Well yes, they have written into their books that you have 10k credit in your account. You can use this 10k of credit in the account to settle your debts and buy things with it. You can even withdraw it to cash, so its as good as money right?

At the end of the day its still only a balance in the banks books. You can say its created out of thin air (which it is, well electronically).

Say the banks go bust, all depositors will lose their balances on their accounts. They wouldn't have the currency notes to back every persons account, not to mention the notes themselves are worth jack all (just a piece of paper, where the majority of sheep thinks it has value).

This is the biggest scam on the planet, yet you try to explain it to people. They think your a religious nut. In this case, I would rather hold real assets then pieces of paper. I think one day soon, alot of sheep will wake up and rush to flee dollars.

Slam

 

Preaching to the converted here Slam.

Physical or nothing for my mind. I am absolutely aware of the scam and ponzi of the fiat system and whilst I lament it, I know the cognitive leap for many is simply too big a bridge to cross at the moment.

But whilst I can still convert my worthless paper into metal, I'm not going to complain.

 

So basically every loan that is made new credit is created and entering the money supply? That is why they call is fractional reserve hence they only need a fraction of deposits of the reserve amount they are loaning out but that amount can be anything from 2:1 - 100:1?

 

Yes, the (credit/money supply) is expanded and contracted as people take out loans and pay down debt. Over the years, people have taken out more loans then those that have paid it down. Hence expansion in money supply and the effects are increased price-inflation (ie. goods / services going up, home prices going up, food prices and oil prices going up).

The fractional reserve system runs off a reserve base of 1/10th or 1/11th (10% or 9%) I believe. So for every $100 they get in deposit, they can loan out $90. The person depositing the $90, now makes that bank able to loan out $81. So it continues. Now you see why $100 of base money is now suddenly $1000 of available money ($100 in fiat notes M0/M1, and $900 in M3 credit balances in accounts).

Slam

Edit: Now helicopter Ben is able to print $600 billion and buy up treasuries. This $600 Billion is M0/M1, they loan or purchase treasuries which converts to M2 to the government and other banks. This then ultimately ends up at M3 when it gets spent into the general economy. So 600 billion M0/M1 is really 6 Trillion M3 (if people are taking out loans).

But it seems people are not borrowing as much now in the US, so the M3 money (credit) supply is still shrinking (which is deflation).

Slam

 

Just noticed your sig quote Slam. That's an absolute pearler!