# Thread: So, fractional reserve banking.

1. ## So, fractional reserve banking.

I recently heard JEGriffin mention that fractional reserve banking works this way:

Assuming 10% reserves required by banks: I deposit \$100, so the bank can now lend out up \$900

I remember thinking myself that 10% reserves meant that if I deposited \$100, the bank could loan up to \$90 of that \$100, leaving \$10 reserves.

To me these are very different, the first example being inflationary, the second one not (I think).

Which one is correct? I figure JEG is correct, but just thought I'd ask.

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3. Originally Posted by georgiaboy
I recently heard JEGriffin mention that fractional reserve banking works this way:

Assuming 10% reserves required by banks: I deposit \$100, so the bank can now lend out up \$900

Actually, you were correct later when you said that they can lend out \$90. However, it is assumed whatever they lend becomes someone else's deposit. So, that \$90 becomes a deposit at another bank. That bank can now lend out \$81. That \$81 is now deposited someplace, and 90% of that \$81 becomes another corresponding deposit and loan. Rinse and repeat.

4. Exponents come to mind.

Mind-blowing exponents.

The bummer is in the unwinding, I'm told.

5. Originally Posted by MoneyWhereMyMouthIs2
Actually, you were correct later when you said that they can lend out \$90. However, it is assumed whatever they lend becomes someone else's deposit. So, that \$90 becomes a deposit at another bank. That bank can now lend out \$81. That \$81 is now deposited someplace, and 90% of that \$81 becomes another corresponding deposit and loan. Rinse and repeat.
Ah! Yep, and it eventually addes up to JEG's original statement. So the mechanism is as you and I stated, and the end result is JEG's.

Thx.

Now that I know, I wish I didn't know. :/

6. GOLD and SILVER.

The coming GLOBAL sized bank run will not effect me nearly as much.

Originally Posted by georgiaboy
Ah! Yep, and it eventually addes up to JEG's original statement. So the mechanism is as you and I stated, and the end result is JEG's.

Thx.

Now that I know, I wish I didn't know. :/

7. Originally Posted by georgiaboy
Ah! Yep, and it eventually addes up to JEG's original statement. So the mechanism is as you and I stated, and the end result is JEG's.

Thx.

Now that I know, I wish I didn't know.
Yes... he might have said "banks can lend out..." Usually, when people are talking about this they just call it an expansion of the money supply.

This page has a description of the equation. Search the page for "money multiplier."

http://www.cliffsnotes.com/study_gui...leId-9747.html

money multiplier = 1 / reserve requirement.

8. Originally Posted by georgiaboy
Ah! Yep, and it eventually addes up to JEG's original statement. So the mechanism is as you and I stated, and the end result is JEG's.

Thx.

Now that I know, I wish I didn't know. :/
you wish you were ignorant?

9. Originally Posted by Tpoints
you wish you were ignorant?

Ignorance is bliss. It's not an old saying for no reason.

10. Interestingly, there have been recent, high-profile calls for ending fractional reserve banking (from England).

11. Originally Posted by MoneyWhereMyMouthIs2
Actually, you were correct later when you said that they can lend out \$90. However, it is assumed whatever they lend becomes someone else's deposit. So, that \$90 becomes a deposit at another bank. That bank can now lend out \$81. That \$81 is now deposited someplace, and 90% of that \$81 becomes another corresponding deposit and loan. Rinse and repeat.
But if I take out my deposit, the bank has to try to recall the loan made based on my deposit or attract a new deposit.

Let's do a short run sample.

I have \$100. I deposit it in a bank with a 10% reserve requirement. That means they can lent out \$90. I have zero dollars, the bank has \$10 and the customer has \$90.

That person does not spend the money but deposits it back into the bank. The bank now has \$100. From that second deposit, they can lend out \$81. The bank now has \$19 and I have zero, the first borrower has zero and the second borrower has \$81.

He doesn't spend it and puts it back into the bank. An \$81 deposit so they can loan out \$72.90. The bank has \$27.10 in cash I and the first borrower have zero. The total money is still \$100. What is growing is the amount owed to people.

Let's make it personal. I have \$20. Bill wants to borrow \$20 so I give it to him. Now he owes me \$20. Charles needs money and runs into Bill. Bill lends him \$10. I have zero, Bill has \$10 (but owes me \$20) and Charles has \$10 and owes Bill \$10. How much money was actually created? Is there more than the \$20 out there circulating? Is it \$20 or is it \$50?

12. Originally Posted by Zippyjuan
But if I take out my deposit, the bank has to try to recall the loan made based on my deposit or attract a new deposit.

Let's do a short run sample.

I have \$100. I deposit it in a bank with a 10% reserve requirement. That means they can lent out \$90. I have zero dollars, the bank has \$10 and the customer has \$90.

That person does not spend the money but deposits it back into the bank. The bank now has \$100. From that second deposit, they can lend out \$81. The bank now has \$19 and I have zero, the first borrower has zero and the second borrower has \$81.

He doesn't spend it and puts it back into the bank. An \$81 deposit so they can loan out \$72.90. The bank has \$27.10 in cash I and the first borrower have zero. The total money is still \$100. What is growing is the amount owed to people.

Let's make it personal. I have \$20. Bill wants to borrow \$20 so I give it to him. Now he owes me \$20. Charles needs money and runs into Bill. Bill lends him \$10. I have zero, Bill has \$10 (but owes me \$20) and Charles has \$10 and owes Bill \$10. How much money was actually created? Is there more than the \$20 out there circulating? Is it \$20 or is it \$50?
The bank is creating the "appearance" of wealth and people believe they have a claim (which they do) to their money. So in the example you gave, if the same day the 3 people come calling for their money (me for my \$100, the next person for their \$90 and the next person for their \$81) the bank would have to hand out \$271 even though they only have reserves totaling \$100.

Sure, if the ponzi scheme keeps going and you can find infinite victims to loan money you dont really have out to, then we keep chugging along, the point is, because of the debt based scheme you have created - at some point there is not enough money to pay the debt and then the bank forecloses on individuals, taking from them the property they put up as collateral for money the bank never had in the first place.

13. Originally Posted by CT4Liberty
The bank is creating the "appearance" of wealth and people believe they have a claim (which they do) to their money. So in the example you gave, if the same day the 3 people come calling for their money (me for my \$100, the next person for their \$90 and the next person for their \$71) the bank would have to hand out \$261 even though they only have reserves totaling \$100.

Sure, if the ponzi scheme keeps going and you can find infinite victims to loan money you dont really have out to, then we keep chugging along, the point is, because of the debt based scheme you have created - at some point there is not enough money to pay the debt and then the bank forecloses on individuals, taking from them the property they put up as collateral for money the bank never had in the first place.
Ummm.... They DID have that money.

14. Originally Posted by Bohner
Ummm.... They DID have that money.
They only have the amount that the original depositor put in... again, 1 person puts money in (\$100), 2 people take loans (\$90 and \$81). If those 2 put that money back in the bank, they now have 3 accounts totaling \$271... yet I am the only person who put money in and it was only \$100...

The point is, that when a bank takes my deposit in a checking account, I have a claim to that money whenever I want it...therefore, lending it out creates more money into the supply.

15. Originally Posted by CT4Liberty
They only have the amount that the original depositor put in... again, 1 person puts money in (\$100), 2 people take loans (\$90 and \$81). If those 2 put that money back in the bank, they now have 3 accounts totaling \$271... yet I am the only person who put money in and it was only \$100...

The point is, that when a bank takes my deposit in a checking account, I have a claim to that money whenever I want it...therefore, lending it out creates more money into the supply.
Lets look back at my example. After all the loans and deposits how much is out being spent? \$72.90 of the original \$100 I gave them (the bank is holding the rest). If I want to get my money back, they have to borrow that \$100 from somebody else to get their deposits back to matching their outstanding loans. Paying me my \$100 back puts money into circulation but them borrowing another \$100 from somebody else to replace my deposit reduces money circulating by the exact same amount so the net effect is zero. The account is really an IOU- not actual money.

16. Bank credit is money only until it isn't. /learn history

17. Originally Posted by Zippyjuan
Lets look back at my example. After all the loans and deposits how much is out being spent? \$72.90 of the original \$100 I gave them (the bank is holding the rest). If I want to get my money back, they have to borrow that \$100 from somebody else to get their deposits back to matching their outstanding loans. Paying me my \$100 back puts money into circulation but them borrowing another \$100 from somebody else to replace my deposit reduces money circulating by the exact same amount so the net effect is zero. The account is really an IOU- not actual money.
I am not expert on the banking system, but I believe the bank simply gets a loan from the fed with the loan as collateral, so all parties in fact do have accessible cash. How else can you explain the ever expanding credit over the last 4 decades?

I know there are certain deposits that require no reserves, which is one reason credit continues to grow, but I do not believe it is the sole or even main reason.

18. Fed loans are typically over-night and that is not used very often. A bank can try to attract new deposits (which takes time) or they can also try to borrow from another bank which has excess reserves to support their outstanding loans.

19. Originally Posted by Zippyjuan
Fed loans are typically over-night and that is not used very often. A bank can try to attract new deposits (which takes time) or they can also try to borrow from another bank which has excess reserves to support their outstanding loans.
How do you explain such growth in credit then as monetary base remained relatively flat(pre 2008)?

20. Originally Posted by Zippyjuan
Fed loans are typically over-night and that is not used very often. A bank can try to attract new deposits (which takes time) or they can also try to borrow from another bank which has excess reserves to support their outstanding loans.
Not true... No way could the banks have kept interest rates so low for so long (since the early 90's, through 2 recessions, and while household debt was rising to an all time high) without borrowing a significant amount of funds from the fed.

21. Originally Posted by Bohner
Not true... No way could the banks have kept interest rates so low for so long (since the early 90's, through 2 recessions, and while household debt was rising to an all time high) without borrowing a significant amount of funds from the fed.
Low inflation. There are basically three things which go into determining an interest rate. First is the desired rate of return the lender wants. They add on to that the expected rate of inflation during the time of the loan (so that the return is real- after inflation) and a premium based on the riskyness of the borrower (more likely to pay back the loan- lower premium). If the future inflation rate is uncertain, that adds the same as a higher rate of inflation would. Demand for money is factored in as well- if people aren't borrowing you may have to lower your rates to attract more customers. Inflation has been low so that has allowed interest rates to stay low.

We can kinda thank China for that- in two ways. First, all the cheap junk they sell us kept the price inflation rate low. Second, their demand for US Treasuries kept the prices for them higher and longer term interest rates (like those for mortgages) lower (Treasury note prices move inversely to the interest rates- higher prices due to higher demand means lower rates- and long term loans like mortgages tend to track longer term Treasury notes- mostly the fifteen year ones).

22. Originally Posted by cubical
How do you explain such growth in credit then as monetary base remained relatively flat(pre 2008)?
What is in the monetary base? The monetary base is the amount of cash in the system combined with the amount of excess reserves banks keep with the Federal Reserve. If they aren't keeping lots of excess reserves (like they are now), the monetary base is lower. They currently have about \$2 trillion in excess reserves. That is money not getting lent out. If they are making loans (such as during the housing bubble), they have fewer excess reserves and the monetary base is lower.

The Adjusted Monetary Base is the sum of currency (including coin) in circulation outside Federal Reserve Banks and the U.S. Treasury, plus deposits held by depository institutions at Federal Reserve Banks. These data are adjusted for the effects of changes in statutory reserve requirements on the quantity of base money held by depositories
http://research.stlouisfed.org/fred2/series/BASE/

23. Originally Posted by Zippyjuan
What is in the monetary base? The monetary base is the amount of cash in the system combined with the amount of excess reserves banks keep with the Federal Reserve. If they aren't keeping lots of excess reserves (like they are now), the monetary base is lower. They currently have about \$2 trillion in excess reserves. That is money not getting lent out. If they are making loans (such as during the housing bubble), they have fewer excess reserves and the monetary base is lower.
Total credit is over 50 trillion.

Now look at how little the monetary base has grown(up till 08) relative to credit.

If spending was really only limited to the monetary base, as you explain in your example, I find it hard to believe 50 trillion could exist in credit.

24. Originally Posted by TomtheTinker
This is what I was speaking to about the banks getting the fed to cover any cash requests, as long as they had the loan as collateral on their books as one of their assets.

But it does not explain why 50 trillion in credit can exist on top of a 800 billion in monetary base. If the 9x rule was followed, it would mean total credit should peak at 7.2 trillion, but this is not even close. This could only happen if, in this example, the original 10 billion was withdrawn at the bank, and deposited elsewhere, creating a new 9x money creation. Or something along those lines.

25. The base is not a measure of bank deposits or lending potential- only excess deposits they chose not to lend out. It is also not a measure of money supply. The more they lend out (from those excess reserves), the smaller the monetary base gets because that lowers their excess reserves.

26. Originally Posted by Zippyjuan
The base is not a measure of bank deposits or lending potential- only excess deposits they chose not to lend out. It is also not a measure of money supply. The more they lend out (from those excess reserves), the smaller the monetary base gets because that lowers their excess reserves.
Required reserves also count towards monetary base.

27. Correct. But the monetary base still does not necessarily reflect the amount of money available to the bank to lend out. They can also keep reserves in their own facilities to meet reserve requirements or to park excess reserves.

http://www.federalreserve.gov/moneta...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.

Beginning October 2008, the Federal Reserve Banks will pay interest on required reserve balances and excess balances.

28. Originally Posted by Zippyjuan
Correct. But the monetary base still does not necessarily reflect the amount of money available to the bank to lend out. They can also keep reserves in their own facilities to meet reserve requirements or to park excess reserves.
Are you saying the reserves in their own facilities are not part of the monetary base? That does not see right. Monetary base from Wiki:

Notes and coins (currency) in circulation (outside Federal Reserve Banks, and the vaults of depository institutions), Notes and coins (currency) in bank vaults, Federal Reserve Bank credit (minimum reserves and excess reserves)

So money held in vaults outside of the Fed still counts towards MB.

Imagine if the entire monetary base was require reserves(which isn't the case). The total credit outstanding would be 7.2 trillion(in 2008). Where does the extra 40+ tillion come from.

29. Originally Posted by Zippyjuan
Low inflation. There are basically three things which go into determining an interest rate. First is the desired rate of return the lender wants. They add on to that the expected rate of inflation during the time of the loan (so that the return is real- after inflation) and a premium based on the riskyness of the borrower (more likely to pay back the loan- lower premium). If the future inflation rate is uncertain, that adds the same as a higher rate of inflation would. Demand for money is factored in as well- if people aren't borrowing you may have to lower your rates to attract more customers. Inflation has been low so that has allowed interest rates to stay low.

We can kinda thank China for that- in two ways. First, all the cheap junk they sell us kept the price inflation rate low. Second, their demand for US Treasuries kept the prices for them higher and longer term interest rates (like those for mortgages) lower (Treasury note prices move inversely to the interest rates- higher prices due to higher demand means lower rates- and long term loans like mortgages tend to track longer term Treasury notes- mostly the fifteen year ones).
Again... Not possible. Especially for interest rates to remain low during recessions without printing money like crazy.

This pretty much sums it up.

30. Sums what up? The monetary base is not a measure of the money supply- if that is what you want to look at, M2 is the most commonly used measure. And for all the money the Fed has tried to put out there to cause price inflation, it has to be circulating. That means people earning or borrowing and spending it on goods and services. Prices rising becasue people are using more dollars to try to purchase goods. The POTENTIAL is out there due to the various Quantative Easing the Fed has done but it is not getting lent out and spent so far. That is known as velocity- and that is way down. It is also sometimes known as a money multiplier. If velocity picks up, prices likely will as well and as prices rise, interest rates will rise as well (that iflation portion of interest rates I mentioned earlier). The faster money moves through the system or the more often it changes hands, the greater the pressure on price inflation.
Velocity is a ratio of nominal GDP to a measure of the money supply. It can be thought of as the rate of turnover in the money supply--that is, the number of times one dollar is used to purchase final goods and services included in GDP.
http://research.stlouisfed.org/fred2.../M2V?cid=32242

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