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Thread: So, fractional reserve banking.

  1. #31

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    Quote Originally Posted by Zippyjuan View Post
    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 iflation, it has to be circulating. That means people earning or borrowing and spending it. 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. 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.


    http://research.stlouisfed.org/fred2.../M2V?cid=32242
    Doesn't matter. Any money the fed loans to the bank is added to the monetary base. It doesn't necessarily lead to an increase in M2, much less it's velocity.

    But yes, throughout the past 20 years, the fed has kept interest rates low by lending the bands money. Hence the increase in the monetary base.



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  3. #32
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    Yes, it does matter as far as price inflation goes. You are right that it does't necessarily change M2 or the velocity. The market determines velocity- consumer activity. If a bank borrows money from the Fed and turns around and lends it out it will not effect the Base but if they kept it as reserves it would be added to the base. But unless their books were out of balance why would they borrow and keep it? Pay the fees and put up the collateral for the loan?

    Let's look at how much money the Fed has been lending to the banks over time. We can check that as well. That would be through the Discount Window. Other than the spike during the bailouts (AIG was a huge chunk of it), it has been pretty much zero so they haven't been lending tons of money to the banks over the past 20 years.
    http://research.stlouisfed.org/fred2/series/DISCBORR

    Last edited by Zippyjuan; 12-11-2012 at 11:29 PM.
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  4. #33
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    So lets go back to the original premise of low inflation the biggest reason for low interest rates. One simple chart will show us. The red line is the US inflation rate, the blue line is the interest rate the Fed sets. Nice how they all move together pretty well.


    http://wehrintheworld.blogspot.com/2...ince-1970.html

    Compare that also with mortgage rates chart and you see the exact same thing:


    http://inflation.us/charts.html
    Last edited by Zippyjuan; 12-11-2012 at 11:30 PM.
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  5. #34

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    Quote Originally Posted by Zippyjuan View Post
    So lets go back to the original premise of low inflation the biggest reason for low interest rates. One simple chart will show us. The red line is the US inflation rate, the blue line is the interest rate the Fed sets. Nice how they all move together pretty well.


    http://wehrintheworld.blogspot.com/2...ince-1970.html

    Compare that also with mortgage rates chart and you see the exact same thing:


    http://inflation.us/charts.html
    In some industries where bubbles end up becoming formed, prices rose WAY faster than the CPI. The CPI did a piss poor job of detecting that and the low interest rates allowed the bubble to grow much bigger than they would have under a free market monetary system. Those interest rates were far from natural.
    Last edited by Bohner; 12-12-2012 at 12:22 AM.

  6. #35
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    Quote Originally Posted by Bohner View Post
    In some industries where bubbles end up becoming formed, prices rose WAY faster than the CPI. The CPI did a piss poor job of detecting that and the low interest rates allowed the bubble to grow much bigger than they would have under a free market monetary system. Those interest rates were far from natural.
    There are always some prices rising faster or slower than others or the CPI. The CPI measures prices- it does not predict them. It weighs the prices based on what percent of they average person's income gets spent on that item. If the average person spends 10% of their income on food, changes in the prices of food count as ten percent of the total CPI figure.

    Bubbles constantly form and pop- some quietly, some with a bang. That says nothing about if interest rates were "natural" or not. If they are not "natural" what should interest rates be and why?
    I am Zippy and I approve of this message. But you don't have to.

  7. #36

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    Quote Originally Posted by georgiaboy View Post
    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.
    They're both correct in a sense.

    Because that $90 can potentially get into the banking system and then that bank can lend out 90% of that etc

    If you keep going it adds up to a total amount of $1000 in the M1 money supply out of the $100 base money.

  8. #37

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    Quote Originally Posted by Zippyjuan View Post
    There are always some prices rising faster or slower than others or the CPI. The CPI measures prices- it does not predict them. It weighs the prices based on what percent of they average person's income gets spent on that item. If the average person spends 10% of their income on food, changes in the prices of food count as ten percent of the total CPI figure.

    Bubbles constantly form and pop- some quietly, some with a bang. That says nothing about if interest rates were "natural" or not. If they are not "natural" what should interest rates be and why?
    I kind of agree with this guy on the issue...


  9. #38

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    Quote Originally Posted by Zippyjuan View Post
    So lets go back to the original premise of low inflation the biggest reason for low interest rates. One simple chart will show us. The red line is the US inflation rate, the blue line is the interest rate the Fed sets. Nice how they all move together pretty well.


    http://wehrintheworld.blogspot.com/2...ince-1970.html

    Compare that also with mortgage rates chart and you see the exact same thing:


    http://inflation.us/charts.html
    Or you can look at the real inflation rate. When new money enters the system through the purchasing of debt, of course rates will go lower(at least for a time).


  10. #39

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    A Mandrake headache is 9 times worse than a migraine headache.

    http://www.freerepublic.com/focus/f-news/888963/posts

  11. #40

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    Quote Originally Posted by Zippyjuan View Post
    There are always some prices rising faster or slower than others or the CPI. The CPI measures prices- it does not predict them. It weighs the prices based on what percent of they average person's income gets spent on that item. If the average person spends 10% of their income on food, changes in the prices of food count as ten percent of the total CPI figure. ...
    Are you suggesting the CPI is not manipulated for political (or centrally planned economic) reasons?

    ...
    In a letter sent to the White House, Republican leaders outlined a plan that they said would provide $2.2 trillion in deficit reduction over the next decade. On top of the $800 billion in new revenue from a tax code overhaul, Republicans estimated they could save $300 billion by cutting discretionary spending, $600 billion in "health savings," $200 billion in changes to the consumer price index and another $300 billion in mandatory spending.
    ...
    http://news.yahoo.com/blogs/ticket/h...-election.html
    I compiled a "brief" history of events since October 2008 that are defining the global currency war and the role that gold is playing:

    Tin Foil Hats, Economic Reality and the Total Perspective Vortex

    Also, have you contacted your Congressional Rep and asked them co-sponsor Ron Paul's Rep. Paul Broun Jr.'s HR 1098 77: Free Competition in Currencies Act?

  12. #41

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    Quote Originally Posted by Zippyjuan View Post
    Yes, it does matter as far as price inflation goes. You are right that it does't necessarily change M2 or the velocity. The market determines velocity- consumer activity. If a bank borrows money from the Fed and turns around and lends it out it will not effect the Base but if they kept it as reserves it would be added to the base. But unless their books were out of balance why would they borrow and keep it? Pay the fees and put up the collateral for the loan?

    Let's look at how much money the Fed has been lending to the banks over time. We can check that as well. That would be through the Discount Window. Other than the spike during the bailouts (AIG was a huge chunk of it), it has been pretty much zero so they haven't been lending tons of money to the banks over the past 20 years.
    http://research.stlouisfed.org/fred2/series/DISCBORR

    Wait--I thought the Gov't said there is NO inflation. Nuff said

  13. #42

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    Quote Originally Posted by Zippyjuan View Post
    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.
    The banking system is like a pyramid. The Fed is at the top. The primary dealers are below them...the big money banks below them and everybody else at the bottom.

    The primary distribution source of new Fed money to cover bank loans/reserves is not really from the discount window but from the open market (and now our messed up bailout system).

    So say small town bank X is starved for reserves...it bids up the price for reserves from the big banks and gets what it needs. The big banks in turn look to replenish their reserves by borrowing from each other and the primary dealers. This bids up the money market upstream and then the primary dealers look to replenish their reserves. So they borrow from each other...or sell assets to the Fed.

    In this fashion it is clear how small town 'Mom and Pop' banks can and CONSTANTLY borrow indirectly from the Federal Reserve. In fact without this constant borrowing the banking system would collapse because it has and always will overbook deposits for reserves.

  14. #43

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    Quote Originally Posted by Zippyjuan View Post
    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.
    Why can't an IOU be money? If I pay my groceries with a corporate bond and the grocer uses that to buy a car and the car dealer uses that to buy a vacation....wasn't that IOU money?

  15. #44

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    On the topic of what is the monetary base...that is pretty easy. It is the supply of money that government directly created. Coins, dollar bills, electronic dollars (confusingly conflated with terms such as reserves or federal reserve credit) are all included in MB. It is absolutely a measure of the money supply, albeit a narrow one because it doesn't include non-government sources of money. We exchange gold for services, bank deposits, savings deposits and more for what we want... That is why higher monetary aggregates that include deposits are more accurate in determining the supply of money to the economy and therefore its affect on inflation.

    Now the supply of MB is still very important because the banks can only use government money to meet reserve requirements and withdrawals which makes them somewhat unique. The supply of MB helps determine how much banks can in turn leverage that to multiply their own bank deposits (non-government money). A high ratio between M2 and MB may mean we're on the verge of a collapse. A low ratio may mean we're on the verge of hyper-inflation as banks will surely multiple MB to the max once possible.

    On the subject of the money multiplier...this is a very important idea that needs to be understood to knowing how banks work, create money and create inflation/bankruns/bailouts. However in a modern economy, things are done in a slightly different fashion (although still fraudulent and they still multiply the money supply).

    A modern bank (and they've done studies on this) is not really constrained with lending by its reserves...nor it is overly in danger by withdrawals. This is because banks have what is called the money market which is an effective cartel. If I want to loan you 100 million and I think you'll pay it back...I make the loan as the loan officer. The asset manager will then borrow that 100 from money center banks. But wait...what if the money center banks don't have that money? They always will! That is because the money center banks borrow from the Primary Dealers and the Primary dealers 'borrow' (or sell assets) to the Fed to get WHATEVER reserves they need. In fact the whole system is on auto-pilot so banks in effect determine the supply of MB...the tail wags the dog.

    Perhaps a modern multiplier example would look like this.

    Bank A incorporates with $1,000 equity and $1,000 cash.
    Customer A wants and gets a $10,000 deposit in exchange for a $10,000 loan.
    Customer A writes a check for $10,000 to Vendor X who deposits at Bank B
    Bank A borrows $9,000 from Bank B through the money market to meet its withdrawal
    Bank A ends up with 10k in loan assets and 9k in loan liabilities and 1k in equity
    Bank B ends up with +10k in deposits and +1k reserves and +9k in loan assets

    In this fashion you can clearly see how 1k of money create 10X without the steps illustrated by most econ 101 texts with the money multiplier. But wait...how did Bank A's withdrawal clear if they didn't have they money. Well ultimately Bank B financed it (or any other indirect banking agent thought the money market). But more immediately this apparent contradiction was made possible by Fed float and lax clearing rules. But this is not significant. Even if the Fed played had very strict requirements, the banks could use a small percentage of equity to grease the distribution of reserves and loans to each other. That or the bank temporarily converts the deposits to near deposits and then back again. Either way they multiply the money supply with impunity and efficiency.

    So if the banks max on the reserve ratios...they can still create deposits...they just borrow the money from the fed (mostly indirectly) to get the reserves they need.

    To understand the banking system you have to imagine it has one entity...that takes in all MB and creates say 5X of M2. The money market is the circulatory system that distributes the MB throughout the body to the various organs. And the Fed is the intravenous drip. When the banks stop lending to each other because of credit concerns...then body gets quite sick...and the Fed tries to inject more fluid into the body.

    One last note...while the conventional money multiplier considers really demand deposits (M1) and base money (MB) this is not an accurate picture of the economy because many of the deposits held by businesses and the wealthy are 'near-deposits'. They yield a small percentage of interest and/or have slight time restrictions on their withdrawals. Banks also play games by shuffling what should be demand deposit into near-deposits to skirt reserve requirements...truly one has to look at the higher aggregate to understand the banking system as a whole.

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