Fractional reserve lending - do banks create money out of thin air?

[rpwi]

the real multiplier is actually smaller than 1. ... That's really amazing. For the last 2-3 years if the Fed increased M0 by X, the amount of money in circulation (M1) increased by less than X.

Your understanding of classical FRB is still quite correct...it just has to be plugged into a modern context.

The first consideration is that M1 is not defined in a useful manner because it excludes a lot of reserves (base money). So while one thinks of MB>M1>M2>M3...as a natural pyramid...it is not unfortunately.

Now how can this happen...how can MB held by banks not count toward M1? Shouldn't all reserves assets held at a bank have a corresponding demand deposit liability? Well no, because reserves can be matched against bank equity or against near-demand-deposits or even longer term liabilities.

So for example a bank could have say 10million in reserves + 90million in savings accounts matched against 100 million in debt. No demand deposits...so things look rosey, right? Of course not...the bank is still gambling as bad as ever and if/when a liquidity fire breaks out they are in trouble. Near-demand deposits are little different than demand deposits. Just slightly different interest rates and maturity times. Both types of deposits can overbook reserves and play their pyramid games.

In fact, in many ways our economic 'experts' have shifted away from measuring M1 and more so to M2 because M2 is so darn similar to M1. But when you look at the ratio of M2 to MB...now that is positive and a better (but not complete) gauge of what the banks are up to.

Now there are many specific reasons that explain why M1 can dive while MB can climb.

* Sweeps accounts (reserve requirement fraud...which banks make M1 look like M2 to avoid regulations)

* The Fed pays banks not to gamble some of money (big since 2008 and outrageous)

* Economy has more rich people or businesses have more money. Average Joes uses a demand deposit...businesses and rich guys will use interest bearing short term deposits. So this can be a sign the rich are getting richer.

* Basically, M1 gets promoted to M2 and it makes it look like M1 just vanished when it didn't.

* The money market is not functioning...this happened during 2008 with our liquidity fire and still hasn't restarted (it shouldn't naturally because it is based on fraud..so the fed is trying to artificially start it by dumping tons of reserves into the banking system).

* Banks being risk averse during tough times (which with all the new base money we have can mean hyper-inflation when they do start lending again...aka buying loans with counterfeit money).

Advanced FRB can kind of be summed up as mismatching shorter term liabilities against longer term assets. This is inherently unstable because there are always more short term promises than short term assets...and the financiers just have to hope that the short term promises never get redeemed or can be converted into long term promises. The government makes this fraud possible by adding more short term promises to the system in exchange for long term promises, to ensure that all short term promises can be kept.

Another modern consideration to consider is the role of the Fed's 'open market' and indirect lending from it. Banks don't have to lend in increments to achieve the full multiplier...they've studied this and banks just make whatever loans the loan officer feels are good. Then they achieve financing after-the-fact. Much of it comes indirectly from the Fed as demanded which is absurd. So take the classical multiplier model, and insert the banker has the indirect controller of the size of the monetary base and the ability to re-max new based instantaneously.

[truelies]

..............................Personally I'd have no problem with fractional reserve banking in a free banking environment. As long as everyone is aware of it. By depositing money in a fractional reserve bank you basically agree to not get all your money back in the case of a bankrun.

.............................................

it would still be fraud to NOT have a demand deposit available for immediate redemption. A 1 pt type disclaimer on page 57 of a 'contract' does not change that.

[rpwi]

it would still be fraud to NOT have a demand deposit available for immediate redemption. A 1 pt type disclaimer on page 57 of a 'contract' does not change that.

Correct. I don't understand the "free banking" argument. It is akin to arguing that the cure for counterfeiting is to legalize counterfeiting.

[hazek]

Technically speaking it does not create money out of thin air although the way it leaves people perceive their money FRB has the effect as if it did create money out of thin air. And I think it's debatable why that is, I'd argue because people just don't bother to thoroughly read the contracts they signed with a bank since they know banks are FDIC insured and they don't care what happens with their money or the bank.

[cbc58]

Technically speaking it does not create money out of thin air although the way it leaves people perceive their money FRB has the effect as if it did create money out of thin air. And I think it's debatable why that is, I'd argue because people just don't bother to thoroughly read the contracts they signed with a bank since they know banks are FDIC insured and they don't care what happens with their money or the bank.

not sure if you are talking about the fed or banks, but if the banks are creating upto 9x the amount of debt from one deposit, then to me that's creating money out of thin air. wonder if credit unions can do the same thing. you are right that most people don't care - and that is a huge problem because it impacts their daily lives and they don't even know it. i guarantee you that 95% of the population doesn't understand that they don't have money in the bank even though their statement says they do - it's belongs to the bank and all you have is a promise to pay it back - if able. think that's right.

[rpwi]

wonder if credit unions can do the same thing.

Yes...credit unions also practice FRB...they're nothing more than not-for profit banks...in which profits are rolled back into lower interest rates. So they're bad too.

[hazek]

not sure if you are talking about the fed or banks, but if the banks are creating upto 9x the amount of debt from one deposit, then to me that's creating money out of thin air. wonder if credit unions can do the same thing. you are right that most people don't care - and that is a huge problem because it impacts their daily lives and they don't even know it. i guarantee you that 95% of the population doesn't understand that they don't have money in the bank even though their statement says they do - it's belongs to the bank and all you have is a promise to pay it back - if able. think that's right.

No, technically speaking they are not creating money.

On their balance sheet they are taking deposits and loaning a portion of it out while still offering demand deposits. As long as this isn't hidden from their depositors (and it isn't, read your contract with your bank) then there's no fraud and certainly no creation of money. But because these are demand deposits and because banks are FDIC insured and because they have a lender of last resort people don't read and understand their contracts with their banks and they don't know that their demand deposit is levered up to who knows how much so they ignorantly act in the market place as if there is more money when in fact all there is is loans being reloaned that are being reloaned that are being reloaned ect..

[Zippyjuan]

P.S. Believe nothing from ZippyJuan. He has been discredited numerous times.

Can you demonstrate what is incorrect in what I said? Thanks.

[cbc58]

No, technically speaking they are not creating money.

On their balance sheet they are taking deposits and loaning a portion of it out while still offering demand deposits. As long as this isn't hidden from their depositors (and it isn't, read your contract with your bank) then there's no fraud and certainly no creation of money. But because these are demand deposits and because banks are FDIC insured and because they have a lender of last resort people don't read and understand their contracts with their banks and they don't know that their demand deposit is levered up to who knows how much so they ignorantly act in the market place as if there is more money when in fact all there is is loans being reloaned that are being reloaned that are being reloaned ect..

I understand what you are saying "technically speaking" - but they are creating debt which is the basis for money creation so therefore they are creating money - but not technically speaking. What a racket.

[Tpoints]

But that 90$ can be deposited again, and from that 81$ can be lent out again, and so on.

yes, so at the end of the day, there may be close to $900 in circulation. But that's FAR less than somebody saying one $100 is deposited, they're allowed to lend out $900, because that means the next deposit will allow said bank to lend out $8100, where would that stop?