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

1. Originally Posted by Tpoints
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?
Doesn't work like that. If \$100 is deposited, using the mathematical constant e, the most can be loaned out through constantly cycling the money is about \$900. that is where is stops. Each time the principle, and the amount that can be loaned out, shrinks.

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3. this has already been discussed and clarified early on in this thread...

4. Originally Posted by UWDude
Doesn't work like that. If \$100 is deposited, using the mathematical constant e, the most can be loaned out through constantly cycling the money is about \$900. that is where is stops. Each time the principle, and the amount that can be loaned out, shrinks.
that's what I said, isn't it? I specifically said the other part was false and ridiculous.

5. Originally Posted by hazek
No, technically speaking they are not creating money.
Technically a counterfeiter isn't creating dollars bills...but rather mere look-alikes. The concept is similar with FRB. Sure the bank isn't creating base money (like actual dollar bills) but they are conflating base money with deposit money and there-in lies the problem.

On their balance sheet they are taking deposits and loaning a portion of it out while still offering demand deposits.
Deposits don't create loans in FRB...both the deposit and the bank loan establish each other but neither is a sole cause of the other. What the bank in essence is doing is mismatching a short term liability for a long term asset both of whom are held by external parties. The problem is that their short term liabilities (deposits) aren't real liabilities at all...I mean who would invest in a 0% checking account if it were an investment? Instead these liabilities are conflated with as base money and there-in lies the problem. There are more short term promises in the economy than can be met, because these short term promises are balanced by long term promises...which can't work...and instability/fraud is the natural byproduct.

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
There is no need to hide how FRB works because people don't understand it. That doesn't mean it is not fraudulent.

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..
If government pulled support from the FDIC (and presumably) the open market, the banking system would crash and depositors and not banks would really be hurt. We need to end FRB, but probably in a more stable way.

6. Originally Posted by UWDude
Doesn't work like that. If \$100 is deposited, using the mathematical constant e, the most can be loaned out through constantly cycling the money is about \$900. that is where is stops. Each time the principle, and the amount that can be loaned out, shrinks.
The multiple assumes that all of the money is left in the bank as each person borrows more money. As soon as anybody decides to take out their money, it stops. All the "extra" money is only on the books at the bank- not out being spent on anything.

7. Originally Posted by Zippyjuan
The multiple assumes that all of the money is left in the bank as each person borrows more money. As soon as anybody decides to take out their money, it stops. All the "extra" money is only on the books at the bank- not out being spent on anything.
It is too being spent. It is being spent by the borrower, and then being deposited by the seller back into the seller's bank.

And do you not understand that the money is not created for one bank, but for the banking system as a whole? Seems like you are talking about it as if this is only a one-bank system.

Either way, there is a drain that makes this little racket fraudulent: interest. Book or no book, You deposit \$100, eventually the banking system will loan out \$900, and charge interest on it.

Furthermore, at the highest level, there are no more reserve tables anymore. Banks can loan out as much as they want, regardless of the reserves. This was changed first to 1/30th, than anything in 2008.

Get out some monopoly money and try it amongst three people. Don't forget the interest.

8. Originally Posted by UWDude
It is too being spent. It is being spent by the borrower, and then being deposited by the seller back into the seller's bank.

And do you not understand that the money is not created for one bank, but for the banking system as a whole? Seems like you are talking about it as if this is only a one-bank system.

Either way, there is a drain that makes this little racket fraudulent: interest. Book or no book, You deposit \$100, eventually the banking system will loan out \$900, and charge interest on it.

Furthermore, at the highest level, there are no more reserve tables anymore. Banks can loan out as much as they want, regardless of the reserves. This was changed first to 1/30th, than anything in 2008.
that doesn't explain why so many companies and houses went bankrupt. who benefitted from that? Banks?

9. Originally Posted by Tpoints
that doesn't explain why so many companies and houses went bankrupt. who benefitted from that? Banks?
Wow, that is quite a leap of topics, dude. Yes, banks benefited, but I don;t have the energy to get into CDS, CDO's, and the TARP bailouts.

10. Originally Posted by UWDude
Wow, that is quite a leap of topics, dude. Yes, banks benefited, but I don;t have the energy to get into CDS, CDO's, and the TARP bailouts.
banks benefitted by seizing and foreclosing on assets they can't sell?

11. Originally Posted by Tpoints
banks benefitted by seizing and foreclosing on assets they can't sell?
I am not going to that \$#@! in this thread, nor do I care to go into that \$#@! today. Get it? WTF? You're just like, "Hey, you're in a thread about FRB, but lets change the whole topic to the 2008 market crash. Yeah."

And uh...

had I wanted to discuss that, I would have posted in a thread about it.
And honestly, every time I see your avatar, I just think troll, so I have had enough bad run-ins with you to know you are probably just trolling again anyway.

12. Originally Posted by UWDude
It is too being spent. It is being spent by the borrower, and then being deposited by the seller back into the seller's bank.

And do you not understand that the money is not created for one bank, but for the banking system as a whole? Seems like you are talking about it as if this is only a one-bank system.

Either way, there is a drain that makes this little racket fraudulent: interest. Book or no book, You deposit \$100, eventually the banking system will loan out \$900, and charge interest on it.

Furthermore, at the highest level, there are no more reserve tables anymore. Banks can loan out as much as they want, regardless of the reserves. This was changed first to 1/30th, than anything in 2008.

Get out some monopoly money and try it amongst three people. Don't forget the interest.
To keep it simple I am using one bank to represent the banking industry. Once money is spent, it isn't a deposit any more. The bank has to replace that deposit which takes back out of the circulating money the same amount the person withdrew to spend.

Get out some monopoly money and try it amongst three people.
I ran an example earlier. But again for simpliciity, I am ignoring interest. I have \$10. Bob borrows \$10 from me. He runs into Chris who needs money and Bob lends him the \$10. How much money is there? Still \$10. What is changed is that now Chris owe Bob \$10 and Bob owes me \$10. The total amount of money is not suddenly \$30. It is debt of \$20 plus \$10 in real money. Bob and I have zero dollars and Chris has \$10. We are owed money but don't have it. Same for the bank depositors.

13. Originally Posted by hazek
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..
That's not true entirely. Let's say all I own is \$5,000.- in cash. That cash is on the asset side of my personal balance sheet. On my liabilities side there would be either debt, or in my case net worth of \$5,000. But what is this cash worth? In whose balance sheet's liabilities side is it listed? It is a liability of the central bank and it is backed by the central banks assets which includes gold, foreign currency, loans to commercial banks, claims against governments, etc. Let's say my \$5,000 is all the currency in circulation, so the central banks asset side is worth \$5,000.

Now I'm going to a bank and deposit that cash in a bank account. What has happened to my personal balance sheet? It has not changed in size. I still have a net worth of \$5000, but my asset category has changed from "cash" to "deposits at commercial banks".

At the same time the banks liabilities side is increased by \$5,000. It obviously has to find a way to balance it's books and the way the bank does that is by loaning out a certain percentage, say 90%, and either keep the rest as cash. I'd like to stress out here, that the banking sector would give itself a reserve requirement, even if they were not forced by law to do that. The reason for this is because the bank knows that a certain ratio of the deposits is cached on a regular basis and the bank doesn't want to risk a bankrun.

Now their asset side consists of \$4,500 in loans to the new customer "A" and \$500 of cash. Note in our example the bank loaned out the physical excess cash and didn't, as usual nowadays, create a new digital account, but we will soon see why that doesn't change much. "A" needed the loan to invest in a new machine. So machine manufacturer B is now in posession of the \$4,500 and goes on to deposit this money to our commercial bank, thus expanding its balance sheet further by \$4,500 of cash respectively deposits.

As we already know this process can go on and on until the commercial bank has all the initial \$5,000 of cash reserves and \$45,000 of loans on its asset side and deposits worth \$50,000 on the liabilities side without any form of central bank intervention at all.

This is obviously extremely simplified. Here, the only form of bank reserves is the cash held physically at the bank. As we have seen the bank can make the maximum amount of loans by keeping the reserves as low in comparison with it's loans as possible. In reality reserves consist of cash as well as deposits at the Federal Reserve System. These are also traded in the interbanking market on an overnight-basis at a rate called the Federal funds rate (some banks have excess reserves and others a shortage at the end of a day, depending on how good business was, so they trade those reserves).

However, at this point commercial banks cannot increase the money supply further. In theory they will also lend out as many loans as the reserve requirement allows them. And since the bank reserves consist of cash and deposits at the central bank and the only institution that is able to create those is the central bank, it ultimately controls the money supply (at least in "normal times"). If it wants to increase the money supply, it loans out additional money to commercial banks in so called "open market operations" (the fed funds rate used to follow the interest rates of these loans very closely). Those loans with a one week maturity, secured by government bonds or other assets, are credited to the banks' deposit accounts at the Fed, serving as newly created bank reserves, that can in turn be used to create a multiple of its value in loans/deposits for non-banking institutions (companies, governments, individuals).

14. Originally Posted by Zippyjuan
To keep it simple I am using one bank to represent the banking industry. Once money is spent, it isn't a deposit any more. The bank has to replace that deposit which takes back out of the circulating money the same amount the person withdrew to spend.

I ran an example earlier. But again for simpliciity, I am ignoring interest. I have \$10. Bob borrows \$10 from me. He runs into Chris who needs money and Bob lends him the \$10. How much money is there? Still \$10. What is changed is that now Chris owe Bob \$10 and Bob owes me \$10. The total amount of money is not suddenly \$30. It is debt of \$20 plus \$10 in real money. Bob and I have zero dollars and Chris has \$10. We are owed money but don't have it. Same for the bank depositors.
Hmm... I'll mull on it. I am kind of embroiled in a flame war elsewhere at the moment, but... hmm. Debt has been created. Which eventually gets packaged and resold as an asset, but that is not exactly the fault of FRB.

15. Originally Posted by Tpoints
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?
That's not possible. The bank can only multiply the loans by a factor of its reserves. And only cash and deposits at the central bank are considered to be reserves, not digital money in bank deposits.

Or you can look at my accounting example if that's more your thing.

16. Originally Posted by Zippyjuan
I ran an example earlier. But again for simpliciity, I am ignoring interest. I have \$10. Bob borrows \$10 from me. He runs into Chris who needs money and Bob lends him the \$10. How much money is there? Still \$10. What is changed is that now Chris owe Bob \$10 and Bob owes me \$10. The total amount of money is not suddenly \$30. It is debt of \$20 plus \$10 in real money. Bob and I have zero dollars and Chris has \$10. We are owed money but don't have it. Same for the bank depositors.
No it's not. Every customer at the bank can now go on and start buying stuff via a debit card at the same time and the banking system wouldn't collapse. It wouldn't even notice, because now the virtual money is on the account of the seller. What did change, however, is the general price level, or inflation.

The example obviously seems a little strange because we never experiened a shift from full reserve to fractional reserve banking, but if we would, we would see inflation at roughly the rate of the money multiplier. There would obviously be a time lag and not every price would increase at the same rate, but overall and in the long run, if you increase the money supply by X prices increase by X, if we believe that real GDP would not be affected at all. According to Austrian Business Cycle Theory we would also see a dillution in the structure of production as the price for credit, the interest rate, would decrease and thus a credit expansion driven recession will occur at some point.

17. Originally Posted by Zippyjuan
To keep it simple I am using one bank to represent the banking industry. Once money is spent, it isn't a deposit any more. The bank has to replace that deposit which takes back out of the circulating money the same amount the person withdrew to spend.
I don't understand your logic. You say the act of spending a deposit (like say me trading 3 deposit dollars to the grocer for bread) destroys the deposit?

That is akin to saying the act of me spending three dollar bills destroys those paper dollars because I no longer have those.

Spending deposits doesn't destroy them...it just moves them around to other banks. Now reserves do accumulate around the banking system and stockpile more at some banks then others...letting those banks practice more FRB banking then their competition...or more likely lending their reserve extras back in the money market. That doesn't mean though that deposits can't be spent though.

Assume there was just one monopoly bank in the US. It started by accepting say deposits of 1 billion dollars. Then created 1 trillion in deposits on top of that because they noticed that statistically the reserves stayed in the system. So say a mega-corporation writes a check for 2 billion dollars to another. This is possible and easily explained by FRB, and yet you and your logic seem to disagree that this is even possible.

In real life, banks don't "replace deposits". They certainly love deposits...they love lending...and pretty much give their loan officer free reign to make whatever loans they feel are prudent. As banks make loans and see withdrawals, their capital ratios and reserve ratios shrink which can encourage them to borrow reserves from the money market. Frequently they don't have to because incoming deposits frequently match outgoing deposits.

18. Originally Posted by Zippyjuan
I ran an example earlier. But again for simpliciity, I am ignoring interest. I have \$10. Bob borrows \$10 from me. He runs into Chris who needs money and Bob lends him the \$10. How much money is there? Still \$10. What is changed is that now Chris owe Bob \$10 and Bob owes me \$10. The total amount of money is not suddenly \$30. It is debt of \$20 plus \$10 in real money. Bob and I have zero dollars and Chris has \$10. We are owed money but don't have it. Same for the bank depositors.
You did not describe the type of debt in this example. But certainly short term credit is a component of the money supply.

So yes...there may still be 10 dollars (say in base money)...but there is now an additional 20 dollars of credit...which if short term might count toward say M3. So M3 might have gone up by 20 dollars.

Say in your debt example, these was a 10 year loan. This is not so bad because the 10 year debt would be matched by a 10 year credit. What a bank does is different. They will mismatch the maturities dishonestly to earn profit. So they will issue a 1 year debt to finance a 10 year credit...and cross their fingers that they can keep rolling over that 1 year debt until the 10 year matures.

Why do this? Because long term credit has higher yields...but for good reason! It lacks the liquidity of short term credit. Yet banks try to cheat this by mismatching the maturities and externalizing risk and inflation onto the general public.

The other key difference is that we don't accept say 10 year bonds as payment. We do accept payment from debt maturing at ∞/1 years though...it is this conflation that creates so much problems, inflation and instability.

19. Originally Posted by UWDude
I am not going to that \$#@! in this thread, nor do I care to go into that \$#@! today. Get it? WTF? You're just like, "Hey, you're in a thread about FRB, but lets change the whole topic to the 2008 market crash. Yeah."

And uh...

had I wanted to discuss that, I would have posted in a thread about it.
And honestly, every time I see your avatar, I just think troll, so I have had enough bad run-ins with you to know you are probably just trolling again anyway.
so by telling me FRB and 2008 market crash is "changing topic", you're admitting they're unrelated?

20. Originally Posted by Tpoints
so by telling me FRB and 2008 market crash is "changing topic", you're admitting they're unrelated?

Originally Posted by UWDude
Hmm... I'll mull on it. I am kind of embroiled in a flame war elsewhere at the moment, but... hmm. Debt has been created. Which eventually gets packaged and resold as an asset, but that is not exactly the fault of FRB.
You are annoying.

21. Originally Posted by UWDude
You are annoying.
Sorry, had to ask. I was under the impression that everybody who loves Ron Paul has to scapegoat FRB for everything wrong with the economy.

22. Originally Posted by Tpoints
I was under the impression that everybody who loves Ron Paul has to scapegoat FRB for facilitating and amplifying the vast majority of what is everything wrong with the economy.
Fixed it for you.

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