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 IgorFrankensteen
Joined: 6/29/2009
Msg: 51
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Banks and the financial systemPage 3 of 7    (1, 2, 3, 4, 5, 6, 7)

For the most part, I wanted to discuss (or muse about) our debt-based economy and its implications. The economic truth is that the vast majority of the money in the economy is debt money (current estimates in the US put physical currency at about 10% of money in circulation). I find it sort of a sad fact, since it means that our prosperity depends almost entirely on the bank's willingness to extend credit, but I think it's also something that many people don't realize when they talk about things like government debt.


First of all, I think I am finally getting a handle on what you are on about here. It's a good subject, but I do think that you went too directly to the details of the mechanics of the economy, and so both confused me (always tragic, I know), and more significantly, lost sight of the Big Picture.

On the "debt based economy," for one thing...I shy away from terminology like that, because it implies that we all purposely WANT to be in deep debt, among other things. It's been politicized to the point where no two people mean the same thing when they use such phrases.


A lot of people talk about how the government should stop spending and try to reduce the national debt. This sounds good in principle, but decreasing the debt load for such a large entity at a time of slow economic growth would also mean decreasing our money supply, which is disastrous for the economy. Of course the government will eventually have to start paying some of it off (not always necessary, since inflation and a growing GDP can reduce debt levels) but the rest of society will have to pick up the slack and take on more debt if we are to have a prosperous economy.


The way that debt is the exact same challenge to both peasant class individuals and to the nation, is that it's of tremendous importance HOW each go about reducing it. This is far more important than the fact that it exists.

If an individual decides to pay off their debt faster by refusing to feed their children, ignoring the need for maintenance on their personal infrastructure (i.e. car, house, that sort of thing), and refusing to pay regular expenses, such as gas, electricity and other utilities...they WILL get their debt down but quick, but at the expense of their long term well being, if not their existence.

I personally am convinced that a too-influential portion of our country's leadership want to do the exact same kind of ignorance-based, and destructive "belt-tightening." Not their own personal belts of course.

It's not JUST a matter of maintaining a sufficient money supply to "lubricate" the economic wheels. It's very much a matter of where exactly said "lubrication" is applied. Right now, the proponents of "supply side" ideas of economics, want all the lubrication to be poured directly into the pockets of the people who already have a lot, with the thought that if enough money gushes into their already full vats, that those people will decide to let SOME of it out, in the form of business expansion. I think that's nuts, myself, since there has never been any indication that anyone invests in business expansion while the customer base is shrinking. I think this simple and basic fact, is why even though a lot of Federal money has been poured into the economy, that not much movement has resulted. It's been going to people and places where the goal is not to spend it, but rather to build up reserves, to prepare against ANOTHER failure of loan companies.

I am very worried for the future. But not because of the national debt. It's the self-destructive "solutions" being foisted on us, that hold the real danger.
 Demigod1979
Joined: 12/4/2011
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Posted: 2/21/2014 6:33:40 PM

First of all, I think I am finally getting a handle on what you are on about here. It's a good subject, but I do think that you went too directly to the details of the mechanics of the economy, and so both confused me (always tragic, I know), and more significantly, lost sight of the Big Picture.

Sorry, I assumed that people knew what I was talking about (plus, this thread was initially in response to OMG!WTF!'s comment in the prostitution thread so I thought I'd get right into the mechanics).


On the "debt based economy," for one thing...I shy away from terminology like that, because it implies that we all purposely WANT to be in deep debt, among other things. It's been politicized to the point where no two people mean the same thing when they use such phrases.

Perhaps, but I think to a large extent, debt is a part of our lives. Taking out a mortgage, getting a car loan, getting credit cards and utilizing other types of credit is a normal part of our everyday experience (in many ways, it is positively expected of us). We also hear that it's a good thing to have a clean credit record ("you don't want to hurt your credit score!"), even though what it really means is that we don't want to hurt our chances of being in debt. It's also become somewhat necessary - with incomes stagnating for the lower- and middle-classes for the past couple of decades, the only way to maintain a good standard of living nowadays is to use debt. In short, I think people today would rather be in debt if it allows them to get the things they need and want.


It's not JUST a matter of maintaining a sufficient money supply to "lubricate" the economic wheels. It's very much a matter of where exactly said "lubrication" is applied. Right now, the proponents of "supply side" ideas of economics, want all the lubrication to be poured directly into the pockets of the people who already have a lot, with the thought that if enough money gushes into their already full vats, that those people will decide to let SOME of it out, in the form of business expansion. I think that's nuts, myself, since there has never been any indication that anyone invests in business expansion while the customer base is shrinking. I think this simple and basic fact, is why even though a lot of Federal money has been poured into the economy, that not much movement has resulted. It's been going to people and places where the goal is not to spend it, but rather to build up reserves, to prepare against ANOTHER failure of loan companies.

Yes, I'm a die-hard opponent of supply-side economics as well (snake oil economics, as Keynesian economists call it ;) ). I also feel that the Fed pumping money in the economy isn't doing much, not with the wealthy hoarding cash the way they do (not that I blame the wealthy for doing it - hell, I would do the same if I had several million dollars under my name). The distribution if income has become a gaping chasm over the past couple of decades, and I think that's hurting the economic recovery. The rich tend to store away most of their money while the poor and the middle-class tend to spend most of it, thus the most effective way to get the economy going again is to reduce that income gap and put more money into the hands of those who will spend it (it's no surprise that the greatest period of economic prosperity in American history came about when the middle-class was empowered after WW2). Of course that's not going to happen with the leadership that we have today, who would prefer to coddle the rich.

BTW, it should be noted that not all wealthy people are so corrupt. I greatly admire Warren Buffett for his investing acumen, and although he's one of the richest men in America, he actually proposes raising taxes on the rich (he said if the nation needs money then they should take it from those who have it). He also finds it ludicrous that he only pays about 15% in taxes (capital gain and dividend) while normal workers under him pay 30% or more.


I am very worried for the future. But not because of the national debt. It's the self-destructive "solutions" being foisted on us, that hold the real danger.

Well, I think some of that debt load can safely be reduced without causing economic chaos (a lot of that money isn't doing anything anyways and isn't causing inflation, so removing it would not automatically cause deflation). My biggest fear is that the problems with the banking system have not been resolved. Although the risks of another crash are low (despite cheap money, it's not blowing up another bubble), I have no doubt that banks will once again "innovate" once conditions are better. IMO, breaking up the big banks should be a major priority, along with some very serious legislation (the new legislation that has come out is too tepid and limited to fix the core issues). They should reinstate Glass-Steagall at the very least, as well as creating new regulations for investment banks (perhaps have them regulated by the FDIC, instead of the SEC). Without a stable financial system, economic prosperity is a pipe dream.
 Proteaus
Joined: 6/9/2009
Msg: 53
Banks and the financial system
Posted: 2/21/2014 8:50:35 PM
Here is one example of how mortgages work , the moment you sign the mortgage , that is when the money is created out of nothing . So basically the bank puts up money created out of nothing that has zero intrinsic value . Basically the whole financial system is a scam . They have been systematically removing the wealth from the USA for a long time now . Parts of the country are beginning to resemble a third world country .
 OMG!WTF!
Joined: 12/3/2007
Msg: 54
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Posted: 2/22/2014 6:46:06 AM
Banks still do not create money by issuing loans. The mighty Wiki article that is repeated here has it vaguely wrong and sort of half right. At least the interpretation of it is wrong. The original thesis...


Of course it's mathematically impossible for everyone to pay back their loans since there is not enough money in the money supply to do so, no matter what how hard they work (SOMEONE will default, simply because of the arithmetic


That isn't right. It's not at all mathematically impossible. It's just as mathematically possible to receive more than the amount owed as it is to not receive it all. New money can be brought in from a world full of sources that can fullfill the money supply expansion.


Here is one example of how mortgages work , the moment you sign the mortgage , that is when the money is created out of nothing


No that's not how it works.

This is how it works...

http://neweconomicperspectives.org/2013/06/do-banks-create-money-from-thin-air.html

You can't walk into a bank and receive a loan for 200k with nothing in return. That loan is secured by existing assets. The bank forwards you the money without first obtaining anything but a legal right to the asset in the event of a default. But the asset already exists. It is the dinosaur in the chicken and egg dilemma.


People who are fond of saying the banks create money “from thin air” often seem to suggest that banks are no different than the government in that regard, and can thus obtain valuable monetary assets simply by manufacturing them ex nihilo, in effect profiting from pure seigniorage in the way a currency-issuing government can. But this picture is wildly inadequate. If banks could simply summon their assets into existence out of the aether, then every bank in the country could be as rich as an Arabian Gulf emir, manufacturing money at will to purchase solid gold chandeliers, 100-story luxury high rises, Olympic swimming pools, indoor ski slopes, and a personal entourage of world-renowned chefs, attendants and masseuses. The sky would be the limit. But clearly this is clearly not the case. There is a lot to complain about with regard to banking; lots of people in the banking system are making completely unwarranted profits from a massively bloated and exploitative financial system. But the wrongness here comes from the banking system’s ability to suck, squeeze and swindle assets from others; not from its simply conjuring these assets out of nothing.


The assets of a bank exist because they first existed elswhere...not the other way around. The bank doesn't lend you money without first knowing that it exists in some form in the world. Not even credit card debt is without a viable path to reality. Your credit worthiness is an actuarial reality. In fact, credit worthiness is as much a barrier to the credit card business as it is necessary. They hate it when you pay on time. Nothing the bank does is responsible for increasing the money supply unless they venture out from behind the desk and force loans on people with a zero net worth. And as we saw in 2008, they sometimes do that and the result is disasterous. From the above source...


What is true in the “from thin air” metaphor is that commercial banks are able to initiate the process of expanding deposit balances via lending without first obtaining any additional assets that might be needed to handle the added payment obligations and withdrawal claims that the additional deposit liabilities might impose on the bank. It can expand the deposits first and acquire the additional assets, if necessary, afterwards.
 IgorFrankensteen
Joined: 6/29/2009
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Posted: 2/22/2014 9:23:35 AM
Good post, OMG. The only thing I would note is, that if a loan institution does opt to "acquire additional assets afterwards," they damn well better be able to prove that said assets exist, and COULD be acquired before making the loan.

The reason why things went bad a in the last decade, wasn't because money was being loaned out. Not even because a LOT of money was loaned out. It went bad because it was being loaned out against wildly inflated, functionally non-existent assets. People weren't getting loans on real estate for the value it had at the time, they were getting loans for the amount it was EXPECTED to be valued for, if it continued to increase in value at the pace it had done recently...and that itself was a mis-use of valuation processes, since it was clear that the real estate was NOT increasing in value at all, it's apparent value was being INFLATED by the very game of future mis-evaluation that led to the assumption that the inflation would continue.

Thus, when things tightened ever so slightly and assets were called upon as payment, it was discovered that they didn't really exist. If they HAD existed, there wouldn't have been any problem.


And now we are in another stage entirely. At least half of our leadership is intent, not on dealing with and solving our economic problems, but in using them for political advantage, and as an excuse to do away with all sorts of things they are opposed to for entirely non-economic reasons. Because they are completely ignoring the ACTUAL economy, their "solutions" will make everything much worse for everyone, if enacted as described. And since no one with a large audience is pointing out the fallacies of it all, they are all too likely to succeed.
 IgorFrankensteen
Joined: 6/29/2009
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Posted: 2/22/2014 3:58:09 PM
^^^ You missed that we already covered this. The loan institution doesn't "create interest money." No one does.

Interest is the fee which they charge, and is expected to be paid via the creation of new wealth, by the borrower.
 OMG!WTF!
Joined: 12/3/2007
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Posted: 2/23/2014 4:31:56 AM

too funny ... did you actually read the wiki post that explained the out of thin air thing.... or not?

It states ... there is some truth to the statement ... but of course to you guys ... that is ignored for your own personal opinion. ... cool. let's go over it again ... because its not fully understood.


You've really blown this one. The example given in the article of debt "created from thin air" is of the author giving an IOU to Pat Brown and Pat Brown taking it to the grocery store and the grocer accepting it as payment. If you can get people to accept an iou with zero asset backing as payment it becomes legitimate debt. However that's not the same as what banks do. Do you see any difference here with government issued and bank negotiated debt? More from the article...


Banks can indeed create deposit account liabilities from thin air, just as you and I can create liabilities from thin air when we issue IOU’s and someone accepts them. But those deposit liabilities are debts of the bank, just as the IOUs that you and I issue are our debts. And these bank debts are not just so-called debts or pro forma debts. They are real debts which banks must and do routinely pay off in the course of doing everyday business; and the assets a bank uses to pay these debts come from sources external to the bank. A bank cannot simply manufacture its own payment assets from thin air.


An iou from Pat Brown is not the same thing as asset based debt. One has a real asset behind it and one doesn't. Pat's iou may be sourced from a lost bet, a favour or a future consideration and it is therefore created out of nothing. Whereas the bank debt actually exists in the world somewhere. In very simple terms, can you go to a bank and say, I own absolutely nothing but I need you to give me 200 bucks because I lost a bet? Will they lend to you based on those terms? That's the point your failed example was making.

The only thing you vaguely understand is that subprime lending throws a wrench into the whole plan becuase the value of the asset backing is questionable. However, regulated lending practices can safely achieve legitimacy and sustainability and confidence in reserve banking...ie Canada.
 IgorFrankensteen
Joined: 6/29/2009
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Posted: 2/23/2014 5:00:40 AM
Indeed. One of the problems all of us have, who are trying to understand this rather subtly complicated area based on reading what seemingly authoritative sources say online, is that said sources don't agree. They aren't as authoritative as we need them to be.

In connection with this thread, I decided to look up "what causes booms and busts?", to see what there was to say about things like the "creation" of money, inflation, and so forth. I couldn't find two sources which agreed, and instead I found lots of sources with axes to grind, and heavy bias. In particular, there is one linked to Forbes (which has SOME authority) that showed an obvious bias towards using a Gold Standard for stability. The thing is, as I read it, I noticed that right in the article, the author admitted that we had plenty of booms and busts under the gold standard as well, but he blithely brushed them off. He claimed that "Gold standard = good," because economics is complicated, and booms and busts with a gold standard aren't gold's fault, but booms and busts under the modern system ARE entirely the fault of NOT having the gold standard.

In other words, I like Wikipedia for source material too, but I keep in mind (Historians training) that just because someone uses a nice type-face and spells fairly well, doesn't mean that they know what they are talking about, and doesn't mean they mightn't have written something in the wee hours of the morning after a long bachelor party or something.

By the way, I found no good "boom and bust" explanation in particular yet, so I'm staying with what I've collectively read and observed, which is that it comes down to correctly assessing value, correctly assessing necessities, and borrowing or spending accordingly. Whenever a significant number of powerful (i.e. rich) groups manage to get everyone to over-value something, in order to borrow and spend lots of money against the over-valued things, we get a boom, followed by a bust when the true value is recognized. That means that there IS no SINGLE thing that can be done to make an economy function well and smoothly. Like parents attending children, we have to constantly watch the ENTIRE situation, be constantly vigilant for even our smartest "kids" to decide to do something stupid and destructive, out of some mistaken idea that it will get them a bigger piece of chocolate cake.
 IgorFrankensteen
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Posted: 2/23/2014 5:21:54 AM
And by the way, the parallel error in things like "correctly valuing assets and necessities, and borrowing and spending accordingly," comes from ANOTHER bad idea being pushed these days, by some "authoritative" folks. That is, if we correctly value assets, but we choose to ignore basic necessities, or fail to recognize the importance and function of resources (including especially human ones) , we will STILL undercut the total economy, and we will have another kind of 'boom and bust.'

This kind occurs when someone, for example, decides to stop performing scheduled maintenance, or cut wages, to reduce spending, and then use THAT "savings" as though it is created wealth. Lots of even large companies have tried this exact thing, and had the natural result happen every time. At first, they seem clever, as the deterioration from the missed maintenance and/or reduced wealth of their employees, doesn't show up instantly. The company appears to function as before, and the clever CEO who ended maintenance spending, pockets a huge bonus, and passes out more money to others, and even invests in new enterprises. But eventually the lack of maintenance WILL catch up, and the core company WILL suddenly find that it no longer has the resources needed to perform it's basic functions. Worse, because of their mismanagement, and the damage they have done, legitimate, responsible lending institutions will not rescue them with further loans, because their core assets have BECOME overvalued, via deterioration.
 Demigod1979
Joined: 12/4/2011
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Posted: 2/23/2014 12:16:12 PM
Banks still do not create money by issuing loans. The mighty Wiki article that is repeated here has it vaguely wrong and sort of half right. At least the interpretation of it is wrong. The original thesis...

To quote from the Wiki again (http://en.wikipedia.org/wiki/Money_creation):

In economics, money creation is the process by which the money supply of a country or a monetary region (such as the Eurozone) is increased.

When banks create loans they increase the money supply. According to the definition above, this is creation of money (this does NOT mean that new value, assets or wealth has been created).

Also remember that when a loan is paid back, the new money created by the loan (the principal) is extinguished, thus it is not permanent money (only the interest is permanent). It's not like printing physical coins or dollar bills, which circulates permanently in the economy. The loan money is to serve a purpose, after which it will be removed.

You can't walk into a bank and receive a loan for 200k with nothing in return. That loan is secured by existing assets. The bank forwards you the money without first obtaining anything but a legal right to the asset in the event of a default. But the asset already exists. It is the dinosaur in the chicken and egg dilemma.

Yes, banks do not just create money out of this air, they need to secure it with an asset that the borrower pledges as collateral. However, this does not invalidate the idea that banks create new money (as per the definition above, if it increases the money supply, it's new money).

Say the bank has $3000 to lend to 3 individuals, each get $1000 with 10% interest. The first comes up with an item the other two would like. The second offers him $100 for it, which he accepts. The first individual then repays his loan of $1100. The third individual offers the second $200 for the item. The second now repays his loan of $1100. The bank sees this item as an investment and offers $300 for it from the $2200 it has. Individual number three now pays off his loan of $1100.

In a world where banks spend every single penny of interest they have back into the real economy in such a way that borrowers can earn it again (the $300 offered would be this example), every borrower can pay back his loan. But like I said, this is a highly theoretical scenario and does not happen in real life. Banks are under no obligation whatsoever to spend all their interest money, and will often times use it to increase their own wealth, such as investing in stocks, debt, currency exchanges and other profit-making venture. Unless a law is passed to force banks to spend every single penny of interest into the real, goods & services economy, someone will always come up short (in my continuous example I had the bank spending a portion of their interest earnings).

They don’t re lend it they use it as the basis for loans? That is the same thing. It works like this when a bank borrows from a central bank. Lets say they borrow $10,000 to fund their lending activities.

Assets (Loans) $10,000 Liabilities (Central Bank) $10,000

Again, you are thinking of full-reserve banking. In fractional-reserve banking the bank reserves a small portion as reserves, lends out the rest, and then creates a brand new IOU for the original amount (this is what I mean by "basis for loans"). So with a 10% reserve ratio $9000 is lent out, $1000 is kept as reserve, and a new $10,000 IOU is created. The total money supply is then $19,000 ($9000 + $10,000). Do you get it now? The bank borrowed $10,000 from the bank, and has expanded the money supply by $9000. The bank balanced this newly created money by the value of whatever asset was pledge as collateral, but it is essentially new money.

Again, take the time to learn how money is created by the commercial banks before you attempt to discuss this topic (you are in way over your head here).

Why would you want to break up the big banks? That doesn’t make economic sense. Banks make billions of dollars in profit. They pay tax on that and so are a major source of revenue for the Govt.

Do you actually know how the economy works?

Are you implying that small and medium-sized banks don't pay taxes?
 Demigod1979
Joined: 12/4/2011
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Banks and the financial system
Posted: 2/23/2014 12:36:41 PM
In connection with this thread, I decided to look up "what causes booms and busts?", to see what there was to say about things like the "creation" of money, inflation, and so forth. I couldn't find two sources which agreed, and instead I found lots of sources with axes to grind, and heavy bias. In particular, there is one linked to Forbes (which has SOME authority) that showed an obvious bias towards using a Gold Standard for stability. The thing is, as I read it, I noticed that right in the article, the author admitted that we had plenty of booms and busts under the gold standard as well, but he blithely brushed them off. He claimed that "Gold standard = good," because economics is complicated, and booms and busts with a gold standard aren't gold's fault, but booms and busts under the modern system ARE entirely the fault of NOT having the gold standard.

In other words, I like Wikipedia for source material too, but I keep in mind (Historians training) that just because someone uses a nice type-face and spells fairly well, doesn't mean that they know what they are talking about, and doesn't mean they mightn't have written something in the wee hours of the morning after a long bachelor party or something.

By the way, I found no good "boom and bust" explanation in particular yet, so I'm staying with what I've collectively read and observed, which is that it comes down to correctly assessing value, correctly assessing necessities, and borrowing or spending accordingly. Whenever a significant number of powerful (i.e. rich) groups manage to get everyone to over-value something, in order to borrow and spend lots of money against the over-valued things, we get a boom, followed by a bust when the true value is recognized. That means that there IS no SINGLE thing that can be done to make an economy function well and smoothly. Like parents attending children, we have to constantly watch the ENTIRE situation, be constantly vigilant for even our smartest "kids" to decide to do something stupid and destructive, out of some mistaken idea that it will get them a bigger piece of chocolate cake.

By "boom and bust", are you referring to the business cycle, or to credit bubbles?
 Demigod1979
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Posted: 2/23/2014 3:27:59 PM

This is what we've been trying to tell you all along. Your claim was that the interest didn't exist but it does in the reinvestment of the principle. The bank initially had $3000 to loan out, when the individuals redeposited the loans, the bank has a further $2700 to supply the market. They're expecting $300 back which the are going to want to invest themselves.

You claim that my example is highly theoretical and does not happen, but yours is perfectly fine.

Once again, this can only happen if banks recycle 100% of the interest money back into the general economy in a way that borrowers can access it - that is, by spending on goods and services. In your example, the $300 would have to be spend by the bank (why would they "invest" that money if the borrower is just going to give it right back to them?)
 IgorFrankensteen
Joined: 6/29/2009
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Posted: 2/23/2014 6:28:37 PM

By "boom and bust", are you referring to the business cycle, or to credit bubbles?


The people who profit from them, or who are trying to side-step their responsibility for them, like to call them "business cycles." What they all are, are episodes of investors betting that they can get away with failing to follow standard practices and/or showing due diligence to the fundamentals of investment and loan procedures.
 Demigod1979
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Posted: 2/24/2014 8:07:56 AM

Sorry, I've got no idea what you are saying here. The bank isn't recycling 100% of the interest money. The bank has $1980 to invest and uses $300 of that to buy what has been create as wealth, it might have been gold the first individual had mined or a share in his company he had formed. Banks make these investments all the time.

In your example, no one redeposits their loans so the bank is insolvent until it receives a payment, if it is waiting for the whole (principle+interest) this isn't going to happen. The individuals walk away with the notes but the notes are worthless because where it says 'the bank of x promises to pay the bearer...' it cannot

I've been trying to figure out where you got the $1980 figure, but now I see that you were using a full-reserve system, where banks lend existing money. I'm going to have to go back to your initial example to sort this out so bear with me.


Say the bank has $3000 to lend to 3 individuals, each get $1000 with 10% interest. The first comes up with an item the other two would like. The second offers him $100 for it, which he accepts. The first individual then repays his loan of $1100. The third individual offers the second $200 for the item. The second now repays his loan of $1100. The bank sees this item as an investment and offers $300 for it from the $2200 it has. Individual number three now pays off his loan of $1100.

Each individual is now debt free and the bank has $3000 plus the item which is valued now at $400 (each transaction has increased its value by $100).

By the way you describe the initial $3000 money the bank has, it would seem to be high-powered money deposited or borrowed from the central bank. The bank, when it lends this money, will create a new $3000 IOU and so the money supply will increase by that amount minus the reserve. Ultimately, with a 3% reserve ratio (tyipical of countries like the US) the banks can create up to $100,000 of checkbook money from the initial amount of $3000. Assuming an interest of 10%, borrowers would need to pay back a total of $110,000 ($100,000 * 1.1), whereas the total money supply is $103,000 ($3000 + $100,000). Once again, the total owed by borrowers exceeds the total amount of money in the money supply, which can only be remedied by them spending all their interest money back into the economy.

Also, you seem to be saying that the bank will arbitrarily value some asset at a higher price than it bought it for (on what basis is it doing so?). Wouldn't this depend on market prices and/or supply and demand? (also consider the fact that once all the loans have been repaid, that $100,000 is now gone so the money supply has been drastically reduced)


When a loan gets paid back either in full or portion. That same money is available for bank’s to re lend. That is what they do. They are recycling money back into the economy by lending it. If at the end of the week a bank has received principal repayments totalling say $10,000. They have $10,000 available to lend. So if they write a loan for $10,000, they are not creating new money at all. They are just putting that money back into the economy from where it came from.

I've pointed out numerous times, backed by various Wikipedia articles, that banks create new money. Your continual refusal does not change the matter - it just means you are in denial. The textbook definition of money creation is an action that increases the money supply - whether that's done by physically printing or entering digitally on a computer doesn't matter. Money is a medium of exchange, used to buy goods and services. Banks, when they make a loan, increase the ability to buy goods and services because the IOUs they create can be used like cash.


Increasing the money supply isn’t creating new money at all. It is just transferring it into the economy by lending it.
...
I fully understand how commercial banks increase the money supply. It is so simple I don’t understand how you can’t grasp the concept. All you do is keep repeating that they create new money, when in fact they are not creating new money.

So if I lend you $10 of existing money I've actually increased the money supply? Really??? Oo

Lending existing money might increase liquidity and circulation, but it should be plainly obvious that it would not increase the total supply of money in the economy. Increasing the money supply can only happen if new money is created.


It is profitable businesses that create new money.

Like I said before, counterfeiting is a crime.


Why don’t you take the time to learn that when a bank borrows off a central bank it has nothing to do with fractional reserve banking. Fractional reserve banking is when money is deposited into a bank. And they have to keep whatever the reserve requirement is in reserve with a central bank.

Umm, my example was based on what happens when a commercial bank makes loans, NOT what happens when they get loans from the central bank (I thought that would be obvious).


Nope, you didn’t answer the question. What would it achieve by breaking up the big banks?.

It means that no single bank can threaten the entire financal system. If one of the big banks, like Bank of Ameica, runs into financial trouble then the government would most likely have to bail then out, since their failure can lead to the collapse of the entire system. Breaking it up into smaller banks lessens this risk (you can let one bank fail without bringing down the other banks). Basically, you don't want to put all your eggs in one basket.
 Demigod1979
Joined: 12/4/2011
Msg: 65
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Banks and the financial system
Posted: 2/24/2014 6:32:33 PM
The two initial players deposit their $2200 which is the $ 1000 borrowed plus $100 interest times 2. In my example the bank keeps 10% as its reserve so can lend out $1980... (2200-220).

Wait a minute, are you suggesting the borrowers, after receiving their loan money, will deposit that loan money into their account with interest? What, are borrowers sitting on a pile of cash that they can use as interest even before they get the loan? Also, if they simply deposited their money back into the bank (with that magical interest included), then how it supposed to generate wealth? (are you sure you are not confusing this with loan repayment?)

The $5000 is loaned out but in reality never leaves the bank, so the bank under a fractional reserve has now a further $4500 (5000-500 keeping 10% reserve), which it has yet to loan out. The creation of wealth and therefore the interest can be found in this $4500. So the equation is at any one time

p + p2 > p + i

No, it's p + p2 on the left and p + i + p2 + i2 on the right. What, you are forgetting the fact that the second loan also has to be paid back with interest?

Under the fractional-reserve system, money is added to the money supply when a bank makes a loan. A corollary to that is that until the bank makes that loan, that money does not exist. In your example, that $4500 basically is the bank's capacity for more credit, but it will only be added to the money supply (that is, come to exist as money) when it is lent out (p2 is created). However, the instant that they lend it out it also has an interest charge attached to it (as soon as p1 is created i1 is also created, and as soon as p2 is created i2 is also created and so forth).

So basically, it goes like this:
First loan: p1 < p1 + i1
Second loan: p1 + p2 < p1 + i1 + p2 + i2
Third loan: p1 + p2 + p3 < p1 + i1 + p2 + i2 + p3 + i3

Your equation would only work if p2 was introduced into the money supply by commercial banks but did not need to be paid back at all (that is, it is NOT a loan). This is not possible. Commercial banks cannot just create money willy-nilly (they can only do so based on a borrower's pledge of debt - that is, a loan contract).

Again, I feel that you are working under the assumption of full-reserve banking, in which banks loan money which already exists.

(Note: for simplicity, the example above excludes the original high-powered bank money, which ultimately contributes so little to the money supply that is does not affect the equation)
 Ed Bear
Joined: 5/19/2007
Msg: 66
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Banks and the financial system
Posted: 2/25/2014 12:00:46 AM
Banks aren't payday loan operations or loan sharks. They don't make unsecured loans (though they operate credit-card businesses that DO, charging astonishing interest rates - as do the payday loan operators and loan sharks). Callable business loans are not so simple, but the banks still make sure their debt is always covered.

Banks make a loan by demanding you provide security. They are not permitted to make unsecured loans because they have no upside profit; they only get fixed interest, and a small amount, to avoid risk.

When a bank makes a mortgage, it is in effect doing a hock - it gains legal control of the property (a lien) and is sort of conditionally selling it to you (like a pawn shop), and you have the right to buy it back with interest. Where you get the interest is your problem; if you don't pay, the bank still has your house and will sell it to recoup its cash. If your home's value threatens to fall below the amount owed, the bank will "call" your loan - pony up enough to cover the uncovered amount or get foreclosed right now. Callable business loans, too, take action immediately if the bank thinks the business isn't going to make it, and the banks will close a still-profitable operation if they don't have confidence in its future, just to get what they can before things get worse.

The banks aren't creating money. They are trading value - cash for the security - in a reversible transaction where they get a fee. The client come in with a house, which already has value, and the bank comes in with cash. Only if the house burns down is the value destroyed - and that's why you are required to insure secured property like houses and cars. It's why buying a car on credit not only screws you for the interest, it requires you to over-insure, as it's VERY easy for a car to devalue below its outstanding loan amount. Not so much for a house.

If you borrow money, buy a house, rent it and make money, you are bringing in the wealth you need to pay back the interest; you are creating (rental) value by putting the place on the market to be rented, rather than just sitting in it as it consumes money for maintenance and all the other costs. If you buy a sewing machine and start making clothes and selling them, you are creating value - the clothes.

Printing cash or issuing IOUs (bonds, certificates of deposit, etc.) does not create or destroy value.

In both the S&L and investment-banking disasters, the sensible banking rules were voided and warnings ignored, or pushed aside "to enable freer wealth creation," but all that was created was bad debt. The shysters who sold them got their money even if both the lenders and borrowers ended up bled dry. They lobbied for it, they got it, and they ran off with a generation's life's work of value.

That's why I agree with Buffett - nobody's going to give up those ill-gotten gains unless they're forced to.
ED BEAR
 IgorFrankensteen
Joined: 6/29/2009
Msg: 67
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Banks and the financial system
Posted: 2/25/2014 4:22:45 AM
Right on Ed.

One of the reasons I think I've been arguing against the idea that "a debt-based society/economy is destined to suffer," isn't just because I think it's being misunderstood.

The bigger reason I'm opposed to it, is that the greedy people who are using the unregulated approach to playing games with our lives for their profit, are COUNTING on people to think that we're stuck with these kinds of results.

It's just like the burglars who want everyone to become depressed and think that "everyone steals, so why bother trying to stop them?"

Like so many things in life: if you do whatever it is right, the results are generally positive. If you do it wrong, you'll make a mess.

The reason we have the problems we do, isn't because we allow debt. The reason we have this mess is, that we allowed scam artists, liars, and already rich thieves to pretend that rules and principles didn't matter.
 Demigod1979
Joined: 12/4/2011
Msg: 68
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Posted: 2/27/2014 5:31:49 AM

The client come in with a house, which already has value, and the bank comes in with cash.

Not to nit-pick here, but neither the client nor the bank comes in with anything. The property that the client wishes to buy is obviously not owned by him/her when he/she comes in for a mortgage, and the bank does not use its own cash/earnings to buy the property. The moment that new money is created is when a mortgage loan document is signed. The signature on a loan contract is a borrower's promise to pay the amount of the loan plus interest, otherwise forfeit the property that he bought with the loan. Based on this contract, the bank can create brand new promise-to-pay money (IOU), which is treated exactly like government cash. In effect, the borrower and the bank have exchanged promises. Today, a large chunk of money in the economy is in the form of promises, which is why people need to have faith in the banking system in order for it to work (the moment that people no longer believe in the bank's promises is called a bank run).


Printing cash or issuing IOUs (bonds, certificates of deposit, etc.) does not create or destroy value.

Yes, I've said this before. When banks create money they're only creating more representations of value (money) - they are not creating value or wealth itself.


Like so many things in life: if you do whatever it is right, the results are generally positive. If you do it wrong, you'll make a mess.

This system works for most people most of the time, only a small number of people will fall through the cracks. However, the sad fact is that the more we produce, the less our money is worth. If we make repairs on a home or improvements to a car then we expect it to be worth more. The time and effort we put into it makes it more valuable and we can expect some tangible benefits, in functionality, aesthetics or monetary value. With money, this is not the case. We work all year long, producing things of value, and in the end our money decreases in value.

The thing is, as we create more and more wealth in the economy, shouldn't money, which is the representation of that wealth, be worth more?
 IgorFrankensteen
Joined: 6/29/2009
Msg: 69
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Posted: 2/27/2014 3:53:49 PM

If we make repairs on a home or improvements to a car then we expect it to be worth more. The time and effort we put into it makes it more valuable and we can expect some tangible benefits, in functionality, aesthetics or monetary value.


You are talking about a number of different things there.

First, set aside the idea that making improvements on a car causes it to be worth more. Cars are very tricky to develop value in. Most cars fall tremendously in value the moment you drive them off the lot, for reasons that have nothing to do with the cost or quality of the vehicle (though the better ones do retain more value than the cheaper ones).

Houses and real estate in general are market-linked. They rise and fall in value depending on the general economy, more so than on what you do with them. Again, of course, a house that is well maintained and improved, will always bring a better selling price than one that isn't. But as most any knowledgeable real estate person will tell you, how much you put into them, and your choice of improvements, wont always directly relate to how much they sell for later. In fact, there are lots of improvements that people spend to change their houses, which actually cause them to fall in value, even in a good market.


With money, this is not the case. We work all year long, producing things of value, and in the end our money decreases in value.

The thing is, as we create more and more wealth in the economy, shouldn't money, which is the representation of that wealth, be worth more?


If our money decreases in value through a year of labor, that has nothing at all to do with how hard we worked, or with how much wealth we created. The value of money is tied to other things entirely, which are beyond the control of a single working stiff. Inflation(the DECREASE in the value of money) and deflation (the INCREASE in the value of money) cause problems for everyone, depending on their position in the money-for-goods-and-services exchange. if you SAVE your extra money, and the economy suffers INFLATION, your savings will buy less for you at the end of the year, than you could have purchased if you had spent the money as you went along. If the economy DEFLATES, the opposite results would obtain. This is no doubt why so many rich people who are "investing" or saving their extra money, hope for DEFLATION, and why so many people who borrow money, hope for INFLATION.

Now, if you want to get into the relative injustices in how much real wealth a worker creates, versus how much money employers give them in return, that's another subject area entirely.
 Demigod1979
Joined: 12/4/2011
Msg: 70
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Posted: 2/27/2014 5:37:32 PM
You are talking about a number of different things there.

First, set aside the idea that making improvements on a car causes it to be worth more. Cars are very tricky to develop value in. Most cars fall tremendously in value the moment you drive them off the lot, for reasons that have nothing to do with the cost or quality of the vehicle (though the better ones do retain more value than the cheaper ones).

Houses and real estate in general are market-linked. They rise and fall in value depending on the general economy, more so than on what you do with them. Again, of course, a house that is well maintained and improved, will always bring a better selling price than one that isn't. But as most any knowledgeable real estate person will tell you, how much you put into them, and your choice of improvements, wont always directly relate to how much they sell for later. In fact, there are lots of improvements that people spend to change their houses, which actually cause them to fall in value, even in a good market.

I was making a general point. When you do maintenance or improvements on things like a house or vehicle then it is generally worth more afterwards (otherwise, what would be the point?).

If our money decreases in value through a year of labor, that has nothing at all to do with how hard we worked, or with how much wealth we created. The value of money is tied to other things entirely, which are beyond the control of a single working stiff. Inflation(the DECREASE in the value of money) and deflation (the INCREASE in the value of money) cause problems for everyone, depending on their position in the money-for-goods-and-services exchange. if you SAVE your extra money, and the economy suffers INFLATION, your savings will buy less for you at the end of the year, than you could have purchased if you had spent the money as you went along. If the economy DEFLATES, the opposite results would obtain. This is no doubt why so many rich people who are "investing" or saving their extra money, hope for DEFLATION, and why so many people who borrow money, hope for INFLATION.

My point is that as you work and produce goods and services, your money SHOULD buy more. Instead, inflation eats away at the value of money, driven by an ever-growing money supply, and within less than a century the value of our money has fallen 90+%. An inflation rate of 2% means that the value of your money will be halved about every 35 years (a bitter reward for 35 years of wealth-creation and productivity, don't you think?).

Of course you're right that inflation benefits some people, but that largely depends on the money system. In a debt-based money system such as ours, inflation is the healthy choice. Borrowers need a growing money supply to be able to pay interest costs, and inflation will eat away at the value of debt so it's good for people who are in debt. Inflation is also beneficial to banks, since it encouraged people to put their money in the bank to make it grow (sitting on cash is a bad idea). Deflation, on the other hand, would benefit a cash-based money system, where the vast majority of the money in the economy is existing money (or money that does not have an interest charge attached to it). In such a society money would only be created as needed, by the government or central bank, since only very little of it would be needed to pay interest charges. In such a society you wouldn't need to put your money in the bank to make it grow - it'll grow all by itself (sitting on cash is a good idea). Naturally, this latter kind of system makes banks almost redundant (they'd be relegated to just moving money around the economy to facilitate wealth-creation). The latter kind of system also makes being in debt disastrous, since the value of your debts will grow over time.

Now, if you want to get into the relative injustices in how much real wealth a worker creates, versus how much money employers give them in return, that's another subject area entirely.

I think that would require a separate thread altogether ;)
 bamagrl68
Joined: 11/14/2010
Msg: 71
Banks and the financial system
Posted: 2/28/2014 3:47:30 PM
demigod1979- A concept that would save a lot of people is an understanding of actual value verses inflated value.
Real estate is a perfect example.
When a house is brand new it is at it's highest actual value, the only way to increase it's value is to ad to the house.
Time decreases it's value.
Now, look at what happened during the craziness of the market before the crash.
You had houses that a few years before would have only sold for, say 150,000, going for 200,000.
The house wasn't really worth more, people were willing to pay more.
What is the value of anything? The answer is what someone is willing to pay for it.
People need to be smarter about taking on bad debt based on inflated value.
No one does that with cars, we all know they decrease in value to moment you drive it off the lot, so why would you do it with a house?
 IgorFrankensteen
Joined: 6/29/2009
Msg: 72
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Banks and the financial system
Posted: 3/1/2014 10:58:37 PM

I was making a general point. When you do maintenance or improvements on things like a house or vehicle then it is generally worth more afterwards (otherwise, what would be the point?).


The point is, that changes are made to your house so that YOU enjoy living in it more. Whether those changes increase or decrease the market value is a separate issue, unless the person making them uses only market tastes to decide what changes to make. This is specifically what I was referring to. There are lots of changes that people make to their houses, which are great for them, but which actually make them more difficult to sell later. There is no "natural" or intrinsic relationship between putting money into your house, and how much it will be seen to be worth by the market.


My point is that as you work and produce goods and services, your money SHOULD buy more. Instead, inflation eats away at the value of money, driven by an ever-growing money supply, and within less than a century the value of our money has fallen 90+%. An inflation rate of 2% means that the value of your money will be halved about every 35 years (a bitter reward for 35 years of wealth-creation and productivity, don't you think?).


I think we are talking about different things here. I suspect that you really aren't talking about "money being worth more" at all. I think what what you mean is, that as a person labors, their total life value should increase accordingly, such that they ought to be able to accumulate a lifetimes worth of wealth, in exchange for a lifetime of work. They should be able to buy more, not because their MONEY has changed in value, but rather because they have MORE of it, because they worked so hard.

As for measuring the value of money, that seems pretty tricky to me. I read all sorts of stories about how much you used to be able to buy for a nickel, but not all of the changes have been due to changes in the value of money. Sometimes it's been all about inflation and money supply, but many changes have come due to technological changes, which reduced the actual value of various things. When an item that used to require a hundred people, several days to make, can be made instead by a single person in a few hours or minutes, the actual value of that item can change. And further, changes in people's tastes can make a given product or service go from being a sure fire way for a guy to get rich, to being a sure fire way to be seen as the local nutcase who lives in that shack at the end of the alley.
 Coma_White
Joined: 9/15/2013
Msg: 73
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Posted: 3/2/2014 12:01:04 PM
One thing that disturbs me is the obsession with "virtual money" and how convenient it is. I've never been interested in bitcoin. I'd rather have a silver dollar that I can put in my sock drawer. I think a lot of kids will miss out on valuable lessons on how to save money if everything goes virtual. No more putting coins into books that organize them by year. No more putting quarters in a jar every time you swear or clean your room. I also like the idea of money physically trading hands with the goods. You give me a watch and I hand you $20. I think it's good for business too. People can feel the money in their hands and their pockets and they'll want to spend it or gamble with it, etc. No more "keep the change" if everything is clicking a button on your iphone. No more anonymous transactions (unless it's through a different medium like bitcoin).
Also, money will no longer have a historical value. People are collecting coins and bills from 1967 because of the silver content, the animals on the coins, and because they have value to collectors. In the future, we're going to say: "Hey, remember all that digital money I had in the bank? Wow, that was awesome." Your virtual money or bitcoins willl never be traded hundreds of times on ebay, creating tax revenue with each transaction. It will never be displayed at an antique store, bearing historic and national significance. You can't really put a gold medal winner from the Sochi Winter Games on some binary information stored in your electronic bank account. And like all fiat currency, it leaks purchasing power over time. Your silver dollars pre-1968 can buy roughly the same amount of goods they could when they were first distributed because of the silver content. A dollar you earn today won't buy a ten cent candy in fifty years. I think we're just moving in a direction where banks and the government will charge you fees for everything.
 MikeTO12345
Joined: 2/9/2014
Msg: 74
Banks and the financial system
Posted: 3/4/2014 7:03:12 AM
Let's not talk in aspect to money. Let's use gold bars. Let's say there's 100 gold bars in the economy. Let's say there's only one bank in this economy just to make things simple. Now let's say 80 gold bars are deposited in the bank. In the old days the bank could only loan out a certain percentage of money because that's all they had. It is not like today where you get a cheque or amount transfers to another bank. It's rare to be able to get $20 000 cash. It's possible but you would have to ask in advance, days or even weeks because the bank usually don't have enough cash to give out.

So let's say the bank loans out 40 gold bars. If some of the account holders want their gold bars back it's ok. But if you loan out higher it would be more difficult. If all 80 gold bars are loaned out then the bank is in trouble unless someone deposits.

What banks are doing now is loaning out more money than that's in supply. So someone is going to default on the loan or the bank will go under.

For me personally I don't borrow money any longer. I do have a student loan but that's it. I save money and if I need something I charge it on my credit card and pay it off when the bill arrives. No loans no default. Problem is people spend beyond their means which makes it easier for banks to take advantage of them.
 Demigod1979
Joined: 12/4/2011
Msg: 75
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History
Banks and the financial system
Posted: 3/5/2014 8:23:04 PM
I think we are talking about different things here. I suspect that you really aren't talking about "money being worth more" at all. I think what what you mean is, that as a person labors, their total life value should increase accordingly, such that they ought to be able to accumulate a lifetimes worth of wealth, in exchange for a lifetime of work. They should be able to buy more, not because their MONEY has changed in value, but rather because they have MORE of it, because they worked so hard.

Under the current system, we HAVE TO have more of it in order to have anything. A constant inflation rate means that the amount of money in the economy always exceeds the amount of goods and services produced every year. As it is now, we need a raise of 2% on average just to maintain our standard of living. On the other hand, if our money increased in value over time then we wouldn't need a raise at all. Our money would automatically buy more, in proportion to the goods and services produced. Our productivity will be its own reward, a kind of dividend that will allow us greater access to that increased wealth while making the same dollars as before (and of course our failure to produce will result in the opposite - our money will buy less). In other words, if we work hard then our money will buy more, and if we work less then our money will buy less. I mean, am I the only one who finds it strange that if we stop producing wealth (like in the Great Depression) then the value of our dollars actually increases?

A permanent money system also means that we, the people, would be in control of our own money, as opposed to the current system where the banks control the money. Currently, we have to hope and pray that the banks don't run into trouble, otherwise the wealth that we've built up over a lifetime can suddenly disappear (by controlling the money supply the banks own all the real wealth in the economy as well).

As for measuring the value of money, that seems pretty tricky to me. I read all sorts of stories about how much you used to be able to buy for a nickel, but not all of the changes have been due to changes in the value of money. Sometimes it's been all about inflation and money supply, but many changes have come due to technological changes, which reduced the actual value of various things. When an item that used to require a hundred people, several days to make, can be made instead by a single person in a few hours or minutes, the actual value of that item can change. And further, changes in people's tastes can make a given product or service go from being a sure fire way for a guy to get rich, to being a sure fire way to be seen as the local nutcase who lives in that shack at the end of the alley.

There seems to be a general consensus that the money supply affects prices in the long run, whereas many factors contribute to prices in the short-term. It's for this reason that the consumer price index, used for measuring inflation, usually only considers commodity items (with the exception of oil), since the price of other consumer items can fluctuate wildly in the short-term.
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