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 Demigod1979
Joined: 12/4/2011
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Banks and the financial systemPage 1 of 7    (1, 2, 3, 4, 5, 6, 7)
This thread is in response to the prostitution thread, which led to a side-discussion on the banking system. I want to discuss, in detail, how the current system works, what its implications are, and what we can do about it.

(Of course this is primarily for OMG!WTF! but anyone else can contribute as well)

So to start off, under the fractional-reserve banking system money is created by banks as interest-bearing debt. The banks create the principal of the loan, but not the interest, but demand principal + interest as "repayment". There is only one place where the interest can come from, and that's the general money supply (namely, the principal of other people's loans). 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). Of course it MIGHT be possible if the banks spent every single cent of interest that they earn back into the general economy, but of course there is no obligation (and in real life, they don't). Thus, the money supply must continually increase in order for current borrowers to avoid defaulting on their loans, resulting in an ever-growing money supply. And unless goods and services increase at the same rate, this will cause inflation, which is in modern times is targeted at around 2% a year (note that this grows exponentially, since it's 2% of the previous year's figure).

My question is, is this a superior money system compared to, say, one with a fixed money supply (e.g., actual physical money or equivalent) or one where money is created as value (this would be spending by government or banks that create things of value)? Is the current system the only one that can exist? Is permanent inflation unavoidable?

A second sub-topic I had in mind has to do with bank failures and their consequences. In the 2008 financial crisis the banks were bailed out by the government in order to save the financial system. This was done to avoid a complete meltdown of the financial system and the system of credit that fuels our economy (and most of us today who have jobs can be thankful for those actions). The problem is, there is no guarantee that the banks won't take such risks again, and what the tab will be next time. I've often times thought that the government should have temporarily nationalized the troubled banks or forced the bondholders of the bank to take a haircut (if even a fraction of bonds were converted to equity then a bailout might not have been necessary). Of course in the end, the crisis was resolved by changing an accounting rule, and the banks have long since paid back the bailout money.

My question for this is, what should be do about bank failures in the future? Should they be bailed out like before, allowed to go bankrupt or be nationalized?
 Demigod1979
Joined: 12/4/2011
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Banks and the financial system
Posted: 2/14/2014 7:19:53 PM
Yes, see comparisons to gold standard and great depression and why we do not use it.

Okay, how about a system where money is not created as debt? That is, a system where actual physical money would be created, instead of debt money that has to be continually created and destroyed.

Speaking of which, why is it that governments around the world take out loans from private banks (i.e., the Federal Reserve) when they can print all the debt-free money they want?

No, see the problems Japan has been facing with deflation over the last 20 years.

But that's the issue. With our current monetary system, there must be inflation in order for the economy to be prosperous; deflation or stagnation equals a sinking economy. Why is prosperity in our current economy incompatible with deflation?

Banks are now bigger than they were post crisis, if in the case of Iceland, you may not get a choice and the problem to big for the 'lender of last resort'. Protecting the economy is far more important than the bank so letting the bank go into receivership may be the only option next time.

Ah yes, I actually wished that the US government temporarily nationalized the big banks, who pretty much got away scott-free. You know, I found it ironic that Obama severely chastised the big three auto makers (one of the main victims of the credit crunch) while saying nothing about the big banks that got them into that mess in the first place (the main villains). Not that the big three had good businesses, but their fall came about primarily because of the economic shock produced by the financial crisis. I mean, during the Great Depression at least some people went to jail for their crimes (e.g., Richard Whitney). This time, no one did (aside from Madoff, but that was a different matter).

See Iceland's crisis recovery to understand why this statement isn't necessarily true.

Iceland's economy is relatively small though; what works for one country may not apply to the rest of the world (just like being debt-free is healthy for an individual while it's disastrous for the economy as a whole). Remember that the breaking point of the crisis came when AIG became a problem, which threatened to bring down large sections of the economy (viable large-scale businesses also became threatened with lack of credit, which they need to do business at all). The government had bet that the crisis from the fall of Lehmans could be contained but they were proven disastrous wrong when more than a trillion dollars of value was wiped out from the stock market the day after (as an institution trader, I watched as the value of my stocks, and the market as a whole, fell in ways that I had never seen before), and the safest financial assets were shown to be risky (it got so bad that the interest rate on short-term US debt actually became negative! Imagine that!).
 IgorFrankensteen
Joined: 6/29/2009
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Banks and the financial system
Posted: 2/14/2014 10:14:06 PM
I am only an Historian, and not that educated about economics, but I do know that you have a large number of things wrong in your understanding of how money stuff and banks actually work.

You are far from alone, and a lot of why so MANY people don't have a correct idea about where money comes from, is because the system has never been as straightforward as it ought to be.

To begin with, it is tremendously important to realize fully that MONEY, is a MEDIUM OF EXCHANGE OF VALUE. It is not itself valuable, especially now that so few places use precious metals to manufacture it.

There was a time long ago when money WAS the valuable item. Coins evolved from making decorative equivalents of reliable measures of precious metals, which people could use to facilitate trade. This was for the simple reason that people would meet, and find that though one wanted what the other had to offer, the other did not want in turn what the first had. Money provided a way to trade goods and services in a delayed fashion.

Basic, but very imprtant to start from.

SO now we have money, which REPRESENTS value, but has none itself. This is why a government can't simply print money in order to make everything happen. It has to REPRESENT something.

In the case of banks making loans, that began with them loaning money they got from other people who placed it in the bank for safe-keeping. A bank loan is not a gift. It is another exchange of values. They exchange present value, for future value. The person getting the loan is expected to generate NEW additional value, either for labor, or for some other increase in wealth (acquisition of more precious metals for example....called "mining"by some).

As for what was done in reaction to the near collapse, it was the same thing that was done in reaction to the Stock Market collapse that triggered the Great Depression long ago: most banks and related loan originators were required to increase the "fraction" of actual money they keep in their "vaults" to back the "virtual" money that they loan out.

One of the reasons why we stopped having precious-metal backed money in this country, was that it caused us to be limited to however much gold and/or silver which the government had in Fort Knox. No matter how much real wealth could be had via investment and work, it could not be pursued, unless loans could be made to support the ADVANCE payments required to go and get it. To allow the economy to expand as rapidly as there was wealth to be had, loan originators were allowed to loan money they did not have at all, not even in real value (such as real estate holdings).

The problems happen when money loaned out so far exceeds how fast the new wealth can be created, that those creating it default. The banks cease being able to make more loans, and so no further economic expansion is possible. And since loan originators also have to pay for things, when their income stops, so does their bill paying, and THEY are in trouble.

What went wrong most recently, was that loan originators were making loans against wealth that never existed to begin with, and was therefore never attainable. Speculation that real estate would increase in value all on its own, with nothing else at all happening in the economy, which it does not do.

The idea of increasing the fraction of cash they are required to keep on hand at all times to support their loans, is that this will put a limit on how much imaginary (i.e. future) money they can hand out in loans, thereby reducing overall risk.

As for bank failures themselves, I hope they do NOT do as the most wealthy people want them to do, and simply allow them to be liquidated. The only people who make out like bandits when a bank is liquidated, are the already rich people who can now buy the banks remaining assets (i.e. real estate, usually) for pennies on the dollar.

It's an idea designed to let your local richest citizens take COMPLETE ownership of all of your land when there's a crisis, at bargain basement prices.
 Demigod1979
Joined: 12/4/2011
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Banks and the financial system
Posted: 2/15/2014 7:55:38 AM

I'm not sure what you are driving at here? Actual physical money? We used to make actual physical money (silver coins) set on the gold standard but it is unwealdy. The fiat monetary system is much better in a crisis. Don't forget a bank has two main purposes, deposit and lending. It only has to keep a certain percentage called the capital tier ratio in case there is a run on the bank, the rest is lent out, this is how banks make money.

Sorry, should have been clearer. My point was, if banks loaned out existing money (along with existing interest) then there would be no problem. Existing money would circulate around the economy, facilitating trade, and only being created or destroyed as needed for the reasons of price stability. Instead, banks create brand new money whenever they make a "loan" and then have borrowers extract the interest out of other people's loans, which the banks have to continually create. It certainly creates a competitive market, but it also ensures that someone will always default, no matter how hard they work or what they produce. It also means that inflation is unavoidable, which devalues everyone's money.


This is called monetizing the debt. Just printing money devalues the currency because more people have more money to spend on goods, goods therefore go up... See Germany's problems after the war or Zimbabwe . If the government borrows and has the tax payer pay back the interest, the burden is spread and avoids hyperinflation.

Inflation only happens when there is more money relative to goods and services. If the government created new money for the purposes of expanding the economy and increasing trade (e.g., building roads and other infrastructure) then it would cause little to no inflation (and if it DID cause inflation then money can easily be taxed and taken out of circulation). Currently, the central banks are tasked with maintaining price stability, although they can only do so indirectly, and look to maintain at least a positive inflation rate.

The main problem with the government borrowing from private banks is that a large chunk of our taxes go towards servicing the national debt, which means we get less value for our money. In other words, we would be able to buy a lot more government services with our taxes if this wasn't the case.


What went wrong most recently, was that loan originators were making loans against wealth that never existed to begin with, and was therefore never attainable. Speculation that real estate would increase in value all on its own, with nothing else at all happening in the economy, which it does not do.

That's certainly a part of it, but I think it should be recognized that the reason they made such loans, and made them so widely, is due to securitization. By taking mortgages off the balance sheets of the mortgage originators it reduced their risk, increasing their willingness to make risky loans. The demand for these securitized products also increased demand for mortgages in ways that would normally not happen, and the demand for these products encouraged the investment banks to take on more and more leverage.

Subprime mortgages going bad, in itself, wouldn't cause the kind of crisis that happened in 2008 (there might be a mild recession, but that would be it). Securitization was what made it a crisis.


The idea of increasing the fraction of cash they are required to keep on hand at all times to support their loans, is that this will put a limit on how much imaginary (i.e. future) money they can hand out in loans, thereby reducing overall risk.

Yes, I think that was one of the main elements of the crisis. At the height of the credit boom investment banks like Lehman Brothers had a leverage ratio of something like 1:44. The thing is, those banks requested such increases and were able to get it. How do we prevent those banks from being able to take such risks in the future?


Deflation can be good in the sense you become more competitive in the world market. Because your goods are becoming cheaper to produce, overseas buyers see them as better value so you start generating wealth.

International trade depends more on currency appreciation/depreciation, not inflation/deflation (e.g., think about China and their currency manipulation).


You make it sound like inflation is a bad thing, don't forget your wages go up in line with inflation (that's what drives inflation) so 1 unit buys you a loaf of bread, next year your wages go up to 2 units but so does the price of bread. So you are no better off. If your wages do not go up, the loaf of bread cannot either. Eventually you either knock off a zero and reprint so a 100 unit currency becomes a 10 unit currency or like we have done in the uk, lose the lower end denominations.

Although there is a general expectations that employers will give raises in line with inflation, there is no actual obligation - my previous company gave out 1% raises, which meant I was losing money during that time (one of the reasons why I quit). Central banks target a 2% inflation rate - they do this to make sure there is enough money in the economy for previous borrowers to service their debts, while at the same time making sure that the depreciation in value won't break people's wallets (it has nothing to do with wages).
 IgorFrankensteen
Joined: 6/29/2009
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Banks and the financial system
Posted: 2/15/2014 9:09:57 AM
Some more misapprehensions, I think.


banks create brand new money whenever they make a "loan" and then have borrowers extract the interest out of other people's loans, which the banks have to continually create.


As I said, what loan originators are SUPPOSED to do, is not depend on those they make loans to, to extract interest out of other loans.

They are SUPPOSED to make loans supported by reliable future ACTUAL wealth creation.

The reason why the sub-prime thing turned into the mess it did, was because all those loan originators got insanely greedy, and decided to "create money" to loan out, supported by future wealth which they KNEW AT THE TIME was unlikely to come into being. What they did instead, was to play a financial game of musical chairs. They KNEW that sooner or later, chairs were going to be removed, and someone was going to be left holding a bag of empty, worthless promises. They disguised their bags of worthless promises under extra layers, called "derivatives," and sold them to other institutions as though they WERE viable, well supported loans. In the financial musical chairs game, that meant that they purposely and knowingly arranged it to be true, that if the music WAS ever turned off, that instead of only one chair, EVERYONE who was holding a bag of empty promises would have a chair removed.

So what turned the music off? The financial music always gets turned off, the moment someone actually calls upon a loan company to make good on their promise to provide ACTUAL wealth for the promises they gave in the past. In this case, the unfunded war expenses, and the unfunded tax revenues being given back to the rich by the government, constituted a call for ACTUAL wealth to be provided in exchange for all the promissory notes. Had the wars been launched, or the tax revenues given away at a time when everything financial was supported by REAL wealth, it is likely nothing special would have happened. Since it was done at a time when greedy people had been allowed to send out all that UNSUPPORTED imaginary money, the music went silent, and instead of a single chair, almost ALL the chairs were pulled at once.

That meant that suddenly NO ONE had any real wealth, which they could use to provide believable guarantees to vendors that they would ever receive real payment. The reason why the Government stepped in as they did, with BOTH major political parties support (until after the Dems got into power later, at which point the GOP started to lie, and pretended that they never had anything to do with emergency funding), was because they HAD learned from the Great Depression, that if all you do is wait for the dust to settle, that it will be a VERY long time before the economy naturally recovers.


My point was, if banks loaned out existing money (along with existing interest) then there would be no problem. Existing money would circulate around the economy, facilitating trade, and only being created or destroyed as needed for the reasons of price stability.


That is in fact what they used to do. The result of that practice, was that human beings needs expanded at a rate that vastly outstripped their ability to create new wealth, and a HUGE swath of permanently poor people was created. If we switch back to that, we will have a choice between massacring 75% of the existing population, AND limiting birthrates by law to match the rate of wealth production... or we will have to accept a return to the days when there were a very few very rich people at the top, a tiny few merchants in the middle, and a huge class of nearly starving peasants, locked in a state of continual poverty. This is, in fact, what some modern "conservatives" want to do, though they pretend that they simply want a return to "responsible banking," and claim that the natural consequences of such notions are not real.


I think it should be recognized that the reason they made such loans, and made them so widely, is due to securitization. By taking mortgages off the balance sheets of the mortgage originators it reduced their risk, increasing their willingness to make risky loans. The demand for these securitized products also increased demand for mortgages in ways that would normally not happen, and the demand for these products encouraged the investment banks to take on more and more leverage.

Subprime mortgages going bad, in itself, wouldn't cause the kind of crisis that happened in 2008 (there might be a mild recession, but that would be it). Securitization was what made it a crisis.


You have that halfway backwards. If instead, you said that UNREGULATED, and SELF-BLINDED securitization led to the crisis, you would be much closer to correct. Securitization is identical to basic banking. If the insurance company fails to properly vet the people it is insuring, then they will be opening themselves to having to pay out more in claims, than they ever had in investments.

Derivatives markets were ignored, and unregulated. They grew up in the shadow of the Great Deregulation fad started by the GOP under Reagan, and so even when various people repeatedly warned that there was danger there, no one acted. BOTH political parties are to blame for repeatedly and purposely turning a blind eye to the growing danger.

If securitization processes had been set up RESPONSIBLY, then there would have been no problem, because the people insuring the shaky loans would have told those about to make them, that they would lose all their insurance if they proceeded. They did not, and so the biggest financials insurance companies all failed (Lehman Brothers, as well as the Government insurance systems).
 OMG!WTF!
Joined: 12/3/2007
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Banks and the financial system
Posted: 2/15/2014 9:23:36 AM

Instead, banks create brand new money whenever they make a "loan" and then have borrowers extract the interest out of other people's loans, which the banks have to continually create.


If you're just going to stick with the same incorrect information you got from that spooky banking video making the rounds on Youtube, why would you start another thread? You've gotten the right answers already but you're not getting it.

Banks don't create money when they issue debt. People are not mandated to pay interest expenses with borrowed money. People can and often do create wealth. Inflation is organic and necessary.

http://www.ied.info/articles/an-honest-bank-is-so-simple-you-can-run-it/logical-reasons-proving-private-banks-do-not-create-money....


Every monetary textbook carefully describe how the Federal Reserve, a central bank, creates base money and the circulation of that base money is known as the money supply. Not taking a serious look and sloppy use of words has created a large following that believes private banks create money when all they do is maintain, or accelerate, the speed money is circulating.

The faster it circulates, the more money an economy has even though base money has not increased. These theorists cannot mention base money when they make the claim that “private banks create money.” To do so, would destroy their theory.


You should read the article. It's a good antidote for whatever it was you read/saw about banking.
 Demigod1979
Joined: 12/4/2011
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Banks and the financial system
Posted: 2/15/2014 11:20:58 AM

That meant that suddenly NO ONE had any real wealth, which they could use to provide believable guarantees to vendors that they would ever receive real payment. The reason why the Government stepped in as they did, with BOTH major political parties support (until after the Dems got into power later, at which point the GOP started to lie, and pretended that they never had anything to do with emergency funding), was because they HAD learned from the Great Depression, that if all you do is wait for the dust to settle, that it will be a VERY long time before the economy naturally recovers.

Even still, it took a lot of scare in order for the government to respond positively. Remember that the first vote on the bailout bill failed, sending markets into a nosedive (I think the Dow dropped more than seven-hundred points that day). It was only afterwards that they responded favorably. Tim Geithner was also peppered with questions about his controversial PPIP initiative to buy the toxic assets from the banks.

The ironic thing is that neither the bailout bill nor the PPIP fully resolved the issue with the banks. The bailout money may have kept them solvent for a while longer, but the way the crisis was finally resolved was when the banks were allowed to use in-house valuations for their derivatives, as opposed to mark-to-market. In the end, it was all a numbers game - all they had to do was change the law to allow them to use their own numbers and presto, problem solved, and we've not heard of derivative problems since.


That is in fact what they used to do. The result of that practice, was that human beings needs expanded at a rate that vastly outstripped their ability to create new wealth, and a HUGE swath of permanently poor people was created. If we switch back to that, we will have a choice between massacring 75% of the existing population, AND limiting birthrates by law to match the rate of wealth production... or we will have to accept a return to the days when there were a very few very rich people at the top, a tiny few merchants in the middle, and a huge class of nearly starving peasants, locked in a state of continual poverty. This is, in fact, what some modern "conservatives" want to do, though they pretend that they simply want a return to "responsible banking," and claim that the natural consequences of such notions are not real.

I don't mean to go back to gold-based money - I prefer fiat money myself. I also have no problem with banks creating money by lending, just the part where they charge interest that doesn't exist. Of course banks do spend most of that interest money so it gets put back into the real economy, but it will never sum up entirely so the money supply must necessarily always grow.


You have that halfway backwards. If instead, you said that UNREGULATED, and SELF-BLINDED securitization led to the crisis, you would be much closer to correct. Securitization is identical to basic banking. If the insurance company fails to properly vet the people it is insuring, then they will be opening themselves to having to pay out more in claims, than they ever had in investments.

Derivatives markets were ignored, and unregulated. They grew up in the shadow of the Great Deregulation fad started by the GOP under Reagan, and so even when various people repeatedly warned that there was danger there, no one acted. BOTH political parties are to blame for repeatedly and purposely turning a blind eye to the growing danger.

If securitization processes had been set up RESPONSIBLY, then there would have been no problem, because the people insuring the shaky loans would have told those about to make them, that they would lose all their insurance if they proceeded. They did not, and so the biggest financials insurance companies all failed (Lehman Brothers, as well as the Government insurance systems).

Yes, you're right, lack of oversight and regulation were big factors in this mess (probably the main factor, along with cheap credit). I think there was a movement by Brooksley Born to try to regulate these derivatives (make sure they actually had capital backing them up) but was shut down savagely by Greenspan and his ilk.

As a person who's traded derivatives, I know they can often times be useful (I can't trade actual physical gold, so I traded gold derivatives instead). I think one of the most tragic things is how these mortgage-backed securities were rated as triple-A by the rating agencies. Although the agencies have stated that their ratings are just their own "opinions", they should have done their job better (but of course then they would have missed out on those fat payments offered by the banks).


If you're just going to stick with the same incorrect information you got from that spooky banking video making the rounds on Youtube, why would you start another thread? You've gotten the right answers already but you're not getting it.

Banks don't create money when they issue debt. People are not mandated to pay interest expenses with borrowed money. People can and often do create wealth. Inflation is organic and necessary.

http://www.ied.info/articles/an-honest-bank-is-so-simple-you-can-run-it/logical-reasons-proving-private-banks-do-not-create-money....

The article is correct that the Fed is the only bank that is allowed to create money whole cloth. When other private banks create money they must do so on the basis of some asset that the borrower pledges. This would be fine in itself (once that loan is repaid the principal will be destroyed so it does not permanently increase the money supply), except the bank keeps the interest that it charges. In theory, and in practice, that same asset can be pledged over and over again for further loans, and each time there is an interest charge applied to it. Where do you think that interest money comes from?
 91MW
Joined: 2/12/2014
Msg: 8
Banks and the financial system
Posted: 2/15/2014 12:33:50 PM

My question is, is this a superior money system compared to, say, one with a fixed money supply (e.g., actual physical money or equivalent)...

Of course the gold standard is far superior to fait money. However, it will not do any good to explain why because in school and colleges people are taught Keynesian economics. Therefore, people will automatically reject facts that do not conform to their pre-conceived Keynesian beliefs. Prior to 1913 with the creation of the Federal Reserve, there was no inflation and our economy had its greatest growth. Since then the dollar has lost over 95% of its purchasing power.

Gold has maintained value for thousands of years. However, throughout history, all fait money falls to its intrinsic value of zero and so will the dollar. Show me one fait currency not backed by gold or something with real value that has survived for 200 years and I will say that you can disagreed my statements.
 IgorFrankensteen
Joined: 6/29/2009
Msg: 9
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Posted: 2/15/2014 12:48:32 PM
just the part where they charge interest that doesn't exist.


I have no idea what you are referring to with that. Interest that doesn't exist? Interest on a loan, is essentially a fee that the loan institution charges the borrower for the service of loaning the money to them. Are you referring to the fact that the income from the loan repayments, including interest, is counted as revenue for the loan institution, regardless of how the borrowers managed to come up with their payments? Or what?



Of course the gold standard is far superior to fiat money. However, it will not do any good to explain why because in school and colleges people are taught Keynesian economics. Therefore, people will automatically reject facts that do not conform to their pre-conceived Keynesian beliefs. Prior to 1913 with the creation of the Federal Reserve, there was no inflation and our economy had its greatest growth. Since then the dollar has lost over 95% of its purchasing power.

Gold has maintained value for thousands of years. However, throughout history, all fiat money falls to its intrinsic value of zero and so will the dollar. Show me one fait currency not backed by gold or something with real value that has survived for 200 years and I will say that you can disagreed my statements.


Please explain how the fact that the value of gold rises and falls constantly, meshes with your claim that it has maintained it's value for thousands of years.

Also note, that the reason why our economy grew so much before 1913, based on gold, was because gold was gushing out of the mines in the west. That gushing stopped.

You want to limit the economy to the quantity of metal that miners manage to find?
 91MW
Joined: 2/12/2014
Msg: 10
Banks and the financial system
Posted: 2/15/2014 1:35:18 PM
Please explain how the fact that the value of gold rises and falls constantly, meshes with your claim that it has maintained it's value for thousands of years.

I never said "it's." Gold's value may vary some but, unlike fait money backed by nothing, it always maintains value. Not that any facts are going the change the opinion of someone with Keynesian beliefs, show me any time in history that gold did not have value. I can give lots of examples where the value of fait money fell to zero. Zimbabwe is recent example.
 Demigod1979
Joined: 12/4/2011
Msg: 11
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Banks and the financial system
Posted: 2/15/2014 2:46:12 PM

I have no idea what you are referring to with that. Interest that doesn't exist? Interest on a loan, is essentially a fee that the loan institution charges the borrower for the service of loaning the money to them. Are you referring to the fact that the income from the loan repayments, including interest, is counted as revenue for the loan institution, regardless of how the borrowers managed to come up with their payments? Or what?

Sorry if I wasn't clear. What I mean is, the money creation process only creates the principal of the loan (it does not create the interest).


Gold has maintained value for thousands of years. However, throughout history, all fait money falls to its intrinsic value of zero and so will the dollar. Show me one fait currency not backed by gold or something with real value that has survived for 200 years and I will say that you can disagreed my statements.

What value? The $1300 it's worth now, the $1700 it was at the beginning of 2013 or the $800 it was in 2008? :p

If gold has value, it's purely aesthetic. Of course we're not the only animals who like shiny rocks and pebbles, but what actual value does it have? You can't eat gold, build a house with it, or use it for a tool or weapon. Plenty of other metals have far more utility than gold and other commodities have more intrinsic value (e.g., corn or rice, which can eat to stay alive).

As Igor stated before, money is a representation of wealth/value. It is a medium of exchange, which we use to buy real goods and services. Money itself has no value - what it buys does. IMO, the gold argument basically misses the point of money.
 IgorFrankensteen
Joined: 6/29/2009
Msg: 12
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Posted: 2/15/2014 4:21:51 PM

the money creation process only creates the principal of the loan (it does not create the interest).


Not trying to be difficult, but I still don't understand. I think that by "money creation" you are referring to the fact that loan institutions don't give anyone the ACTUAL wealth that they hold in their vaults, what they give instead is, essentially, a promise document which can be used in place of actual wealth, to buy things. Thus the equivalent of cash is "created," while the value it represents stays in the vault.

The interest which the loan institution expects to receive in return, is, of course, NOT handed to the people receiving the loan. It is not "created." In the loan institutions accounting (note I am NOT an accountant either), I believe that in some kinds of situations they are allowed to count the interest expected as an asset, even though it hasn't been created yet, while for other purposes, such as taxation, it doesn't count as being in existence until it is actually paid. Accounting is like that. Sometimes the "money" exists, and sometimes it doesn't, and everyone involved thinks this makes perfect sense.

The interest itself, is expected to be paid by the person getting the loan. They are expected to CREATE WEALTH in amounts sufficient to pay back the entire loan principle, plus the interest. The loan institution is NOT expected to create the interest wealth at all.

Are you perhaps thinking of the loan institutions who themselves borrow against, or use as purchasing power, the ANTICIPATED interest payments? If so, what is your concern about that common practice? It again relies upon the people who calculate the actual expected value of the anticipated interest payments, to do their job correctly, and not count bad investments. That all comes back to the decision by some greedy loan people, to over value loan applicants assets, and to make themselves rich from commissions for selling loans that are actually losses in disguise.
 flyguy51
Joined: 8/11/2005
Msg: 13
Banks and the financial system
Posted: 2/15/2014 4:59:07 PM

Gold has maintained value for thousands of years. However, throughout history, all fait money falls to its intrinsic value of zero and so will the dollar. Show me one fait currency not backed by gold or something with real value that has survived for 200 years and I will say that you can disagreed my statements.

No gold backed money has ever stood the test of time, either. Going to a gold standard just trades one set of potential problems for a whole slew of others. No type of currency is infallible.
 bamagrl68
Joined: 11/14/2010
Msg: 14
Banks and the financial system
Posted: 2/15/2014 5:49:54 PM
demigod1979- The issue is complex, but I'll start with what I believe is the heart of the problem.
There was a time when people didn't spend beyond their means, especially not to keep up with the Jonses. (sp?)
Houses were where you lived and people didn't have million dollar mansions with rooms nobody slept in. Diddo with multiple cars, tvs in every room etc.
Slow but sure, this wise mind set went away and now it's all about things.
Vultures took notice and are all too happy to fleece people with high interest debt. A sure bet that many will default, but that's not a problem with so many still stuck on the merri go round.
We need to give our selves a serious reality check and demand an end to this madness.
Outlawing pay day and car loans, at as high as 50% interest, would be a good place to start.
That and demand an end to a system where these people buy our politicians into office and then we scratch our heads and ask why things are the way they are.
 Demigod1979
Joined: 12/4/2011
Msg: 15
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History
Banks and the financial system
Posted: 2/15/2014 6:53:03 PM
Not trying to be difficult, but I still don't understand. I think that by "money creation" you are referring to the fact that loan institutions don't give anyone the ACTUAL wealth that they hold in their vaults, what they give instead is, essentially, a promise document which can be used in place of actual wealth, to buy things. Thus the equivalent of cash is "created," while the value it represents stays in the vault.

The interest which the loan institution expects to receive in return, is, of course, NOT handed to the people receiving the loan. It is not "created." In the loan institutions accounting (note I am NOT an accountant either), I believe that in some kinds of situations they are allowed to count the interest expected as an asset, even though it hasn't been created yet, while for other purposes, such as taxation, it doesn't count as being in existence until it is actually paid. Accounting is like that. Sometimes the "money" exists, and sometimes it doesn't, and everyone involved thinks this makes perfect sense.

The interest itself, is expected to be paid by the person getting the loan. They are expected to CREATE WEALTH in amounts sufficient to pay back the entire loan principle, plus the interest. The loan institution is NOT expected to create the interest wealth at all.

Are you perhaps thinking of the loan institutions who themselves borrow against, or use as purchasing power, the ANTICIPATED interest payments? If so, what is your concern about that common practice? It again relies upon the people who calculate the actual expected value of the anticipated interest payments, to do their job correctly, and not count bad investments. That all comes back to the decision by some greedy loan people, to over value loan applicants assets, and to make themselves rich from commissions for selling loans that are actually losses in disguise.

Okay, I'm going to try to explain this as clearly as I can, since it seems I've only been confusing you so far (sorry about that).

Here's an example of what I'm talking about. Let's start out with a blank economy, which has no loans yet and no money in the money supply. A bank is set up and the central bank infuses some base money into this bank. Five people then come to the bank looking for a loan of a thousand dollars each. The bank deems all them fit for a loan and creates an account for each person with a thousand dollars credited. The borrowers get to work and so now there is a total of $5000 in the money supply. Each person is then required to pay back their loan with 10% interest ($1000 + $100). My question is, will all five borrowers be able to pay back their loans? The answer is no, since the total amount owed by the borrowers is $5500 while there is only $5000 in the money supply. The difference is the interest, which was not created by the bank when it made the loans.

Hope this clears this up a bit.

Banks do loan out existing money. It is so simple I don’t understand your apparent confusion. Banks hold deposits and pay interest on the deposits. They lend that money out at a higher interest rate than they pay on their deposits. That is how they make a profit. How simple can it be? This is all regulated and they are not allowed to lend out more than the total of their deposits (in my country anyway).

Bank may have once operated as such, but they no longer do now. Under the fractional-reserve system, banks only have to hold a small portion of deposits and can lend the rest out, which becomes capital for more loans. The end result is that an initial amount of capital can result in a large amount of new debt money.

The Wikipedia article on fractional reserve banking (http://en.wikipedia.org/wiki/Fractional_reserve_banking) does a pretty good job of describing the money creation process (go to the article itself to see the actual table):

The table below displays the relending model of how loans are funded and how the money supply is affected. It also shows how central bank money is used to create commercial bank money from an initial deposit of $100 of central bank money. In the example, the initial deposit is lent out 10 times with a fractional-reserve rate of 20% to ultimately create $500 of commercial bank money (it is important to note that the 20% reserve rate used here is for ease of illustration, actual reserve requirements are usually a lot lower, for example around 3% in the USA and UK). Each successive bank involved in this process creates new commercial bank money on a diminishing portion of the original deposit of central bank money. This is because banks only lend out a portion of the central bank money deposited, in order to fulfill reserve requirements and to ensure that they always have enough reserves on hand to meet normal transaction demands.

The relending model begins when an initial $100 deposit of central bank money is made into Bank A. Bank A takes 20 percent of it, or $20, and sets it aside as reserves, and then loans out the remaining 80 percent, or $80. At this point, the money supply actually totals $180, not $100, because the bank has loaned out $80 of the central bank money, kept $20 of central bank money in reserve (not part of the money supply), and substituted a newly created $100 IOU claim for the depositor that acts equivalently to and can be implicitly redeemed for central bank money (the depositor can transfer it to another account, write a check on it, demand his cash back, etc.). These claims by depositors on banks are termed demand deposits or commercial bank money and are simply recorded in a bank's accounts as a liability (specifically, an IOU to the depositor). From a depositor's perspective, commercial bank money is equivalent to central bank money – it is impossible to tell the two forms of money apart unless a bank run occurs.


With a more realistic reserve ratio (3%) that $100 can create more than $3000 of new money. Of course banks can't just do this willy-nilly (they need to balance the loan amount with an asset that the borrower pledges), but the fact is that when a bank makes a "loan" new money is created.
 Doremi_Fasolatido
Joined: 2/14/2009
Msg: 16
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History
Banks and the financial system
Posted: 2/15/2014 7:02:59 PM
Interesting topic. Banks, large corporations ,government, all have something in common. They're all owned by a handful of wealthy individuals. More and more wealth is being concentrated into fewer and fewer hands than ever before.

To me it seems like it all meshes together like a daisy chain. One hand washing the other and copious amounts of cash exchanging hands in the process.

Bank nationalization... no. A complete review of banking Regs... yes. After said review by a politically balanced and financially educated panel changes could be suggested and or made. Keeping in mind the last disaster and wanting to prevent a re occurence.
 bamagrl68
Joined: 11/14/2010
Msg: 17
Banks and the financial system
Posted: 2/15/2014 8:56:28 PM
Doremi Fasolatido- Yup, but knowing the problem only goes so far in fixing it.
How do we stop a monster we all hand a hand in creating?
I still love the US but I can barely stand the direction things are going (and we have been on this road for a very long time) :(
 IgorFrankensteen
Joined: 6/29/2009
Msg: 18
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History
Banks and the financial system
Posted: 2/16/2014 2:08:33 AM

The borrowers get to work and so now there is a total of $5000 in the money supply. Each person is then required to pay back their loan with 10% interest ($1000 + $100). My question is, will all five borrowers be able to pay back their loans? The answer is no, since the total amount owed by the borrowers is $5500 while there is only $5000 in the money supply. The difference is the interest, which was not created by the bank when it made the loans.


You still appear to think that the problems come because of the interest not being created at the same time as the principle. You are ignoring the whole point of the transaction, which is WEALTH, and not MONEY creation.

Think of a simple agrarian example: the farmer borrows from the bank to buy seed and equipment. The bank 'creates' the money, by giving the farmer notes he can show or give to suppliers, in exchange for that seed and equipment.

He then goes about growing his crops, raising his livestock, etc. His labors CREATE WEALTH. His efforts create wealth of greater value than the amount of money he borrowed, because a bushel of corn is worth more than a hand full of corn seeds. From that now much greater wealth, he repays his loan to the bank, AND pays the interest, AND uses what's left, to feed himself and his family.

What you are leaving out of your calculations is the WEALTH creation, wherein the "virtual money" that the loan originator imagined into existence is balanced away (i.e. the loan principle is reduced to zero as it is paid back, so that money ceases to exist), and both the loan originator and the borrower come away with ACTUAL wealth, due to the entire transaction.

Where our economies have often gone wrong, is when powerful members also confuse "money" with "wealth," and make up little games to play with all the "virtual money," to make it appear that wealth is being created when in fact it is not. That's what the big real estate scam did. Property was over-valued, over and over again, until a single piece of property had had vastly more principle loan money CREATED on it's basis, than it actually represented.

It is the equivalent of if the farmer went to the bank for seed money, and the bank gave him TWO farms worth of seed money instead of one, and expected him to pay them back from ONE farm. Of course he couldn't do so, and they knew that he couldn't do so, but their plan was to sell his loan to another institution as though it WAS worth two farms. Everyone in the loans business saw the larger value being assigned to the farm, and believed that it was a REAL evaluation, and so they bought the loans, and in turn themselves loaned out much more money than their assets could possibly support.

In this simplified example, the whole idiocy would fall apart after a single growing season, when the farmer failed to bring in two farms worth of crops from a single farm. In our larger economy, it took many years of game playing before it was finally made clear that we had no where NEAR as much actual wealth being created from all the games being played, as the loan institutions pretended that there was. When this was revealed, all of the loan institutions, both the lying cheating scum, and the good ones, discovered that they didn't have the wealth they thought they had. Therefore they stopped making loans altogether, and scrambled to take back as many of the loans they HAD made, in order to pay their own debts.

No loans, means no seeds, means no farming, means no food for livestock, means no food for anyone.

And this is also why ideas like "returning to the gold standard" is ridiculous. In the days of gold-backed money, people STILL played the same greedy games, and pretended to have, or to expect to get, more gold than was actually likely to come out of the ground. It isn't what is used to back money that matters, it's whether real wealth is created or not.
 Demigod1979
Joined: 12/4/2011
Msg: 19
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History
Banks and the financial system
Posted: 2/16/2014 6:19:13 AM

I get it! Thing is, it isn't that straight forward, just think what would happen if there was only $5000 in circulation in the American economy, the economy couldn't grow. Counter, if there is too much then you get inflation.

Google money supply m1 - m3 for your answer.

Do the math. With a 3% reserve, the total amount of base money only represent a tiny fraction of the total money in an economy. On the other hand, long-term debt like mortgages can have interest charges that far exceed the principal. Unless a whole lot of new base money is created (and NOT used as a basis for loans), there will always be a shortage.


You still appear to think that the problems come because of the interest not being created at the same time as the principle. You are ignoring the whole point of the transaction, which is WEALTH, and not MONEY creation.

The point of the loan, for the bank at least, is to make money by charging interest. Will they overlook a borrower defaulting on their loan because they created wealth? I don't think so. A default is a default. No matter what new product/service/wealth the unfortunate borrower creates, in the end the bank will declare him/her a defaulter and will take it away.


He then goes about growing his crops, raising his livestock, etc. His labors CREATE WEALTH. His efforts create wealth of greater value than the amount of money he borrowed, because a bushel of corn is worth more than a hand full of corn seeds. From that now much greater wealth, he repays his loan to the bank, AND pays the interest, AND uses what's left, to feed himself and his family.

You're missing the point. Where is he supposed to get the money from? How can he pay back his loan if the money he needs is not available in the money supply? The fact is, unless some new money is put into the system, it is impossible for him to meet his obligations to the bank.

Of course in normal times, a borrower will usually have no problem paying back their loans with interest, assuming they work hard and make a useful product/service. What keeps the system going is that new loans are always being created in sufficient amounts to allow previous borrowers to earn the interest they need not to default. However, the truth is that at no point will every borrower be able to do so, and during periods of economic decline a shortage of new loans will mean lots of borrowers will be forced to default, simply due to the shortage of money. This is what happened in the Great Depression - a severe cutback on new loans caused the money supply to drop dramatically, leading to a huge number of defaults (it's not wealth that decreased, but the supply of money). It also means that society, as a whole, needs to be permanently in debt in order for it to be prosperous.


And this is also why ideas like "returning to the gold standard" is ridiculous. In the days of gold-backed money, people STILL played the same greedy games, and pretended to have, or to expect to get, more gold than was actually likely to come out of the ground. It isn't what is used to back money that matters, it's whether real wealth is created or not.

Yes, that's a crucial advantage that fiat money has over gold. When money is needed, it can easily be created, either by the central bank pumping money into the economy or by banks issuing credit. Having control over your currency is also important (the PIIGS countries would be fine today if they could print their own money). As flexible as it is though, it's still difficult to get the economy going again after a financial crash. What I find interesting about the current scenario is that growth is anemic, even though politicians have urged the banks to extend lending and the Fed has pumped hundreds of billions of dollars into the economy. This excess money is also not causing any inflation, since it's not being circulated.
 IgorFrankensteen
Joined: 6/29/2009
Msg: 20
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History
Banks and the financial system
Posted: 2/16/2014 7:50:29 AM
We are obviously still reading from different pages and even different libraries.



"You still appear to think that the problems come because of the interest not being created at the same time as the principle. You are ignoring the whole point of the transaction, which is WEALTH, and not MONEY creation."

The point of the loan, for the bank at least, is to make money by charging interest. Will they overlook a borrower defaulting on their loan because they created wealth? I don't think so. A default is a default. No matter what new product/service/wealth the unfortunate borrower creates, in the end the bank will declare him/her a defaulter and will take it away.


Yes, the loan originator makes money from the interest. No, they don't overlook a borrower defaulting because they created wealth, they DEPEND on the borrower creating wealth. That's what you aren't getting. The borrower is supposed to use the money they borrow, to create MORE than the same amount of wealth, so that they can pay back the principle as well as the interest.



Where is he supposed to get the money from?


I told you. He gets both the money to repay the principle, AND the money to pay the interest, by selling his labor created "wealth." In the case of the farmer, he sells his crops, and uses the profits to pay the bank, and to care for his family.

I really don't know why you aren't understanding this. The farmer does NOT create "money." He creates actual WEALTH, in the form of marketable crops. By selling them, he gets money to pay the bank. The bank then UNCREATES the "money" (i.e. the loan principle), and pockets the real wealth that the farmer gave them via the interest payments. The bank then "creates" the money again, to loan to someone else.

Where does the farmer get the money for his crops? Well, if you are postulating a world where ONLY the farmer and the bank exist, then you are right, the farmer is stuck, unless the bank wants to consume farm goods. If the farmer (or other entrepreneur) goes to the bank and wants to borrow money to try to create something the bank thinks no one wants, the bank wont make the loan.

I think what you need to work on, is a better understanding of the difference between cash as a medium of exchange, and money, and of what real wealth actually is. So far, you aren't getting that basic thing correct.

Referring back to the Gold fanatic guys, even with them, the real wealth is NOT in the gold itself. The real wealth is in what real things they can GET for the gold. You see, the story of King Midas wasn't JUST a sentimental ditty about how nice hugs are.
 Yule_liquor
Joined: 12/7/2011
Msg: 21
Banks and the financial system
Posted: 2/16/2014 8:41:29 AM

My question for this is, what should be do about bank failures in the future?


In the US, the Glass-Steagall act should be re-instituted; this would be a good start!
 nanshe1111
Joined: 2/7/2014
Msg: 22
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History
Banks and the financial system
Posted: 2/16/2014 9:21:48 AM
The monetary system in laymen's term without the mumbo jumbo that is meant to confuse us:
If you borrowed $100 from the bank. You would owe $100 + interest. How are you going to pay for that when you only have a hundred dollars?
The global economic situation right now is that, even if we gather all the money in circulation from all over the world, it is still not enough to pay the banks.
The monetary system is the greatest scam ever.
The end.
 nanshe1111
Joined: 2/7/2014
Msg: 23
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History
Banks and the financial system
Posted: 2/16/2014 9:44:36 AM
Our economic system is so outdated and stupid. We are measuring the health of the economy based on the amount of paper or digital money we have -- which has no real value instead of the actual amount of REAL resources we have. The measure should be, how much trees do we have, how much land, how much water, how much manpower do we have, etc?

It's horrifyingly funny when I saw an interview of Michiu Kaku and he said, we have the "know how" to build a spaceship that can travel way beyond Mars but we don't have enough money to build it. And I thought, WTF? I didn't know they build spaceships with money. I'm just kidding but does anyone see the picture here?

Another example: Every year people in Kenya, Ethiopia etc are dying of thirst because of the yearly drought. Politicians and Scientists said that it would cost an enormous amount of money build a plant, dam or whatever to help those people. Again, I'm like, you build dams with money? WTF? I'm sure that with 7 billion people on this planet we have enough manpower to build a freaking river there that connects to the ocean. F*ck we built pyramids with primitive technology but we can't dig the ground for water with all the advances we have in technology now. Start digging people!

Go Resource-based Economy!
 flyguy51
Joined: 8/11/2005
Msg: 24
Banks and the financial system
Posted: 2/16/2014 10:26:07 AM

Our economic system is so outdated and stupid. We are measuring the health of the economy based on the amount of paper or digital money we have -- which has no real value instead of the actual amount of REAL resources we have. The measure should be, how much trees do we have, how much land, how much water, how much manpower do we have, etc?

You claim our system is outdated, but the solution you propose is even more outdated by a large degree. You are actually getting into the very fundamental essence of an economy-- resources and their relative scarcity.

You mention the Great Pyramids. As confounding as they are technologically, they were built with brutally treated slave labor. In other words, the "cost" of those pyramids was paid for by forcefully taking the self-determination, health, and even lives of the slaves.

Surely you aren't suggesting that as a better system.
 Demigod1979
Joined: 12/4/2011
Msg: 25
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History
Banks and the financial system
Posted: 2/16/2014 11:15:44 AM

I told you. He gets both the money to repay the principle, AND the money to pay the interest, by selling his labor created "wealth." In the case of the farmer, he sells his crops, and uses the profits to pay the bank, and to care for his family.

And where does this money come from? There's only one place, the general money supply. And where does that come from? The vast majority comes from the principal of loans. Once again, if there is only $5000 in the money supply, yet borrowers need to pay back a total of $5500 then it is mathematically impossible for everyone to pay off their debts (you seem to be consistently missing this very basic point). The only way to avoid a default is to put more money into the money supply, which means creating more loans, but of course that just makes the debt hole bigger, necessitating even more loans.

It should be fairly obvious that paying a loan with the principal of another loan is the equivalent of paying one credit card bill with another credit card. Sure you can make your payments every month (at least for a while), but you have to add more and more debt to do so, with more and more interest to pay. Is this sustainable? Absolutely not. Eventually, it's going to collapse.


Yes there isn't enough base money to pay people off but that's the whole point of fractional reserve. Banks don't call all their debt in at the same time. This would cause a run on the bank and the whole system would crash.

http://en.wikipedia.org/wiki/Bank_run

None of this money is real (has no real value) it never really leaves the bank. The bank borrows $100 it can now lend $1000 on its tier 1 ratio. Joe takes his $1000 dollars and invests it (which ends up back in the bank which they can then lend out $10000 to other customers which ends up back in the bank...) over the 5 years Joe's investment has doubled, he now has $2000 dollars after repaying the principle plus interest, which is on deposit in the bank. The money is still in the system and has never left the system. Because the bank only has to hold 10%, they can lend out $20000 dollars to another customer... And so it goes on.

What the banks rely on is not everyone paying back or withdrawing all the money at the same time, there simply isn't enough, that's why it's a fractional system and fiat. Fiat money is based solely on faith.

See also http://en.wikipedia.org/wiki/Asset_liability_mismatch

And http://en.wikipedia.org/wiki/Duration_gap

The duration gap measures how well matched are the timings of cash inflows (from assets) and cash outflows (from liabilities).

Yes, that's precisely how it works. In order for the banking system to work at all, people need to have faith in it (after all, banks don't need to create IOUs if they have the actual money itself). They require people taking on debt and leaving their money in their bank account most of the time.


In the US, the Glass-Steagall act should be re-instituted; this would be a good start!

Yup, that would be a great start. That would naturally force the big banks to break up, making those too-big-to-fail banks just a bit smaller. Of course the banks would never agree to this, since being too big to fail means that the government will be forced to bail them out.


Our economic system is so outdated and stupid. We are measuring the health of the economy based on the amount of paper or digital money we have -- which has no real value instead of the actual amount of REAL resources we have. The measure should be, how much trees do we have, how much land, how much water, how much manpower do we have, etc?

Not sure about the resource-based economy part, but there are many ways of gauging societies that do not rely on GDP. The US may have the highest GDP (at least for now, China is quickly catching up) but it is far lower than other industrialized countries on others.

http://www.huffingtonpost.com/2013/09/09/world-happiness-report-happiest-countries_n_3894041.html

http://www.forbes.com/sites/christopherhelman/2013/10/29/the-worlds-happiest-and-saddest-countries-2013/
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