This is a fantastic page. I just have an issue with one of his points though:
> That banks do not have any special powers in relation to money creation
They most definitely do though: FDIC insured accounts have legal government backing—a random IOU from me can't achieve that, no matter how much anyone trusts me. Put another way, a bank deposit seems less like an "IOU" and more like a "WeOU"—"we (the bank or the government) owe you". That seems like quite a fundamental difference, no? It seems to distinguish "fake" and "real" money (or banks).
Hey, author here. Your criticism is correct. Deposit insurance is a fundamental difference between bank IOUs and non-bank IOUs. So it's incorrect for me to say that banks have _no_ special powers (still not even close to central bank's power though).
Hi author, excellent article. But I'm just not seeing the central premise that Werner is wrong in saying that banks are unique in their ability to create money. What Full Tilt Poker did was illegal, simply because they were not licensed as a bank. We do have a special class of institution in our society that is blessed with the ability to create money through fractional reserve that we call "banks". Do you mean regardless of law?
How confident are you on that point? I don't have a reference on me right at this moment but I expect it is illegal for a non-bank entity to hand out IOUs at scale. People would be arrested.
This article is misleading. Banks do ultimately create money. Even if you ignore the details and complexity of how this works, the empirical evidence is clear:
- How do you explain that the M2 money supply is always going up? Where is all that new money entering into the system? Government contracts funded by government bonds? If that was the case, government contractors would be getting very wealthy and everyone would be working for them (directly or indirectly)...
- How do you explain the recent, significant, almost instantaneous jump in stock prices of major tech companies after the Fed printed and injected trillions of new dollars into the economy? Did these corporations all suddenly score huge government contracts from the bonds which the government created? Seems more like investors and company insiders used loan money from banks to do stock buybacks or increase their positions.
- Under the model suggested by the article, how does one explain why there are so many millionaires are in the real estate industry? If you assume the opposite argument that banks are able to print money (directly or indirectly), the number of millionaires makes perfect sense since everyone buys houses using 'loans' from banks; so it's natural that all this free money from banks would constantly inflate real estate prices; each new generation of citizens would inflate the prices of the properties which were bought by the previous generation with increasingly larger loans from newly printed credit from their banks.
What is claimed by the article does not match the evidence, even the people have wised up to this scheme which is why Bitcoin and cryptocurrencies have been able to hold their value.
I agree with you, but as a non-expert in the matter, I have to add that banks are heavily regulated in that regard and have to deposits certain reserves to central banks (depending on the country) for that privilege. It's not that they operate differently than LLCs while having the privilege of insurance. They pay a price for that privilege, and we can argue whether that price is too low or not.
> Deposit insurance is a fundamental difference between bank IOUs and non-bank IOUs.
Deposit insurance is a fundamental difference but it's not the main difference. Individuals and most non-banks don't have access to Federal Reserve accounts and therefore access to reserves. The main distinction between a bank and a non-bank is the ability to create IOUs ultimately backed by reserves (whether they have sufficient amounts or not) which can only be created by the FR (and in this context) to back a bad IOU. Whether the new reserves go directly to backing up the IOU or indirectly via added liquidity is irrelevant. A bank can create a misguided IOU that defaults, which if too big to fail, is a liability that the FR and thus all holders of the IOUs, cash, and reserves must bear.
This is not entirely accurate. Suppose a fraudulent bank decided to credit my account with a trillion dollars. The federal reserve would not honor this IOU with actual dollars. This is in stark contrast to federal reserve's ability to create a trillion dollars. They could create an actual trillion dollars and give it to a corrupt politician. A regular bank does not possess this ability.
I love the IOU vs WeOU differentiation. Banks need to have licenses and adhere to strict regulations, which are checked at least yearly by auditors. (Joke: Unless you are a German bank, in which case you get checked only once-a-decade.) That is what makes banks special: They have legal backing, but also legal responsibility.
Side note regarding non-bank IOU: I found the idea of having a payment card from my grocery store very appealing. If they run out-of-cash, they can repay me in food, which I'm pretty happy to take at any time. However, that is not how it works in 2020. The grocery entity and the banking entity need to be separated, and have different licenses.
> The grocery entity and the banking entity need to be separated
Quite a few of the grocery chain cards here in Sweden have accounts backed by chain-owned banks. So at least here, the separation is not all that great.
Exactly... not all IOUs are created equal. Any bank that is part of the Federal Reserve System can create US Dollars, the most liquid and trusted form of money in the world presently.
It comes with the downside of being highly regulated. I have no idea if the weights and balances are correct, but it makes sense at the surface level that if you are risking the government’s money, you have to do it on their terms.
Seems like a great scam. Create a bank, go through the many many steps to obtain FDIC backing, pay out enormous loans to insiders, have a run on the bank, then everyone is made whole again while the fraudster skips town.
I understand that this is basically insurance fraud, but the money is gone long before the fraud occurs and the government must pay out, unlike a single insurer.
Quite true. Its also why we should find it deeply concerning when a tech company starts taking on some of the powers of a bank without any of the responsibilities of a bank.
Facebook's digital currency system is one recent example. Paypal's behavior is a much longer-running example.
The article doesn’t adequately cover the role of central banks in fractional reserve banking.
Back in the days of the gold standard you used to be able to redeem a set weight of physical gold from the central bank for a dollar / pound of paper cash or minted coin. This conversion ratio was set by the central bank and acted as a final brake on inflation. When the gold standard was abolished and the dollar and pound became free floating fiat currency, it only became worth something because the government says it is. The “I promise to pay the bearer x pounds/ dollars” is just a hangover from the gold standard days when you could redeem money for gold directly from the central bank rather than through a private gold dealer. Now you can only redeem an equivalent amount of fiat currency at the central bank if day your dollar / pound note becomes damaged.
Banks can create deposits / reserves at the central bank out of nothing, they just have to promise to pay the central bank back at a later date, plus an equivalent amount of interest equal to the central bank set interest rate. This is how the central bank regulates the interest rate in the economy. If a bank charges another bank a higher level of interest for lending than the central bank, that bank can just go to the central bank instead and get charged the lower central bank interest rate. This acts as a brake on maximum inter-bank interest rates and ultimately what interest rates are charged by end consumers. The same is true for cash deposits, the central bank acts a floor / minimum interest rate for deposits as the central bank will pay interest at the central bank interest rate for deposits held at the central bank.
> it only became worth something because the government says it is
That's the only nitpick I have against your otherwise excellent comment: it's not that government says it is, it's the societal consensus that it's worth it.
Of course, government is usually a pretty big entity it the country's economy, and since it uses the currency for all of it's transactions, currency acquires some value at least from these transactions alone; however, if the society as a whole loses trust in the currency, government will not be able to define it's worth. And when it tries, it just leads to black market, barter-based economy and even deeper economical collapse.
That’s where the term legal tender comes from. Society is legally mandated to accept whatever is determined by the government as legal tender for the settlement of debts. However, this does not include everyday transactions, only the settlement of debt. A trader can accept or deny any currency or form of barter as long as it is not for the settlement of debt.
This is why the Scots are wrong to get in a fuss about shops not accepting Scottish bank notes, as shops are not legally obligated to accept them as legal tender does not apply in this case. Also, Scottish bank notes are not actually legal tender anyway.
> it's not that government says it is, it's the societal consensus that it's worth it.
Disagree. The government only accepts their preferred currency for payment of taxes. This is, in my opinion, its initial source of value. Secondly, they may literally stop you from using an alternative currency if they can't figure out how to tax it.
1) Politicians around the world are circumventing central banks with special laws, guaranteed loans programs.
2) Central banks can just "temporarily" buy treasury bills with fictional money -- the only thing keeping us from Weimar inflation is the fact the money hasn't trickled down enough, the population is on the decline, and most of the money goes into propping up asset prices.
Gold itself only became worth something because the government says it is. Or rather, it became worth far more once governments started demanding that taxes be paid in gold. Before that it probably wasn't worth all that much, because despite its rarity it wasn't useful for much in the ancient world. Gold isn't some magic substance with intrinsic value.
Also, a key idea of Graeber's book is that money is in fact debt (the example with English soldiers checks being used as bills in Hong Kong bars is quite striking in my opinion).
Money is basically a small abstraction over explicit debt bonds linked to material goods, making it more easily exchangeable.
This comes from the fact most economic chains are far from synchronous (example: a farmer needing tools to prepare his field, but being able to pay for said tools only after the harvest, the blacksmith needing coal and iron ore to produce said tools, but not being able to pay until the farmer has paid him, etc).
In this context, the banker (or any other lender) acts as an intermediary, evaluating if the debt can be repaid and bearing the risk instead of the creditor for a fee.
This is misleading. Gold was replaced by other assets, notably 'T-Bills'.
Basically, USD are backed by Government debt, instead of Gold.
To imply the Fed just 'says it is' is misleading.
Since 2008 a lot of the assets on Fed balance sheets are mortgages = notably, underwater mortgages bought by the Fed at face value from banks that were going bankrupt.
But I think the point about Gold->Other Assets is important.
Euros are backed by assets as well.
RMB is the major currency based on the magic will of one man, Xi, who can effectively control currency with the press of a button. We think that is 'bad' because money should be separate from governance, but they look at it differently apparently.
So imagine if Johnson, Macron, Trudeau, Trump etc. could literally decide how much money to 'print', to which banks it goes, and to whom the loans would be made, and under what terms.
This is they key limitation on RMB becoming a truly 'global currency'.
The article is a very worthwhile read though, so as to dispel a lot of conspiracy theories about banking.
Funny enough, there is a lot of shady activity in banking, but it takes a good understanding I think to make sense of it.
Question: Why isn't a one dollar bank note worth more than one dollar in my bank account, since the bank note can be used to pay back the central bank?
Because the dollar in your bank account is an obligation of the bank to pay you a one dollar bank note or another bank a central bank electronic reserve dollar.
Loaning money drives inflation; when a loan check is created, it spends just like cash, except the banks, behind the scene's, trade the loan checks so everyone has enough cash on hand to appear solvent.
Inflation drives interest rates; interest consists of the rate of inflation plus risk and margin, no bank is going to make a loan at less the rate of inflation. This self-regultes the rate of loans; the first people to take out loans gets them cheaper than late comers and have more favorable pricing.
Business loans drive companies to leverage capital by taking out loans using their business as collaterol in order to capture market share (and rarely, creating new markets or shrinking existing ones through technological change). If they do not do this, they will be driven out of business.
Net on net, because the markets are not expanding at pace with interest, prices rise. I like to think of this as the accumulation of cumulative interest; effectively when every business in a supply chain has to pass its labor and material through a bank loan, the end product becomes much more expensive than production cost.
Cumulative interest acts as a tax on the velocity of capital, and when that stagnates, business revenues drop and companies\people begin to play a game of musical chairs of solvency.
What this is supposed to do, in theory, is kill off rotten businesses and ownership, and provide a capital market to ensure the economy can continue expanding and when you have commonwealth companies; companies that pay majority profits to employee's and put employee welfare and interests first; this works because employee's invest in the company during downturns to reap profits in upturns.
In practice, in every downturn, wages stagnate because businesses shed labor and do not have to compete for labor during the upturn. Governments are motivated to assure labor shortages are solved because paying staff more because they demand it never improves profitability of a business and is always a serious detriment. Because wages stagnate and do not recover, the profits from upturns are captured by ownership and investorship.
This cycle, historically, is not new, and tends to repeat until the people become so impoverished they lose their concept of self repect and dignity and actually think burning things and killing people are effective means to solving their problems which tends to break down systems of government and force governemnts to devolve to basal forms such as tyrranies, dictatorships or autocracies out of necessity.
E.G. Many western countries have negative fertility rates despite being the most technologically advanced societies in recorded history, and the way governments are assuring labor shortages do not occur is through replacement-level immigration which further radicalizes politics (it provides people making arguments about genocide with a lot of convincing empricial evidence in favor of their argument).
FRB is the system where a bank is required to have a reserve of X% before it can issue money, while in the current system the banks first emits money and then (in the US) it attempts to get a reserve[0] for that (and in the EU, it doesn't either, tho there are liquidity requirements).
I think there's a mixup between what most people who have no idea what they're talking about (almost everyone including self) mean when they say fractional reserve banking and the technical meaning.
People mean:
Bank has less "hard cash/assets" than deposit liabilities
Technical meaning:
The bank is legally/practically constrained to a fixed minimum reserve fraction of liabilities to harder assets
So banks DO have a "fractional reserve" even when not practising technical "fractional reserve banking"...
I think
So you think this is not fractional reserve banking because instead of having the fractional reserve of X% beforehand they get the fractional reserve of X% right afterwards?
> For example, when you make a bank transfer to another bank, the bank can not simply send over money created by itself.
Uhh, yes it can. That's what LIBOR is (supposed) to represent - short term unsecured lending between major banks. I.e. they can agree that the sending bank is now slightly more indebted to the receiving bank. It depends on what the involved banks agree on.
And because such things are based on trust they do blow up sometimes. For example during the panic in March there was a pretty wide gap between FRA rates (unsecured lending) and OIS rates (secured lending). FRA was quite a bit higher.
Edit: let me just add that this does not invalidate the rest of the article.
Thanks for this feedback. I have now updated the article substantially. The new version covers the possibility of banks lending money to each other as opposed to settling a transaction with cash/reserve deposits. Diffs: https://github.com/baobabKoodaa/blog/commit/c2f7fef53d621acc...
The various types of money usually have interest rates associated with them, and those rates tell you about the relationships between the types of money. For example there is an interest rate differential between the central bank money and the US treasuries (which are equivalent to USD money for most people most of the time), captured by the repo rate minus IOER. This differential blew up quite recently (in 2019), showing a temporary divergence between tbills and "real money".
In the past, before central banks, each region of the US had their own money, and merchants had conversion tables. They would literally tell you that, for example, Boston money is worth for me only 80 cents on the dollar. Much like today we quote prices on bonds.
Robert Shiller has some really good finance lectures on YouTube. The one about central banking:
I think "fundamental" is a treacherous concept for explaining money creation.
Both this article and the stuff Atte is responding to end up with "X is merely Y" explanations. The (arguable, but widely accepted) reality of macroeconomic and monetary dynamics is that it is not merely microeconomics. A layer of emergence separates the two.
It's true that what banks do is not fundamentally different to what full tilt poker did. Even the "bank run" parallels the many bank runs in history, and associated monetary collapse.
You can find other parallels too. My favourite is employees. Say you have no money. You hire 10 people clean pools, with salaries due at the end of the month. They work. You get paid. If you get paid enough, you can pay salaries on time and make profit.
This is the same principle as monetary stimulus, where a government makes loans to stimulate economic activity. We do call that money creation, but it's not fundamentally different to what every employee does.
IRL, a poker site or pool cleaning business will (almost) always hit a point of reversal. Expansion becomes deflationary rather than inflationary. Further growth requires capital, rather than generating it. The business models that don't do reach levels where their money creation starts to have macro-scale effects. These tend to join the financial sector (eg, the stock market), where they are regulated in some fashion to curb monetary inflations and deflations.
What makes banks qualitatively different is stability. They can do this long term, continuously increasing scale, without bank runs. Quantity is a quality of its own. If banks expand mortgage lending, real estate will inflate... either with higher prices or with more building. This isn't money that was redirected from one sector to another. It's new money.
This is why monetary policy isn't just central banking. It's regulators. The regulator controls this sort of activity (eg mortgage lending) in order to regulate the supply of money.
It's not the wild west, though. The Central Bank do know how much these banks are issuing; and also differentiate between the different kinds of money. And not only banks issue money, other financial institutions do also issue some kind of money. From Wikipedia (https://en.wikipedia.org/wiki/Money_supply)
- M0: In some countries, such as the United Kingdom, M0 includes bank reserves, so M0 is referred to as the monetary base, or narrow money.[20]
- MB: is referred to as the monetary base or total currency.[17] This is the base from which other forms of money (like checking deposits, listed below) are created and is traditionally the most liquid measure of the money supply.[21]
- M1: Bank reserves are not included in M1.
- M2: Represents M1 and "close substitutes" for M1.[22] M2 is a broader classification of money than M1. M2 is a key economic indicator used to forecast inflation.[23]
- M3: M2 plus large and long-term deposits. Since 2006, M3 is no longer published by the US central bank.[24] However, there are still estimates produced by various private institutions.
- MZM: Money with zero maturity. It measures the supply of financial assets redeemable at par on demand. Velocity of MZM is historically a relatively accurate predictor of inflation.[25][26][27]
By the way, you can issue money too. Let's say you buy a computer for $1.000 and promise the seller that you are going to pay him $1.050 by next year. You just issued $1.050 of M2.
Counter-intuitively, this money supply system is helping developed countries control inflation. In some developing countries, inflation is harder to control because people are issuing money on their own.
I’d recommend ‘Money As Debt’ if you’re interested in this subject. It’s done as a cartoon but makes it really easy to understand why the world works like this and what the big problems are with it.
Namely that if money is created only when you lend it to people, but they have to pay back what you created + interest, there is never enough money to pay all debts back. So bankruptcy is built into the system. It’s like musical chairs. It has to happen.
Paying back all debt would mean there was no more money! What would that even look like?
It was years since I saw 'Money as Debt' but I remember it as quite flawed in its arguments.
Let's say there's a silly town with a single evil bank. The good people borrow a hundred dollars in total. Horror! The evil bank is now owed one hundred and ten dollars. This can never be repayed, there is not enough money!
Except the good janitor at the bank has his wage of ten dollars credited to his account by the bank for the value created by his labour. He pays the grocer, the landlord and so on and now the silly town people can pay all their loans, should they ever want to.
And then the old grocer dies and his estate defaults on its debts. And it turns out the bank overvalued his house. The banks is now down ten dollars on its loan assets. But the bank still has its liabilities to the other good town people the grocer paid when he took out the loan. Suddenly the town can pay back all their debts and still have ten dollars left owed to them by the bank! The evil bankers are foiled.
'Money as Debt' goes to all this trouble to explain that money is debt. Then we are supposed to be shocked by the fact that debt can be created by no more than signing a paper! It's stupid.
Well I, like many people. was very surprised money is created that way. And your fictional town doesn’t seem to work much like anywhere else. All the banks seem to be doing fine just fine. Houses usually go up in value not down so when someone defaults on a loan the bank makes money rather than loses it. With the exception of the credit crunch (where we all just gave the banks our hard earned money instead)
But, probably more importantly, that relies on an ever increasing economy, which relies on ever increasing use of natural resources, which = earth is screwed.
Readit News
> That banks do not have any special powers in relation to money creation
They most definitely do though: FDIC insured accounts have legal government backing—a random IOU from me can't achieve that, no matter how much anyone trusts me. Put another way, a bank deposit seems less like an "IOU" and more like a "WeOU"—"we (the bank or the government) owe you". That seems like quite a fundamental difference, no? It seems to distinguish "fake" and "real" money (or banks).
Yes, but that is relatively recent development. Bank money (and IOU-based money creation) is much older than deposit insurance.
I'm thinking of things like https://en.wikipedia.org/wiki/Liberty_dollar_(private_curren... which ended in FBI raids.
- How do you explain that the M2 money supply is always going up? Where is all that new money entering into the system? Government contracts funded by government bonds? If that was the case, government contractors would be getting very wealthy and everyone would be working for them (directly or indirectly)...
- How do you explain the recent, significant, almost instantaneous jump in stock prices of major tech companies after the Fed printed and injected trillions of new dollars into the economy? Did these corporations all suddenly score huge government contracts from the bonds which the government created? Seems more like investors and company insiders used loan money from banks to do stock buybacks or increase their positions.
- Under the model suggested by the article, how does one explain why there are so many millionaires are in the real estate industry? If you assume the opposite argument that banks are able to print money (directly or indirectly), the number of millionaires makes perfect sense since everyone buys houses using 'loans' from banks; so it's natural that all this free money from banks would constantly inflate real estate prices; each new generation of citizens would inflate the prices of the properties which were bought by the previous generation with increasingly larger loans from newly printed credit from their banks.
What is claimed by the article does not match the evidence, even the people have wised up to this scheme which is why Bitcoin and cryptocurrencies have been able to hold their value.
Deposit insurance is a fundamental difference but it's not the main difference. Individuals and most non-banks don't have access to Federal Reserve accounts and therefore access to reserves. The main distinction between a bank and a non-bank is the ability to create IOUs ultimately backed by reserves (whether they have sufficient amounts or not) which can only be created by the FR (and in this context) to back a bad IOU. Whether the new reserves go directly to backing up the IOU or indirectly via added liquidity is irrelevant. A bank can create a misguided IOU that defaults, which if too big to fail, is a liability that the FR and thus all holders of the IOUs, cash, and reserves must bear.
Side note regarding non-bank IOU: I found the idea of having a payment card from my grocery store very appealing. If they run out-of-cash, they can repay me in food, which I'm pretty happy to take at any time. However, that is not how it works in 2020. The grocery entity and the banking entity need to be separated, and have different licenses.
Quite a few of the grocery chain cards here in Sweden have accounts backed by chain-owned banks. So at least here, the separation is not all that great.
Deleted Comment
I understand that this is basically insurance fraud, but the money is gone long before the fraud occurs and the government must pay out, unlike a single insurer.
Facebook's digital currency system is one recent example. Paypal's behavior is a much longer-running example.
Back in the days of the gold standard you used to be able to redeem a set weight of physical gold from the central bank for a dollar / pound of paper cash or minted coin. This conversion ratio was set by the central bank and acted as a final brake on inflation. When the gold standard was abolished and the dollar and pound became free floating fiat currency, it only became worth something because the government says it is. The “I promise to pay the bearer x pounds/ dollars” is just a hangover from the gold standard days when you could redeem money for gold directly from the central bank rather than through a private gold dealer. Now you can only redeem an equivalent amount of fiat currency at the central bank if day your dollar / pound note becomes damaged.
Banks can create deposits / reserves at the central bank out of nothing, they just have to promise to pay the central bank back at a later date, plus an equivalent amount of interest equal to the central bank set interest rate. This is how the central bank regulates the interest rate in the economy. If a bank charges another bank a higher level of interest for lending than the central bank, that bank can just go to the central bank instead and get charged the lower central bank interest rate. This acts as a brake on maximum inter-bank interest rates and ultimately what interest rates are charged by end consumers. The same is true for cash deposits, the central bank acts a floor / minimum interest rate for deposits as the central bank will pay interest at the central bank interest rate for deposits held at the central bank.
That's the only nitpick I have against your otherwise excellent comment: it's not that government says it is, it's the societal consensus that it's worth it.
Of course, government is usually a pretty big entity it the country's economy, and since it uses the currency for all of it's transactions, currency acquires some value at least from these transactions alone; however, if the society as a whole loses trust in the currency, government will not be able to define it's worth. And when it tries, it just leads to black market, barter-based economy and even deeper economical collapse.
This is why the Scots are wrong to get in a fuss about shops not accepting Scottish bank notes, as shops are not legally obligated to accept them as legal tender does not apply in this case. Also, Scottish bank notes are not actually legal tender anyway.
Disagree. The government only accepts their preferred currency for payment of taxes. This is, in my opinion, its initial source of value. Secondly, they may literally stop you from using an alternative currency if they can't figure out how to tax it.
1) Politicians around the world are circumventing central banks with special laws, guaranteed loans programs.
2) Central banks can just "temporarily" buy treasury bills with fictional money -- the only thing keeping us from Weimar inflation is the fact the money hasn't trickled down enough, the population is on the decline, and most of the money goes into propping up asset prices.
See Debt: The First 5,000 Years by David Graeber.
Money is basically a small abstraction over explicit debt bonds linked to material goods, making it more easily exchangeable.
This comes from the fact most economic chains are far from synchronous (example: a farmer needing tools to prepare his field, but being able to pay for said tools only after the harvest, the blacksmith needing coal and iron ore to produce said tools, but not being able to pay until the farmer has paid him, etc).
In this context, the banker (or any other lender) acts as an intermediary, evaluating if the debt can be repaid and bearing the risk instead of the creditor for a fee.
This is misleading. Gold was replaced by other assets, notably 'T-Bills'.
Basically, USD are backed by Government debt, instead of Gold.
To imply the Fed just 'says it is' is misleading.
Since 2008 a lot of the assets on Fed balance sheets are mortgages = notably, underwater mortgages bought by the Fed at face value from banks that were going bankrupt.
But I think the point about Gold->Other Assets is important.
Euros are backed by assets as well.
RMB is the major currency based on the magic will of one man, Xi, who can effectively control currency with the press of a button. We think that is 'bad' because money should be separate from governance, but they look at it differently apparently.
So imagine if Johnson, Macron, Trudeau, Trump etc. could literally decide how much money to 'print', to which banks it goes, and to whom the loans would be made, and under what terms.
This is they key limitation on RMB becoming a truly 'global currency'.
The article is a very worthwhile read though, so as to dispel a lot of conspiracy theories about banking.
Funny enough, there is a lot of shady activity in banking, but it takes a good understanding I think to make sense of it.
Inflation drives interest rates; interest consists of the rate of inflation plus risk and margin, no bank is going to make a loan at less the rate of inflation. This self-regultes the rate of loans; the first people to take out loans gets them cheaper than late comers and have more favorable pricing.
Business loans drive companies to leverage capital by taking out loans using their business as collaterol in order to capture market share (and rarely, creating new markets or shrinking existing ones through technological change). If they do not do this, they will be driven out of business.
Net on net, because the markets are not expanding at pace with interest, prices rise. I like to think of this as the accumulation of cumulative interest; effectively when every business in a supply chain has to pass its labor and material through a bank loan, the end product becomes much more expensive than production cost.
Cumulative interest acts as a tax on the velocity of capital, and when that stagnates, business revenues drop and companies\people begin to play a game of musical chairs of solvency.
What this is supposed to do, in theory, is kill off rotten businesses and ownership, and provide a capital market to ensure the economy can continue expanding and when you have commonwealth companies; companies that pay majority profits to employee's and put employee welfare and interests first; this works because employee's invest in the company during downturns to reap profits in upturns.
In practice, in every downturn, wages stagnate because businesses shed labor and do not have to compete for labor during the upturn. Governments are motivated to assure labor shortages are solved because paying staff more because they demand it never improves profitability of a business and is always a serious detriment. Because wages stagnate and do not recover, the profits from upturns are captured by ownership and investorship.
This cycle, historically, is not new, and tends to repeat until the people become so impoverished they lose their concept of self repect and dignity and actually think burning things and killing people are effective means to solving their problems which tends to break down systems of government and force governemnts to devolve to basal forms such as tyrranies, dictatorships or autocracies out of necessity.
E.G. Many western countries have negative fertility rates despite being the most technologically advanced societies in recorded history, and the way governments are assuring labor shortages do not occur is through replacement-level immigration which further radicalizes politics (it provides people making arguments about genocide with a lot of convincing empricial evidence in favor of their argument).
Dead Comment
The paper is short and concise enough and the diagrams are very helpful to the uninitiated.
Money Creation in the Modern Economy: https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...
Would be cool to make it even more accessible. Something that can be shared virally via WhatsApp by my aunt. :D
I don't think that is fractional reserve banking.
FRB is the system where a bank is required to have a reserve of X% before it can issue money, while in the current system the banks first emits money and then (in the US) it attempts to get a reserve[0] for that (and in the EU, it doesn't either, tho there are liquidity requirements).
[0] https://en.wikipedia.org/wiki/Reserve_requirement
People mean: Bank has less "hard cash/assets" than deposit liabilities Technical meaning: The bank is legally/practically constrained to a fixed minimum reserve fraction of liabilities to harder assets
So banks DO have a "fractional reserve" even when not practising technical "fractional reserve banking"... I think
I do agree that, 0 being an integral, that name lost its meaning, but it's still the same thing, so people keep using the same name.
[1] https://www.deflation.com/Articles/The-Roving-Cavaliers-of-C...
[2] https://researchdatabase.minneapolisfed.org/concern/parent/b...
Uhh, yes it can. That's what LIBOR is (supposed) to represent - short term unsecured lending between major banks. I.e. they can agree that the sending bank is now slightly more indebted to the receiving bank. It depends on what the involved banks agree on.
And because such things are based on trust they do blow up sometimes. For example during the panic in March there was a pretty wide gap between FRA rates (unsecured lending) and OIS rates (secured lending). FRA was quite a bit higher.
Edit: let me just add that this does not invalidate the rest of the article.
The various types of money usually have interest rates associated with them, and those rates tell you about the relationships between the types of money. For example there is an interest rate differential between the central bank money and the US treasuries (which are equivalent to USD money for most people most of the time), captured by the repo rate minus IOER. This differential blew up quite recently (in 2019), showing a temporary divergence between tbills and "real money".
In the past, before central banks, each region of the US had their own money, and merchants had conversion tables. They would literally tell you that, for example, Boston money is worth for me only 80 cents on the dollar. Much like today we quote prices on bonds.
Robert Shiller has some really good finance lectures on YouTube. The one about central banking:
https://m.youtube.com/watch?v=_SpIaGTq0u8
Both this article and the stuff Atte is responding to end up with "X is merely Y" explanations. The (arguable, but widely accepted) reality of macroeconomic and monetary dynamics is that it is not merely microeconomics. A layer of emergence separates the two.
It's true that what banks do is not fundamentally different to what full tilt poker did. Even the "bank run" parallels the many bank runs in history, and associated monetary collapse.
You can find other parallels too. My favourite is employees. Say you have no money. You hire 10 people clean pools, with salaries due at the end of the month. They work. You get paid. If you get paid enough, you can pay salaries on time and make profit.
This is the same principle as monetary stimulus, where a government makes loans to stimulate economic activity. We do call that money creation, but it's not fundamentally different to what every employee does.
IRL, a poker site or pool cleaning business will (almost) always hit a point of reversal. Expansion becomes deflationary rather than inflationary. Further growth requires capital, rather than generating it. The business models that don't do reach levels where their money creation starts to have macro-scale effects. These tend to join the financial sector (eg, the stock market), where they are regulated in some fashion to curb monetary inflations and deflations.
What makes banks qualitatively different is stability. They can do this long term, continuously increasing scale, without bank runs. Quantity is a quality of its own. If banks expand mortgage lending, real estate will inflate... either with higher prices or with more building. This isn't money that was redirected from one sector to another. It's new money.
This is why monetary policy isn't just central banking. It's regulators. The regulator controls this sort of activity (eg mortgage lending) in order to regulate the supply of money.
By the way, you can issue money too. Let's say you buy a computer for $1.000 and promise the seller that you are going to pay him $1.050 by next year. You just issued $1.050 of M2.
Counter-intuitively, this money supply system is helping developed countries control inflation. In some developing countries, inflation is harder to control because people are issuing money on their own.
Namely that if money is created only when you lend it to people, but they have to pay back what you created + interest, there is never enough money to pay all debts back. So bankruptcy is built into the system. It’s like musical chairs. It has to happen.
It was years since I saw 'Money as Debt' but I remember it as quite flawed in its arguments.
Let's say there's a silly town with a single evil bank. The good people borrow a hundred dollars in total. Horror! The evil bank is now owed one hundred and ten dollars. This can never be repayed, there is not enough money!
Except the good janitor at the bank has his wage of ten dollars credited to his account by the bank for the value created by his labour. He pays the grocer, the landlord and so on and now the silly town people can pay all their loans, should they ever want to.
And then the old grocer dies and his estate defaults on its debts. And it turns out the bank overvalued his house. The banks is now down ten dollars on its loan assets. But the bank still has its liabilities to the other good town people the grocer paid when he took out the loan. Suddenly the town can pay back all their debts and still have ten dollars left owed to them by the bank! The evil bankers are foiled.
'Money as Debt' goes to all this trouble to explain that money is debt. Then we are supposed to be shocked by the fact that debt can be created by no more than signing a paper! It's stupid.
But, probably more importantly, that relies on an ever increasing economy, which relies on ever increasing use of natural resources, which = earth is screwed.