100% reserve banking

December 2022 Forums General discussion 100% reserve banking

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  • #86751
    ALB
    Keymaster

    Yet another news item, in today’s Daily Telegraph, confirming that banks are essentially just intermediaries between savers and borrowers. It’s a report of a talk by a top official of the Bank of England in which he speculates that developments in communications technology might lead to the elimination of banks as “middle men”. Arguing that banks could become “disintermediated”, he said:

    Quote:
    With open access to borrower information, held centrally and virtually, there is no reason why end-savers and end-investors cannot connect directly. The banking middle men may in time become the surplus links in the chain. Where music and publishing have led, finance could follow.

    No nonsense here about banks surviving because they can create money out of thin air and so don’t need savers.

    #86752
    alanjjohnstone
    Keymaster

    Ken Griffin , one of the billionaires backing Mitt Romney for president does identify who can “create money out of thin air ” – the government . http://articles.chicagotribune.com/2012-03-11/business/ct-biz-0311-confidential-griffin-web-version-20120311_1_american-crossroads-politics-republicans-and-democrats/5 “…I spend way too much of my time thinking about politics these days because government is way too involved in financial markets these days. QE2. (‘QE’ stands for quantitative easing. That’s when the Federal Reserve pumps money, created out of thin air, into the economy.)…” 

    #86753
    alanjjohnstone
    Keymaster

    This may be of interest – two Glasgow credit unions censured for breaching financial rules.http://www.bbc.co.uk/news/uk-scotland-scotland-business-17513873 Pollok Credit Union put its own solvency at risk by issuing a large loan to a non-member. Shettleston and Tollcross Credit Union made loans to its directors on better terms than those available to members. The Pollok Credit Union made a series of loans to a trust that it had set up to manage a local post office and day-care centre. The watchdog said the loans breached its rules because the trust was not a member of the credit union, and that 88% of its capital was tied up in those loans. The FSA’s rules state that individual large exposures must not exceed 25% of a credit union’s capital.

    #86754
    ALB
    Keymaster

    From the Raconteur supplement on “Funding Britain’s Growth” in yesterday’s Times:

    Quote:
    It is not in the nature of a bank to take risks. As a rule, they make a relatively small profit on lending — usually in single digit percentage points … [Doug Richard, founder of School for Startups]

    What Richard is talking about is the net interest margin, a key concept for understanding how banks work and which currency cranks ignore.

    #86755
    ALB
    Keymaster

    Another one. Today’s Times reports a speech by the Chinese prime minister, Wen Jiabao, calling for an end to the banking monopoly of the big Chinese state banks. Taking for granted that banks are essentially financial intermediaries between lenders and borrowers, the report says:

    Quote:
    The monopoly in question refers to the dominance of China’s four largest banks — hugely profitable, state-owned entities that include the Industrial and Commercial Bank of China, Agricultural Bank of China and Bank of China and get away with offering feeble interest rates on deposits. Three of China’s big four number among the top ten banks in the world. Because the Government sets deposit rates and minimum lending rates, the banks are guaranteed profit margins of 3.5 per cent.

    This compares to a current  “net interest margin” of 2.0 to 2.2 percent in UK banks.

    #86756
    alanjjohnstone
    Keymaster

    Banks Are Not MysticalOf related interest, a debate between NYT Paul Krugman and Australian economist Steve Keen and others on money/credit supply. Is it the Fed or is it the banks and involves understanding Hyman Minsky “who wrote that markets are intrinsically in a state of disequilibrium” so that is where i get lost. I am sure others here will have a better understanding and clarify things to me. Apologies for the scattered and probably unrelated links for you to follow .http://www.businessinsider.com/paul-krugman-vs-steve-keen-2012-4According to Keen “One key component of Minsky’s thought is the capacity for the banking sector to create spending power “out of nothing””  His argument is that banks lend first then seek reserves. The Fed will accommodate banks by providing enough reserves to meet any reserve ratio at its target rate; The Fed targets a rate not a quantity. Banks are constrained by capital requirements and borrower demand, not by reserve requirements. While for Krugman “the bottom line: the Fed controls credit conditions…, all the talk about banks creating money…is irrelevant to the actual economic discussion.” Krugman argues that bank lending doesn’t necessarily increase demand in the economy—it just shifts money around. Banks don’t create demand out of thin air any more than anyone does by choosing to spend more; and banks are just one channel linking lenders to borrowers. Canadian economist Nick Rowe was on the side of Krugman with a post arguing that, while commercial banks can create money out of thin air, they are contrained by their reserves. “Commercial banks promise to redeem their money at a fixed exchange rate (at par) for central bank money,” Rowe explains. Which means the central bank controls the size of the money supply, because it is the source of bank reserves. http://www.debtdeflation.com/blogs/2012/04/02/ptolemaic-economics-in-the-age-of-einstein/According to Keen, “Minsky thought that irrational market actors can exacerbate disequilibriums when they perceive future stability in the markets. For example, banks in the early 2000s continued extending loans to home-buyers with poor credit because they did not foresee (or did not want to accept) that home prices could not continue rising. Even the initially conservative activity of extending loans to creditworthy homebuyers soon became speculative, as home prices skyrocketed out of control because of unsustainable demand in the market. While it is quite conceivable that bank behavior did indeed exacerbate the housing bubble in this manner, Keen argues that this behavior demonstrates a deeper ideology: fiscal and central bank policy have far less power in controlling credit conditions than we would like to believe. He writes: We cannot rely upon laws or regulators to permanently prevent the follies of finance. After every great economic crisis come great new institutions like the Federal Reserve, and new regulations like those embodied in the Glass-Steagall Act. Then there comes great stability, due largely to the decline in debt, but also due to these new institutions and regulations; and from that stability arises a new hubris that “this time is different”—as the debt that causes crises rises once more. Regulatory institutions become captured by the financial system they are supposed to regulate, while laws are abolished because they are seen to represent a bygone age. Then a new crisis erupts, and the process repeats. Minsky’s aphorism that “stability is destabilizing” applies not just to corporate behaviour, but to legislators and regulators as well. Banks, Keen insisted, form the crux of the problem since they are in control of the monetary base. Banks’ assessments of the risks and rewards to lending grows virtually without reference to the deposits they receive, so banks—and not the government—ultimately determine credit standards.” Keen quotes “Senior Vice-President of the New York Federal Reserve, noted that the key Monetarist policy prescription of regulating the economy by “a regular injection of reserves” was based on “a naïve assumption” about the nature of the money creation process: “The idea of a regular injection of reserves—in some approaches at least—also suffers from a naïve assumption that the banking system only expands loans after the System (or market factors) have put reserves in the banking system. In the real world, banks extend credit, creating deposits in the process, and look for the reserves later.” Holmes would turn in his grave at Krugman’s naïve assertion, half a century later, that banks need deposits before they can lend ”  In the same piece Keen quotes Schumpeter who “put it clearly during the last Depression: he described the view that Krugman puts today, that investment (which is what the most important class of borrowers do) is financed by savings, as “not obviously absurd”, but clearly secondary to the main way that investment was financed, by the “creation of purchasing power by banks … out of nothing“. This is not “Banking Mysticism”: this is double-entry bookkeeping: “Even though the conventional answer to our question is not obviously absurd, yet there is another method of obtaining money for this purpose, which … does not presuppose the existence of accumulated results of previous development, and hence may be considered as the only one which is available in strict logic. This method of obtaining money is the creation of purchasing power by banks… It is always a question, not of transforming purchasing power which already exists in someone’s possession, but of the creation of new purchasing power out of nothing. (Joseph Alois Schumpeter, 1934, p. 73)Paul Krugman counters “As I read various stuff on banking — comments here, but also various writings here and there — I often see the view that banks can create credit out of thin air. There are vehement denials of the proposition that banks’ lending is limited by their deposits, or that the monetary base plays any important role; banks, we’re told, hold hardly any reserves (which is true), so the Fed’s creation or destruction of reserves has no effect…First of all, any individual bank does, in fact, have to lend out the money it receives in deposits. Bank loan officers can’t just issue checks out of thin air; like employees of any financial intermediary, they must buy assets with funds they have on hand.But the usual claim runs like this: sure, this is true of any individual bank, but the money banks lend just ends up being deposited in other banks, so there is no actual balance-sheet constraint on bank lending, and no reserve constraint worth mentioning either. That sounds more like it — but it’s also all wrong. Yes, a loan normally gets deposited in another bank — but the recipient of the loan can and sometimes does quickly withdraw the funds, not as a check, but in currency. And currency is in limited supply — with the limit set by Fed decisions. So there is in fact no automatic process by which an increase in bank loans produces a sufficient rise in deposits to back those loans, and a key limiting factor in the size of bank balance sheets is the amount of monetary base the Fed creates — even if banks hold no reserves. So how much currency does the public choose to hold, as opposed to stashing funds in bank deposits? Well, that’s an economic decision, which responds to things like income, prices, interest rates, etc.. In other words, we’re firmly back in the domain of ordinary economics, in which decisions get made at the margin and all that. Banks are important, but they don’t take us into an alternative economic universe.”This brought forth Scott Fullwiler, an MMT economics professor who declared that “It’s really just a matter of double entry book-keeping, Fullwiler argues. When a bank makes a loan it creates a liability for itself—a customer deposit—and an asset for itself—the loan. The customer, of course, has the mirror opposite: an asset called a bank deposit and a liability in the form of an amount owed to the bank. But what happens when the bank customer who borrowed from JPMorgan Chase spends the money he borrowed and the guy on the other end of the deal deposits the money in Citibank? The deposit gets transferred from JPMorgan Chase to Citigroup. This typically happens by having the Federal Reserve debit reserves from JPMorgan Chase and credit reserves to Citigroup. If JPMorgan’s reserves were to run short of the requirements, it would borrow the reserves on the interbank market. If the reserves were unavailable on the interbank market for some reason, the Fed would automatically credit JPMorgan with a loan of the reserves. In short, the amount of reserves would grow.  “Note that it cannot be any other way. If the central bank attempted to constrain directly the quantity of reserve balances, this would cause banks to bid up interbank market rates above the central bank’s target until the central bank intervened. That is, central banks accommodate banks’ demand for reserve balances at the given target rate because that’s what it means to set an interest rate target. More fundamentally, given the obligation to the payments system, it can do no other but set an interest rate target, at least in terms of a direct operating target.”  Another commentator writes “…banks make loans first and obtain reserves in the overnight market (from other banks) or from the Fed after the fact (if needed). New loans result in a newly created deposit in the banking system – from thin air!…Banks are capital constrained. Banks can always find reserves from the central bank so banks do not check reserve balances before making loans. Instead, they will check the creditworthiness of the borrower and their own capital position to ensure that the loan is consistent with the goal of their business – earning a profit on the spread between their assets and liabilities. Banks attract deposits because they want to maintain the cheapest liabilities possible in order to maximize this spread on assets and liabilities. Banks are, after all, in the business of making a profit! ” HUMMPHHH…I just get more bamboozled the more i try to comprehend.

    #86757
    ALB
    Keymaster

    Krugman seems to be on the ball here, but even his opponents accept that if a bank made a loan without already having the money to lend then it would immediately have to borrow that money (a point crankier currency cranks miss)This quote from Krugman which you cite (from the New York Times of 30 March) is worth adding to the collection (I like his title too “Banking Mysticism”):

    Quote:
    As I read various stuff on banking — comments here, but also various writings here and there — I often see the view that banks can create credit out of thin air. There are vehement denials of the proposition that banks’ lending is limited by their deposits, or that the monetary base plays any important role; banks, we’re told, hold hardly any reserves (which is true), so the Fed’s creation or destruction of reserves has no effect.This is all wrong, and if you think about how the people in your story are assumed to behave — as opposed to getting bogged down in abstract algebra — it should be obvious that it’s all wrong.First of all, any individual bank does, in fact, have to lend out the money it receives in deposits. Bank loan officers can’t just issue checks out of thin air; like employees of any financial intermediary, they must buy assets with funds they have on hand. I hope this isn’t controversial, although given what usually happens when we discuss banks, I assume that even this proposition will spur outrage.
    #86758
    DJP
    Participant

     

    alanjjohnstone wrote:
    Banks Are Not MysticalOf related interest, a debate between NYT Paul Krugman and Australian economist Steve Keen and others on money/credit supply. Is it the Fed or is it the banks 

    The answer to some extent depends on what measure of the money supply you are refering to.http://en.wikipedia.org/wiki/Money_supplySometimes people end up talking at cross purposes because they are referring to different things when they use the word ‘money’As far as I’ve got it worked out, the level of the broad money supply is determined by the amount of base money, the reserve rate and the state of the economic cycle.

    #86759
    alanjjohnstone
    Keymaster

    As you say, DJP, this does lead to confusion. The comments at this report of the Keen/Krugman debate exemplifies the problem. http://www.debtdeflation.com/blogs/2012/04/21/just-banking-presentation/comment-page-1/#comments Comments by Lyonwiss describes what you say.”If you listen carefully to “Money as Debt” by Paul Grignon or read Hawtrey (Currency and Credit) or Schumpeter (Theory of Economic Development) or Holmes (Operational constraint…), they do not confuse credit with cash (only real form of money M0). For example, a bank deposit is debt (or credit to depositors) , NOT money. That’s why a bank can lend without money, which it typically does not have much of, nor does it create (not cash or notes), any time (@ Koonyeow April 21, 2012 at 9:44 pm). Much of the debate (too much) comes from an abuse of language (confusing debt with money). Leverage and endogenous credit creation are the issues, not money, for which government normally has control…..I think one of the confusions is the words money and deposit. For a private sector worker like me, money usually means the notes and coins you have plus your deposit with (usually) a commercial bank. Generally (but not verified by me yet), notes and coins are created by central banks. Deposits on the other hand come into existence in two ways:1. You hand over your notes or coins to your commercial bank. Your notes or coins decrease but your deposit increases; 2. The commercial bank makes a loan to you. Your deposit increases (and so does your debt). However, no notes or coins are created is this process.When you wrote banks can create money from nothing, the more technical statement is commercial banks can create deposits from nothing if there is no reserve requirement.”

    #86760
    ALB
    Keymaster
    alanjjohnstone wrote:
    Comments by Lyonwiss describes what you say.”When you wrote banks can create money from nothing, the more technical statement is commercial banks can create deposits from nothing if there is no reserve requirement.”

    This depends on what you mean by “deposits” ! There are two types: (1) real deposits, as when someone deposits money in their account and (2) notional “deposits”, as when a bank opens a credit line for someone they are lending money to. Obviously, banks can do (2). That’s their main line of activity, but the question is can they create these (ie make loans) “from nothing”?There seem to be three points of view on this:(1) That they can’t: they have to have the funds available before they can make a loan (the position of Paul Krugman and us).(2) That they can, but they then have to find the funds, either by borrowing from the money market or by expected new deposits resulting from the loan (the position of those Krugman is arguing with).(3) That they can, and that’s that (the position of Paul Grignon and other currency cranks).

    #86761
    ALB
    Keymaster

    Further confirmation, for the record, that banks can only lend funds they already have (either from depositors or from what they themselves borrow) and can’t create loans out of thin air. From yesterday’s Times:

    Quote:
    The Bank of England has warned of an extended squeeze on household incomes, saying that the worsening eurozone crisis had made it more expensive for banks to raise money and that UK borrowers could suffer from higher interest rates as a result.

    And from today’s, reporting of the situation in China:

    Quote:
    Some analysts regard the sharp fall in household deposits last month as the most troubling of the data. The 638 billion yuan (£64 billion) month-on-month drop denotes a clear attack of nerves, and contributed to an 8 per cent fall in new loans. (…) “There are major problems,” said Miranda Carr, head of research at China Policy Research. “Money is leaving the country and that is going to affect the ability to stimulate. If the banks don’t have the deposits there to lend out, then that means stimulus is not as effective as it might be.”

    Incidentally, today’s Times also reports that HSBC’s “British retail division makes a return on equity of 17 per cent.”

    #86762
    ALB
    Keymaster

    Just finished reading Debt, The First 5000 Years by David Graeber which Stuart said we should all read. An interesting read. Although he seems to share the delusion that, with so-called “fractional reserve banking”, banks can create credit and money out of nothing, he does expose one of the quotes used to back this up as a fabrication.Banking and currency cranks are always quoting “Sir Josiah Stamp”, a director of the Bank of England in the 1930s, as saying:

    Quote:
    The modern banking system manufactures money out of nothing. The process is perhaps the most astounding piece of sleight of hand that was ever invented. Banking was conceived in iniquity and born in sin. Bankers own the earth; take it away from them, but leave them with the power to create credit, and with the stroke of a pen they will create enough money to buy it back again … If you wish to remain slaves of Bankers, and pay the cost of your own slavery, let them continue to create deposits.

    Graeber comments (p. 344):

    Quote:
    It seems extremely unlikely that Lord Stamp ever really said this, but the passage has been cited endlessly—in fact, it’s probably the single most often-quoted passage by critics of the modern banking system.

    In a footnote (pp. 448-9) he goes into more detail:

    Quote:
    Said to have been given at a talk at the University of Texas in 1927, but in fact, while the passage is endlessly cited in recent books and especially on the internet, it cannot be attested to before roughly 1975. The first two lines appear to actually derive from a British investment advisor named L.L.B. Angas in 1937: “The modern Banking system manufactures money out of nothing. The process is perhaps the most astounding piece of sleight of hand that was ever invented. Banks can in fact inflate, mint and unmint the modern ledger-entry currency” (Angas, Slump Ahead in Bonds, New York, 1937: 20-21) . The other parts of the quote are probably later inventions—and Lord Stamp never suggested anything like this in his published writings. A similar line, “the bank hath benefit of all interest which it creates out of nothing” attributed to William Patterson, the first director of the Bank of England, is likewise first attested to only in the 1930s, and is also almost certainly apocryphal.

    In other words, some banking/currency crank made up these quotes and others just reproduce them as genuine. This probably applies to many of their other quotes too.

    #86763
    ALB
    Keymaster

    Found another article accepting the myth that banks can create money out of nothing. This time endorsed by Green Party MP Caroline Lucas. The incriminating passage reads:

    Quote:
    central banks only create 3% of the money supply. Normally, 97% is created by banks through their extension of bank credit. If you wonder how this works: banks simply pretend that borrowers have deposited the money that they lend them, and thus create it out of nothing when they credit their deposit accounts, adding to the money supply.

    This is to misinterpret double-entry book-keeping. Under this the “liability” (the loan) has to be matched by a corresponding “asset” (the borrower’s debt to the bank). No extra money (purchasing power) is created. It’s just a book entry and of course the bank has to already have the money to make the loan.Note that the article contradicts itself by talking about the Bank of England creating £275bn extra money apart from the 3% mentioned (which are notes and coins).Two points. First, central banks can create more money (additional nominal purchasing power) out of nothing (though if they create too much this will devalue previously existing money). But individual banks can’t (they have to have the money first before they can make a loan, even if they get it from the central bank as in the recently announced scheme to get banks to relend money to small businesses). Second, if you define “bank loans” as “money” then by definition banks create money (but not out of nothing).The Green Party obviously doesn’t mind making a laughing stock of itself. Their way out of the crisis? The Bank of England financing cycle paths in every city ….

    #86764
    jondwhite
    Participant

    Am I correct in thinking the limit of central banks creating money after which the currency devalues is the national growth rate of the economy? As long as the economy is growing, central banks can issue more currency?

    #86765
    ALB
    Keymaster
    jondwhite wrote:
    Am I correct in thinking the limit of central banks creating money after which the currency devalues is the national growth rate of the economy?

    More or less, at least in the short run. The currency shouldn’t devalue if the rate at which it is increased is not more than the rate of increase in economic transactions for which it is used.

    jondwhite wrote:
    As long as the economy is growing, central banks can issue more currency?

    Central banks can of course issue more currency whenever they want, but if the economy is growing they can (and probably should) safely issue more (within limits).But the official government policy in most countries these days is not to maintain a stable price level and currency value (the same thing from a different angle) but to achieve a slowly increasing price level by means of a slowly depreciating currency of about 2 percent a year.

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