>Because unlike in a Ponzi scheme, the US government can simply choose to create more money,
It sure can, but this doesn't go far enough.
The US Govt' can only choose to "print money". It cannot choose otherwise. This is because fractional reserve banking allows financial institutions to lend out the same $1 multiple times.
The result of collecting $1 and lending 6 people that $1 with an expected total payment of $2 per debtor results in $1 causing $13 in the economy.
> Under fractional banking, almost all money is created via debt. Government issues debt which is bought up buy banks which allows the government to issue new money including cash. It is purely created from thin air.
Except fractional reserve banking isn't an accurate model of how money works today. Money is created by bank loans, not deposits - a bank with zero deposits could still lend money.
> I have come to the conclusion that the problem with fractionally reserved money isn't the fractional reservation mechanism at all. Rather, the problem is that banks effectively promise the same money to multiple people at the same time. There is one "piece" of money, but multiple people have claims on it.
Banks get overnight loans to cover the case where creditors want more money than they currently have access to.
There is no single piece of money anywhere anymore.
When you deposit a $100 federal reserve note in the bank you are only giving that bank a means to pay taxes or pay back loans from Federal Reserve Banks. If you take a $100 note to a federal reserve bank they will look at you funny.
The reason this works is that U.S. currency is so stable that any potential commodity you might desire as currency can be paid for with USD money from virtually any bank in the world. Banks are just an accounting system at this point who barely hold any physical thing of value, and only on a just-in-time delivery model. The rest of the economy satisfies the market for transactions between money and goods.
Why doesn't it all fall apart? The federal reserve raises interest rates when there is too much money in circulation, urging banks to pay off their liabilities, thus destroying money.
>It's not like Chase Bank (or whatever non-central bank) can just print more dollars.
Yes, it can, that's what fractional reserve means. Banks create (most of) the money they lend. This is regulated by the central banks but carried out via ordinary retail banking. When you swipe your credit card, buy a car, etc. money is being created out of thin air. The universe remains balanced because it corresponds to your obligation to repay; as you do, the money ceases to exist.
> That isn’t how fractional reserve lending works.
I'm not sure which part of the GP you're disagreeing with.
Fractional reserve is exactly that banks lend out a fraction of the deposits that they take in (the rest is kept in reserve).
The only reason it looks like money is created is because people (and economists) think of 'money in their account' as real money, when in fact it's just a IOU from the bank to you (possibly guaranteed by the government).
If you think of money-in-your-account as actually a debt the bank owes you, then it becomes quite clear that banks don't create money any more than lending money to a friend creates money. And there is a sense in which it does - lending money to a friend results in your friend having money and you having an asset (an IOU from your friend) that you expect to be able to use at some point in the future, so there is a sense in which the sum total of wealth has increased by the value of the IOU.
> If all the money is loaned out to the limits of fractional reserve, more money for interest can only come into existence by printing more.
"Fractional Reserve" banking is not a thing, as banks do not lend out reserves (except overnight to other banks). It does not and has never accurately described how banks lend, nor does it accurately define limits to bank lending. The limit to bank lending is capital. Bank capital consists of trusted assets (e.g. IOUs that central banks are willing to discount or which other banks accept as collateral for overnight loans) that are believed to be risk free. Generally this means government debt. Government debt is the sole constraint on bank lending as well as loan growth. Reserves have nothing to do with this in a modern system, and were only incidentally important in earlier systems.
> more money for interest can only come into existence by printing more.
Please define what you mean by "money". When most people think of money, they think of demand accounts, and these are not created by the government but by the private sector. Clarity in definitions can explain almost all of these misconceptions. A good rule of thumb is that someone who doesn't know what they are talking about mentions only "money". If you know what you are talking about, you specify the asset and matching liability, and so you distinguish between bank reserves, vault cash, deposit accounts, bank bonds, and different bank assets, knowing which meet capital adequacy requirements and which do not.
A good description of how the monetary system works is provided by the Bank of England report "Money Creation in a Modern Economy".
That article does a good job at dispelling myths of "fractional reserve banking", "money printing", and the like, and it accurately describes how modern banks work and what central banks actually do. It is required reading for anyone who goes off about "money printing" or whoever thinks that banks lend out reserves.
> No, that means that all customer deposits can be used for loans. There’s zero requirement for banks to hold any deposits in reserve to ensure they’re able to pay out individual depositors on request.
If I am mistaken please correct me with citations but respectfully, I believe your understanding is incorrect. In a fractional reserve system banks can and do fractionalize dollars into existence. The mechanism is slightly different than when the FED prints money. Instead of creating money out of nothing, banks can only create loan money out of thin air.
For example, when you are issued a new car loan from a bank, those funds do not come from another depositor. (see my comment above on 0% reserve ratio). Instead
the money is literally created by the stroke of a pen when the borrower signs the loan agreement. The funds did not exist anywhere prior to the loan. The numbers were added to the customer's bank account the moment they signed the loan agreement. Money created out of thin air via fractional reserve lending.
If it were not for the free money creation feature of the banks, then banks would have to lend customer funds or their own reserves. The risk and cost of lending these real assets would greatly exceed the ultra-low interest rate environment we currently experience and the cheap credit days would be over.
The fraud involved in fractional reserve lending is that the lender has no cost of funds. They are not risking their own assets and are therefore more willing to lend cheaply. This leads to credit bubbles that perpetuate the business cycle and lead to a series of booms and crashes. Fractional reserve lending is a scam and banks are technically all insolvent.
>If you combine this with the fact that banks work on fractional reserves, then there'd end up being infinite money... but there isn't because it's not true.
In practical terms the only limit to the amount of new money is the amount qualified borrowers are willing to borrow. Banks that don't have enough reserves typically borrow from other banks or from the central bank. The central bank (in the US, at least) isn't bound by reserve limits at all and can create money by changing a number in a computer.
The lack of lending by banks isn't a problem in and of itself. It's a symptom of the underlying problem, which is a lack of economic activity that would require borrowing.
> The whole point of fractional reserve banking is a $100K house being held represents a modest return during a housing bubble, but they could turn that $100K property into $1M of mortgages with a likely higher total return.
That is a significant misunderstanding of fractional reserve banking. Banks can only lend money they have, i.e. that customers have deposited. They can't just invent money to lend. So, a bank with $100,000 in cash can only make loans totaling $90,000 with it (assuming a 10% reserve requirement).
> Yes, it's a juggling act: Person A still has $1000 on the ledger in their deposit even if the bank lends $800 of that to Person B
Fractional reserve banking isn't up-to-date with the modern banking system, where in many cases, like in the UK, and in the US as of 2020, there are no reserve requirements. [1]
> But they aren't just adding numbers to a cell in a spreadsheet without having the money to back it
I disagree; this is the reality. Banks don't have to wait for deposits to extend loans. When creating a loan involves novel financial instruments to hide or offload the loan's risk, this has caused massive bubbles, as in the 2008 mortgage crisis.
This credit they extend to customers is "broad money" that, while not being created by the central bank, is effectively the same, as it is the deposit for someone else, which can be withdrawn.
> someone with a lot more money than you decided that they couldn't make a better return than financing your home loan
I'm not sure this is how fractional reserve banking works. Banks only supply a fraction of depositors money against a mortgage with the majority supplied by the fed. They basically make their money by investing other peoples money (including fed "imaginary" money) and by keeping a relatively low default rate.
>Our financial system uses fractional reserve. When you deposit $1 in a bank account, they are allowed to have ~10x that, or $10. . . . From $1 deposit, they make 900% instantly.
That is not how fractional reserve works. The way it works is when you deposit $1, the bank loans it to some other customer but there is a rule saying that they can loan out at most 90 cents of that $1. The purpose of the rule is to make it less likely that the bank will need to resort to the Federal Deposit Insurance Corporation when the bank's customers withdraw more money than the bank expects or hopes they will withdraw.
> Comes from the Federal Reserve, when they decided to increase the money supply.
Wait, really? I was pretty convinced that the vast majority of new money is created by private banks, when they decide to loan out money that nobody has paid in. It's called fractional reserve banking.
> I'm assuming this means that Banks basically need to operate with 100% reserve ratio
No, not the case at all. You can do fractional reserve banking with a foreign currency as legal tender. Heck, you can even do it with gold as legal tender, which I always find ironic given how gold backing and the perceived evils of fractional reserve banking seem to go hand-in-hand, ideologically.
> Even when countries were on the gold standard, they still had fractional reserve banking. If a troy ounce of gold was $100 , the bank had one ounce of gold and three separate people had a $100 bill, any one of them could go to the bank and get the gold, as long as not all of them did.
Fractional Reserve is easier to understand as debt than as an asset. A bank is given $1000 from a central bank. The bank can now loan that $1000 with interest for a total of $1100. The bank is allowed to loan that debt promise at a fraction reserve rate of 7-1 or 5-1 as loans to other customers. The $1100 promise can be loaned as $800 plus interest for the total loan value of $880. That can then be loaned out as $660 including interest. Then $440 can be loaned out. Then $220.
So the original $1000 from the central bank was used to create $3300 worth of debt.
> Fractional reserve banking absolutely does not create money[1]. It creates credit exactly the same as if you lend a friend of yours some of your money.
Yes, it creates credit that people think is money. I suspect that's a big problem with it. People think their money is in the bank. Instead the bank is just extending them some credit that they can pass on to others when they "purchase" something.
> In reality deposits only cover around 10% of the loan. This is called fractional reserve banking and it means that a bank loan is actually a money creation event!
That's not how fractional reserve banking works. If I deposit $100 in a bank, they're not allowed to lend out $1000. In fact given a 10% cash reserve ratio, the limit is actually $90. The other $10 has to stay at the bank "in reserve", at least in theory. (In practice there's additional complexity because banks can borrow money to fulfill their reserve requirements.)
When people talk about money creation from fractional reserve banking, what they mean is that someone has $90 from the loan and someone else has $100. Which sums to $190: more than the initial deposit.
>>See Fractional Reserve Banking for the gory details, but the gist of it is, private banks create money out of thin air (within limits) so they can lend it to you. And then they charge interest back for it.
So I've googled and read upon it every time I hear this almost exact same sentence (and I see it every now and then), and I don't get it at a basic level. I have little to none awareness of high level finance, but my understanding of 'fractional reserve banking' is thus:
1. 100 people deposit $1 each to a bank. It has $100 of deposits
2. Without fractional reserve banking, bank would basically have to keep $100 in its vaults. It would be useless money going nowhere doing nothing.
3. With fractional reserve banking, bank basically has to (say) keep $10 in its vaults (digital as they may be), but can loan $90 to other entities (and do more complicated things with it). There are risks and benefits to this, and it is basically a full time job of many people at the bank and regulator to find various balances of risk and benefit, to bank and society, based on the policy and goal.
I don't understand where, in this simple math, does a regular bank "create money out of thin air". I'd love to understand when and how this may be the case (but NOT via angry youtubers, please:).
I do understand that central banks and/or the government control circulation and "create money" through various mechanisms, but I never get the feeling that is what we're talking about when people say "fractional reserve banking means private banks get to make money up".
> When you have literally a license to create money out of thin air
This is a common but slightly misleading interpretation of fractional reserve banking.
If I lend you 100 bucks and you lend those 100 bucks to someone else, you’ve “created 100 bucks” in a monetary sense. But it’s not coming from thin air, from an accounting perspective it’s just a debt moving from one person to another
It sure can, but this doesn't go far enough.
The US Govt' can only choose to "print money". It cannot choose otherwise. This is because fractional reserve banking allows financial institutions to lend out the same $1 multiple times.
The result of collecting $1 and lending 6 people that $1 with an expected total payment of $2 per debtor results in $1 causing $13 in the economy.
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