Patterico's Pontifications

5/5/2014

Why Gold? (And, Why the Gold Standard?)

Filed under: General — Patterico @ 7:29 pm

In comments to the gold standard blog post from this morning, a lot of people asked a question that I have asked from time to time in my life: why gold? You can’t eat it. You can’t wear it. Who cares if you have a little yellow metal or not? Who cares if the country does? If banks do? Etc.

It’s a natural reaction, but I think I have learned the basic answer in beginning to study Austrian economics. Beware: I am not an economist. Beware: I have read very little. Beware: A little knowledge is a dangerous thing. And so on and so forth. As always, I am throwing out these ideas to be discussed; this is not my area of expertise and I am happy to be corrected or to have my arguments improved upon. That said, I think I understand enough to contribute some insight into this question.

Before we get there, let’s take a step back and talk about the division of labor. (We’ll get to gold, but this is necessary background.)

As I have remarked before, the division of labor is the reason that we have a standard of living that would have been the envy of kings centuries ago. But it’s as simple as this: people specialize in those areas that they do best.

In providing examples of a very simple economy, economists love to cite Robinson Crusoe and Friday on a desert island, and who I am to try to improve on that? So: imagine a desert island where Crusoe and Friday each need 10 bananas and 10 coconuts per day to live. Crusoe can gather 10 bananas an hour, but only 4 coconuts per hour. Friday can gather 10 coconuts per hour, but only 4 bananas per hour.

If each is left to his own devices, he will work 3 1/2 hours per day: one hour gathering that which he is best at, and 2 1/2 hours gathering that which is he least efficient at gathering.

But if each spends two hours gathering what they are best at, Crusoe can get 20 bananas in two hours, and Friday can get 20 coconuts. Each trades half his supply for half of the other’s, and each has his 10 coconuts and 10 bananas, and each has cut his labor time from 3 1/2 hours to 2 hours.

It is this concept that allows you to live in a comfortable house you could never construct, drive a car that you could never build, and turn on the air conditioning even if you don’t have the slightest clue how it works.

So far so good. But in a more complex economy, it is difficult to barter your own commodities in kind, because the person from whom you need goods or services doesn’t always want what you have. So you want to try to trade your goods or services for something that more people will accept. That’s a “medium of exchange”: a commodity that everyone in the society (or nearly everyone) wants. People will accept that commodity in exchange for providing you with what you want — because they know they can turn around and provide it to someone else for what they want.

Different commodities have functioned as media of exchange in different societies. Some have used cigarettes. Some have used cocoa beans.

The more universally desired the commodity, the more valuable it is as a medium of exchange. Initially, there is competition among various commodities. But over time, people start to notice which are the more universally accepted commodities, and those commodities crowd out other commodities. Think about it. If two people want my services, and one is offering me cigarettes, and the other is offering me gold, I will provide my services to the person who can give me the medium of exchange that most other people will accept when I try to buy something.

With me so far? Good. Here’s the important part. A good medium of exchange should have several characteristics. (I’m not taking these from a textbook, but am rather going from memory, so cut me some slack if I miss some.)

It should be unchanging. Thanks for the fruit, but in two weeks it will be spoiled. Gold is inert — one of the “noble metals” that resists corrosion or oxidation.

It should be transportable. There are fascinating stories of cultures that use giant unmovable boulders as currency. Everyone knows that is Og’s boulder over there, even if Og can’t drag it to his cave. These cultures have been known to employ giant ships to move boulders from neighboring islands — and if the ship capsizes and the boulder sinks to the ocean floor, they don’t even sweat it . . . because, well, Dag’s boulder is the one at the bottom of the sea! That’s nice and all, but most societies tend to think that a medium of exchange should be transportable. A related factor is that it should be divisible, such that different amounts (weights) can be used to represent different values.

It should be rare, in the sense that, while you don’t always want a fixed amount, you don’t want to have a situation where one can easily double the supply. After all, when you increase the supply of a commodity, you decrease the demand and therefore the price. A medium of exchange that is rare, and cannot have its amount increased by multiples overnight, is one that preserves value (purchasing power) for all who hold the commodity.

There are other desirable characteristics that a successful medium of exchange should have. It should be recognizable, hard to counterfeit, easy to store, and have some intrinsic value. And so on.

Well, it turns out that, over time, humans have always gravitated towards gold and silver as containing the best mix of characteristics to serve as a medium of exchange. Silver has typically been employed for smaller transactions, and gold for transactions involving higher values (because gold better provides the mix of characteristics needed for a medium of exchange).

But the most important fact here is this:

GOLD IS A COMMODITY. It is a thing. It is tangible. It is a commodity used as a medium of exchange, but it is nevertheless a commodity. It has some intrinsic value in its beauty and use for ornamentation. But it is a thing, which just happens to be the best thing to use as a medium of exchange.

That answers the question. You can stop reading now if you want. But I have to keep writing.

CIRCLING BACK TO CURRENCY AND THE GOLD STANDARD: I now have to circle back around to paper (currency), because I know that people will object that in a modern economy, you simply can’t have rapid financial transactions occurring with people handing pieces of gold back and forth. That’s why you have to have pieces of paper or the equivalent (nowadays, it could even be computer code) — something that cannot be easily counterfeited, that represents your right to exchange it for gold if you so choose. Call it currency, call it a bank note, call it what you like.

The genius of Murray Rothbard is to compare these currencies to a warehouse receipt. Here’s the idea: again, GOLD IS A COMMODITY. So, you can’t always carry around your commodity. Business will arise that will warehouse your commodity for you, and give you a slip of paper (call it a bank note) which you can use to redeem for gold any time you like.

When these warehouses, which we call banks, begin to engage in “fractional reserve banking” — lending out more gold than they have — they are giving multiple people warehouse receipts to the same commodity. This is fraud. Let me repeat: THIS IS FRAUD. Giving multiple people warehouse receipts to the same commodity is fraud, because the receipt should entitle the holder to repossess his property whenever he so chooses (although this can of course be limited by a contract with the bank).

Although it’s fraud, it works great — unless and until people get suspicious that they can’t get their commodity back . . . and then you have a “bank run.” People line up to get their gold, because they are afraid they can’t get their gold back. And, if their bank is a fractional reserve bank, as all banks are these days, they are right. They can’t get their gold back, because the bank committed fraud the minute it promised the same gold to multiple people.

If society treated fractional reserve banking as the fraud that it actually is, and kept us on a strict gold standard, then maybe — just maybe — governments would not have the ability to borrow endlessly; to mask their debts and lessen their pain by causing runaway inflation; and to generally deprive people of the value of their savings.

I could go on and on, but hopefully this gives readers a better idea of why humans might value gold, why fractional reserve banking is dangerous; and why going off the gold standard unmoors us from any fiscal discipline.

Don’t say any of this too loud, though. People will think you’re crazy.

Ah, but the system of fiat money we have nowadays? The one that is about to drive us into the depression to end all depressions? That system? Yeah, that system is totally awesome. And stuff.

It’s the gold standard that’s crazy, we’re told. What we’re doing right now? Perfection.

330 Responses to “Why Gold? (And, Why the Gold Standard?)”

  1. Did anyone read the whole thing?

    Patterico (9c670f)

  2. grandma printypants at the fed can’t just pull gold out of her butt like she does with american faildollars

    this is a key point that is often overlooked

    happyfeet (8ce051)

  3. That is a shorter way of saying what I said in the post, yeah.

    Patterico (9c670f)

  4. “When these warehouses, which we call banks, begin to engage in “fractional reserve banking” — lending out more gold than they have — they are giving multiple people warehouse receipts to the same commodity. This is fraud.

    Patterico – This is exactly where Rothbard, the fiat currency and the “money is debt” people depart from reality and get in trouble. They appear to believe in single entry bookkeeping rather than double entry bookkeeping.

    Take an example. A bank takes in a deposit of $100 in gold from company A. It book an asset of $100 (the gold) and a liability (the deposit to repay company A) of $100.

    Company B comes along and asks to borrow $50 from the bank. The bank agrees and creates an asset for a loan receivable from company B for $50 and a liability for $50 for the demand account that company B can draw on.

    The amount of gold hasn’t changed. The bank’s balance sheet remains in balance. Deposits are offset by liabilities. No fraud in sight.

    daleyrocks (bf33e9)

  5. . And, if their bank is a fractional reserve bank, as all banks are these days, they are right

    I suppose this would be true if we actually were on the gold standard. As we are not, are you saying that a bank with $400 million in deposits is lending out > $400 million in loans? As I understand the term, FRB means that the bank keeps 10% or so in reserve and loans out the rest. Thus in my example it holds $40 mil in cash on hand and loans out $360 mil.

    WTP (0b94df)

  6. I read it and it states the issue pretty well. What the commodity really is, after all the hype and propaganda, is trust, If my daughter asks me for money as a loan (usually they ask for a gift) I will give it to her because I know her and I trust her to repay the loan.

    With strangers, something else is needed or you quickly go broke. That is what gold does. Now, after 100 years (December 23, 1913), we know that the Federal Researve has not kept faith with the people and is inflating the currency for political reasons.

    Real estate was a hedge for years but that got trashed by the government for political reasons. What’s left ?

    MikeK (cd7278)

  7. Currency is simply a claim on future productivity of people. But if people don’t want to give you that productivity then the currency is increasingly worthless. Same thing holds for gold or any other commodity.

    All the Gold Standard seeks to do is tie in one item with pure psychological value (paper) to another with very low practical value (gold), and by establishing a set relationship between such, limit the growth of paper.

    But here is the rub, the establish exchange of gold to paper is arbitrary anyway. So if the Govt says we are on the gold standard and they say Gold is worth X Ounces then what is to say they won’t change that trade in value later?

    So what is the difference? If by say saying so much gold underlies so much paper but the Govt can change that ratio …. how is that different than simply printing more money??????

    Currency value is a function of the productive value of the people who issue that currency. So if these people are productive and produce lots of useful stuff (like the Chinese) then their currency appreciates versus others and is “valuable.”

    So if you want to think of it a certain way ….. change the world gold for the word “basket of goods” and it is the same concept. A “Basket of Goods” Standard is what we have today because you can exchange a dollar for some fraction of this basket. With the gold standard it was a gold ingot and WTF are you going to do with that??

    But I never got the Gold Standard buzzards. Never made much sense once you work through the arguments for the value.

    Rodney King's Spirit (ca9e04)

  8. I suppose this would be true if we actually were on the gold standard.

    That’s what I am positing. The borrower and the depositor both have a legal claim to the same gold. No wonder depositors got nervous. They were being routinely defrauded.

    Patterico (9c670f)

  9. But here is the rub, the establish exchange of gold to paper is arbitrary anyway. So if the Govt says we are on the gold standard and they say Gold is worth X Ounces then what is to say they won’t change that trade in value later?

    It was originally arbitrary . . . but based on a system of weight. (I thought about adding this aspect to the discussion, but the post was already long.) A dollar (read Rothbard for the derivation of the word) represented a fixed weight of gold. It was arbitrary what the piece of paper was set to represent — but the thing it represented was real and not arbitrary.

    You could fix the dollar at half the weight, but then it would just have half the real value — because it represents half the weight.

    Patterico (9c670f)

  10. daley,

    The problem is that depositors were told their deposits could be redeemed at any time. But they couldn’t be — because the bank had fraudulently lent out those deposits to multiple other people.

    Patterico (9c670f)

  11. So what is the difference? If by say saying so much gold underlies so much paper but the Govt can change that ratio …. how is that different than simply printing more money??????

    It’s not. That’s why we weren’t really on the “gold standard” when governments were monkeying around with the value. They were taking pieces of paper that were worth one weight of gold and arbitrarily declaring them to be worth a different, lower weight. This is called debasing the currency and governments have done it forever — but it is fraud.

    But fraud is what government is all about.

    Patterico (9c670f)

  12. I’m confused. And apparently so is daily rocks and me be others. If I have a bank that only accepts and lends gold, and it’s an FRB, if I take in 10000 ounces of gold in deposits, loan out 9000 ounces and keep 1000 ounces in reserve, how does this change anything? Who is being defrauded? My reference to “if we were actually on the GS” was meant to avoid a whole other argument that has nothing to do with FRB.

    WTP (0b94df)

  13. You’ve made a decent argument against fractional banking but a fallacious argument in favor of gold (appeal to tradition). As transactions stop occurring in person gold loses much of its utility as a medium of exchange.

    underdown (043b28)

  14. Currency is a claim right now. Debt (IOU) is a claim on future cash flow.

    A bank balance sheet is by its very nature a mismatch in duration and how spreads are created to earn “profits.

    So if gold was the standard, a Bank Asset is a promise by a customer to pay the bank money in the future which could be paid in gold. A liability would be the gold itself. Some gold would be for depositors and other for Owners (equity).

    So, no, gold does not go on both sides of the balance sheet in this example.

    Rodney King's Spirit (ca9e04)

  15. Rodney King’s Spirit:

    I think it all makes sense once you posit (as I do) that the gold standard really means “the gold standard without fraud.”

    Everything we are talking about is fraud.

    And I am not advocating a system based on fraud.

    Patterico (9c670f)

  16. Why stop at gold? Free silver!

    cbuund (2cc14c)

  17. because the bank had fraudulently lent out those deposits to multiple other people. well! ok. But that’s just the meaning of the word “banking”. No fraud is involved. Do you actually think all the mohey you put in a bank is back in a vault somewhere? Have you seen “it’s A Wonderful a Life”?

    WTP (0b94df)

  18. No fractional banking? Oh dear god, please get back to politics.

    You guys are putting us back to the stone age.

    No fractional banking kills the hopes and dreams of millions of billions people to go out and work today to produce something of value tomorrow.

    Rodney King's Spirit (ca9e04)

  19. I’m confused. And apparently so is daily rocks and me be others. If I have a bank that only accepts and lends gold, and it’s an FRB, if I take in 10000 ounces of gold in deposits, loan out 9000 ounces and keep 1000 ounces in reserve, how does this change anything? Who is being defrauded?

    The depositors who are told they can redeem their deposits at any time.

    The only way it can be done in a non-fraudulent way, in my opinion, is some combination of conditioning depositors’ right to reclaim their deposits by contract, as is done with CDs, and/or limiting lending to the amounts made possible with the initial capital and profits of the bank. Banks should make a profit for the service of warehousing your gold, and that profit can be lent, as can the interest earned on past loans. But lending out money while telling people they can have it back any time they want is fraudulent.

    Patterico (9c670f)

  20. because the bank had fraudulently lent out those deposits to multiple other people. well! ok. But that’s just the meaning of the word “banking”. No fraud is involved. Do you actually think all the mohey you put in a bank is back in a vault somewhere? Have you seen “it’s A Wonderful a Life”?

    To answer your questions:

    We are not on a gold standard and we live in a world of fractional reserve banking, so no, I don’t think all my money is in a vault. I have seen the movie and if banks did not commit fraud there would be no need for bank runs such as the movie depicts.

    Patterico (9c670f)

  21. My main question is why one thread of comments isn’t merged with another one?! Even more so since the topic of the “gold standard” is rather obscure.

    I feel sorry for all the many orphaned or short-lived threads — or the abundance of start-and-stop sets of discussions — since seeing everyone’s posts combined into an ongoing, extended conversation, which lasts for more than a day or two, makes for easier and better reading.

    Mark (99b8fd)

  22. Ahhh, no. If you have $400,0000 in a bank, you cannot walk in and ask for it all at once. When you opened your account, I’m quite certain this WS in the not-so-fine print. Plus, what Rondey King said.

    WTP (0b94df)

  23. No fractional banking? Oh dear god, please get back to politics.

    You guys are putting us back to the stone age.

    No fractional banking kills the hopes and dreams of millions of billions people to go out and work today to produce something of value tomorrow.

    See my post, where I say that I am no expert on this. Then please tone it down a tad, and tell me how the gold standard and eliminating FRB would put us back in the Stone Age. Because credit would be tightened? Is your argument that what the world needs is more debt?

    Patterico (9c670f)

  24. “I have seen the movie and if banks did not commit fraud there would be no need for bank runs such as the movie depicts.”

    What is the “fraud” involved? What is the deception? Have you been deceived?

    cbuund (2cc14c)

  25. Oh, wait a minute. You’re saying it should be in a vault, then? You can do that. Put it in a safety deposit box. Then you can get it anytime you want. Help me out here Rodney.

    WTP (0b94df)

  26. Ahhh, no. If you have $400,0000 in a bank, you cannot walk in and ask for it all at once. When you opened your account, I’m quite certain this WS in the not-so-fine print. Plus, what Rondey King said.

    To the extent that such contractual language frees up money to be lent out, I am all in favor of that — and I thought I was clear about that.

    But if banks structured their contracts with depositors such that they were never lending out money they didn’t have, why fear a bank run?

    Bank runs were just people calling bullshit on what was a permanent state of affairs. It is beyond dispute that in a bank run, people were simply asking for the money that they were legally entitled to provide. The fact that contracts may limit withdrawals is irrelevant if the total amount of money that can be claimed is an amount the bank is never in a position to provide to all its depositors.

    Patterico (9c670f)

  27. Patterico,

    A gold standard without fraud?

    Replace the word Gold Standard with Basket of Goods Standard then think it thru.

    That Basket of Goods changes over time, the value of the items change over time, some of the items become obsolete and new ones get created.

    So even if you used Gold and no fraud — the Basket of Goods we need to live change over time and the amount of gold you need to buy this basket changes.

    All money (or gold) is transitive. All that really exists is consumers on one side demanding stuff and the same consumers on the other side producing it. Gold and its value is nothing more than a store of value for producers to then be consumers.

    Rodney King's Spirit (ca9e04)

  28. “But if banks structured their contracts with depositors such that they were never lending out money they didn’t have, why fear a bank run?”

    Even if a bank lends out only “the money it did have” everyone can’t go in there and get their money back immediately. It’s lent out!

    cbuund (2cc14c)

  29. Oh, wait a minute. You’re saying it should be in a vault, then? You can do that. Put it in a safety deposit box. Then you can get it anytime you want. Help me out here Rodney.

    So you’re saying that banks, before the FDIC, while we were on the gold standard, did NOT tell depositors who were not using safety deposit boxes that they could earn interest (not possible with a safety deposit box) AND reclaim their money upon demand (albeit perhaps with certain contractual restrictions for high deposits)?

    Well then. I can’t see how a bank run could ever have posed a problem.

    My basic point is simple and not hard to understand:

    If you can’t handle a bank run, then you are committing fraud on your depositors.

    Patterico (9c670f)

  30. Even if a bank lends out only “the money it did have” everyone can’t go in there and get their money back immediately. It’s lent out!

    Please see my #19.

    Patterico (9c670f)

  31. But if banks structured their contracts with depositors such that they were never lending out money they didn’t have, why fear a bank run?

    Because 90% of the money is not physically available. It has been loaned out to individuals and businesses and they pay the money back, with th interest that allows the bank to operate and to protect the reserves that are in the vault.

    WTP (0b94df)

  32. Patterico,

    A gold standard without fraud?

    Replace the word Gold Standard with Basket of Goods Standard then think it thru.

    That Basket of Goods changes over time, the value of the items change over time, some of the items become obsolete and new ones get created.

    So even if you used Gold and no fraud — the Basket of Goods we need to live change over time and the amount of gold you need to buy this basket changes.

    All money (or gold) is transitive. All that really exists is consumers on one side demanding stuff and the same consumers on the other side producing it. Gold and its value is nothing more than a store of value for producers to then be consumers.

    I agree with everything you said.

    But refer to the post again. When the government controls the gold, or the basket of goods, and its value (by controlling its quantity) then the store of value does not change only by reference to changin values of the goods and services bought and sold. It also changes in response to the government’s manipulation of the quantity of that thing (gold, basket of goods, whatever) used as a medium of exchange. Which government does to suit its own ends.

    Patterico (9c670f)

  33. #23. Fractional banking allows a person to take one piece of gold and it becomes 1 Asset and 1 Equity.

    They then go out and get 9 more gold in the form of debt with the promise they pay that back with 1% interest.

    Now the bank has 10 gold Asset and 9 Debt + 1 Equity.

    The bank now has 10 gold which are doing nothing so they lend it out to some dude and tell that dude pay me back gold plus 5% interest.

    Now those busy little beavers who took the money from the bank are working hard to not only pay back 10 gold but pay it back with 5%.

    That SPREAD (5% – 1%) is what produces wealth for both the bank and society. It not only represents gold as a store of value but actual GOODS AND SERVICES that those borrowers created.

    Rodney King's Spirit (ca9e04)

  34. So instead of earning interest on your savings you would just be paying the bank to hold your savings. I see.

    cbuund (2cc14c)

  35. Because 90% of the money is not physically available. It has been loaned out to individuals and businesses and they pay the money back, with th interest that allows the bank to operate and to protect the reserves that are in the vault.

    And that — if depositors have been told they can reclaim more than 10% of their money on demand — is fraud.

    I mean, I get how it works. You don’t have to keep explaining it. I just don’t agree with it.

    Patterico (9c670f)

  36. It seems like your problem is more with the fact that we carry out monetary policy instead of being at the whims of the supply of a particular (not silver?) commodity.

    cbuund (2cc14c)

  37. God, missed this part
    . Banks should make a profit for the service of warehousing your gold, and that profit can be lent, as can the interest earned on past loans. But lending out money while telling people they can have it back any time they want is fraudulent

    Have you any idea what that costs? Also, the money being lent out into the community is far, far safer than if locked up in a vault in one nice neat tidy place so the crooks can more easily steal more of it.

    WTP (0b94df)

  38. So instead of earning interest on your savings you would just be paying the bank to hold your savings. I see.

    Oh, it’s better to earn interest — but if the bank promises you interest AND the ability to get all your money back on demand, it’s fraud. They’re just hoping the fraud won’t be detected, which happens only if everyone gets suspicious at once. If they don’t, then everybody wins.

    Nowadays, of course, we don’t have to worry about a bank run because our wonderful government takes care of it all. And if the bank fails, the government takes care of that too. And really, none of this has any ultimate cost, and the piper need never be paid.

    Right?

    Patterico (9c670f)

  39. It seems like your problem is more with the fact that we carry out monetary policy instead of being at the whims of the supply of a particular (not silver?) commodity.

    I’d much rather be at the “whim” of gold than at the whim of the Fed. You bet.

    Patterico (9c670f)

  40. “Oh, it’s better to earn interest — but if the bank promises you interest AND the ability to get all your money back on demand, it’s fraud. They’re just hoping the fraud won’t be detected, which happens only if everyone gets suspicious at once. If they don’t, then everybody wins.”

    I’m still not clear on what the deception is. Were you deceived? Has it not been made clear how banks work?

    cbuund (2cc14c)

  41. Patterico,

    I think you are too wrapped by the circular nature of the financial system.

    But no, it is not fraud and if so then we are back to 75BC

    Rodney King's Spirit (ca9e04)

  42. I mean, I get how it works. You don’t have to keep explaining it. I just don’t agree with it.

    Ok, so where’s the fraud? You do have a mattress? Or, as I said put it in a safety deposit box and the rest of us fools can suffer the consequences.

    WTP (0b94df)

  43. “I’d much rather be at the “whim” of gold than at the whim of the Fed. You bet.”

    So like, if there’s an earthquake that wipes out 10% of gold production, reducing the money supply and causing deflation, that’s fine. But the fed trying to reach an inflation target (and failing!), can’t have that?

    cbuund (2cc14c)

  44. Have you any idea what that costs? Also, the money being lent out into the community is far, far safer than if locked up in a vault in one nice neat tidy place so the crooks can more easily steal more of it.

    OK. That’s why there were no bank runs. Because nobody wanted their gold all at home where there wasn’t even a vault. They were perfectly happy having their money be “safe” in the community being lent out. Until it all evaporated and they were left with nothing, which turned out to be not very safe at all. Because they were defrauded by the bank. A fraud revealed by the very terrible specter of all the customers demanding that the institution make good on its obligations at once, which of course is totally unforeseeable except that it happened with regularly and the banks just hoped they didn’t get struck by the lightning.

    Patterico (9c670f)

  45. Oh and that is why we have an FDIC …. and other deposits are at risk.

    So not fraud really unless you mean “fraud in the inducement” which would also apply to those penile enlargement claims I run into on porn sites.

    But even a gold standard does not address it. Bank Balance Sheets are very complicated little animals than even CFOs don’t get because end of the day both sides of Balance Sheet are subject to the whims of people the bank has no control over.

    Rodney King's Spirit (ca9e04)

  46. And also not all deposit accounts are “on-demand” either.

    Rodney King's Spirit (ca9e04)

  47. So like, if there’s an earthquake that wipes out 10% of gold production, reducing the money supply and causing deflation, that’s fine. But the fed trying to reach an inflation target (and failing!), can’t have that?

    I don’t mean to be insulting, honestly, but I do find it laughable that people drag out these arguments like “discovery of the New World increased the supply of gold!” or “an earthquake might somehow wipe out the supply of gold causing deflation!” or “a gold meteor might hit the Earth causing wild inflation!”

    And yet those same people are fine with the Fed creating trillions in quantitative easing, which is like gold meteors hitting the planet monthly. This is not some theory; it’s happening.

    Patterico (9c670f)

  48. Dude it’s late back east here and I need to go, but you’re really not understanding how this all works. You are correct in so far as the banks need to be solvent and before the FDIC etc. this was a problem. And it could eps till become one. But the problem is not because of FRB. I don’t know how else to explain it. I’m a bit stunned.

    WTP (0b94df)

  49. And also not all deposit accounts are “on-demand” either.

    And, for the umpteenth time, IF the bank structures its contracts such that it need not fear a bank run, then there is no problem.

    I will start ending every comment with the point I made above until people stop acting like they never saw it:

    My basic point is simple and not hard to understand:

    If you can’t handle a bank run, then you are committing fraud on your depositors.

    Patterico (9c670f)

  50. Also:

    My basic point is simple and not hard to understand:

    If you can’t handle a bank run, then you are committing fraud on your depositors.

    Patterico (9c670f)

  51. Dude it’s late back east here and I need to go, but you’re really not understanding how this all works. You are correct in so far as the banks need to be solvent and before the FDIC etc. this was a problem. And it could eps till become one. But the problem is not because of FRB. I don’t know how else to explain it. I’m a bit stunned.

    Well. It’s not just FRB but also the lack of a gold standard. Be stunned all you like, but just make an argument rather than implying I’m an idiot. I grant that I’m an amateur and I may be getting stuff wrong, but so far I have not seen a convincing argument and I’m not stupid.

    My basic point is simple and not hard to understand:

    If you can’t handle a bank run, then you are committing fraud on your depositors.

    Patterico (9c670f)

  52. Patterico

    QE is a possible time bomb but if the velocity of money is going down while the volume is going up — it has no effect on wealth.

    That is what has happened last few years. This the concept of the Fed pushing on a strong with money supply. So what you have is large cash balances they are not be put to work except for US Bonds to finance bloated Govt.

    But without QE our deficit would be trillion plus with higher interest rates.

    Rodney King's Spirit (ca9e04)

  53. But even a gold standard does not address it. Bank Balance Sheets are very complicated little animals than even CFOs don’t get because end of the day both sides of Balance Sheet are subject to the whims of people the bank has no control over.

    I’m sure they are very complicated and I don’t pretend to understand them.

    But:

    If you can’t handle a bank run, then you are committing fraud on your depositors.

    Patterico (9c670f)

  54. “And yet those same people are fine with the Fed creating trillions in quantitative easing, which is like gold meteors hitting the planet monthly. This is not some theory; it’s happening.”

    Like I said, it appears that your problem is that we have monetary policy. It’s not that changes happen that is the problem. It’s that we can control them. Free Silver was a thing during the panic of ’93 because there was no way to make monetary policy to answer that crisis.

    cbuund (2cc14c)

  55. #50 That is not true.

    Not all depositors are the same and some accounts are more “safe” than others.

    What you reflect is a naivete of how banks operate, how they create value and the laws governing their operation.

    And I hate the bastards. Blood sucking leeches.

    Rodney King's Spirit (ca9e04)

  56. I guess you could probably expect me to say this, but a gold standard for the value of any monetary standard might work for the short term.

    However, wealth and investment is not built upon a singular asset, such as gold.

    It is built upon labor. People may work for a particular asset, but they mainly work to eat, enjoy the results of labor and establish a family and assure the family has assets to continue to enjoy the fruits of the labor.

    Gold can be a goal, however, gold is an abstract. Work is wealth.

    Ag80 (eb6ffa)

  57. Prof. Jacobson haz Rico in his reading list tonite.

    gary gulrud (e2cef3)

  58. “If you can’t handle a bank run, then you are committing fraud on your depositors.”

    It seems to me that bank runs happen because depositors aren’t deceived as to what is going on. That’s why they run to the bank!

    cbuund (2cc14c)

  59. Patterico

    QE is a possible time bomb but if the velocity of money is going down while the volume is going up — it has no effect on wealth.

    That is what has happened last few years. This the concept of the Fed pushing on a strong with money supply. So what you have is large cash balances they are not be put to work except for US Bonds to finance bloated Govt.

    But without QE our deficit would be trillion plus with higher interest rates.

    I know, Krugman Krugman and liquidity trap and all that. I do think that some people fail to distinguish between the money supply as a whole and the bank money supply. To the extent the money is not getting into the bloodstream of the economy, it will not have the predicted hyperinflationary effect. As I understand it. Again, I am not an economist.

    Patterico (9c670f)

  60. #50 This is like saying a Company that goes bankrupt after they took a deposit to build your home is committing fraud by taking the deposit.

    Rodney King's Spirit (ca9e04)

  61. Like I said, it appears that your problem is that we have monetary policy.

    Correct. I believe that interest rates, like everything else, are better set by the free market than by government overlords at the Fed. I trust no small group of Platonic wizards more than I trust the collective wisdom of all economic decisionmakers as a whole.

    You can point to history and claim things were worse without monetary policy, but I disagree. Markets were never truly unhampered. The Fed created the Great Depression rather than moderated or avoided it. And just before the housing bubble burst, Bernanke was telling us how they finally had the art of moderating the economy down to a science. I think the crash happened within weeks of that statement.

    Yup, I’m an “end the Fed” guy. Guilty as charged. Like I said: I’m not afraid to espouse the crackpot theories!

    Patterico (9c670f)

  62. #50 This is like saying a Company that goes bankrupt after they took a deposit to build your home is committing fraud by taking the deposit.

    Not unless the Company goes bankrupt by virtue of all its contracts being suddenly enforced.

    Yes, banks got surprised by bank runs. But all the depositors were doing was exercising their contractual rights.

    If meeting all your obligations on all your contracts causes you to go bankrupt, then yes, you are committing fraud.

    Patterico (9c670f)

  63. Gold can be a goal, however, gold is an abstract. Work is wealth.

    All true to a point. I say read the post again. The only point I make, really, is that gold is a medium of exchange, and absent fraud (usually encouraged by government) it operates efficiently, until it is replaced by a better one.

    Patterico (9c670f)

  64. Not all depositors are the same and some accounts are more “safe” than others.

    I agree. But If meeting all your obligations on all your contracts causes you to go bankrupt, then you are committing fraud. Says me.

    What you reflect is a naivete of how banks operate, how they create value and the laws governing their operation.

    That is not an argument, just a slap at me.

    Patterico (9c670f)

  65. #63 Yeah good luck with that one. As a business owner, I find that view you have as very odd.

    So All Insurance is fraud too?

    Your pension is fraud too?

    What if every person took every single dollar and ran out to the grocery store and found out no more stuff is there to buy, is that fraud?

    They had money, money represent “an option to claim others work product” but then none exists?

    Don’t see your view point.

    Rodney King's Spirit (ca9e04)

  66. However, banks create capital through investment with the interest on deposits. Gold, in and of itself, does not generate capital. It only generates capital through mining, labor, and it’s rarity and usefulness.

    Other things are rare, useful and less labor intensive.

    Ag80 (eb6ffa)

  67. “The problem is that depositors were told their deposits could be redeemed at any time. But they couldn’t be — because the bank had fraudulently lent out those deposits to multiple other people.”

    Patterico – I don’t follow your logic at all. I understand depositors being told they can reclaim their deposits at any time. That’s fine. What are people using for currency, warehouse receipts or U.S. currency based on the gold standard?

    If it’s currency, I don’t know how you can trace individual deposits from one account to the next to make the case that banks are lending the same deposits over and over. They are leveraging their equity as pointed out by other commenters, but banks do not create money out of thin air as folks like Rothbard like to imply. the inability to meet a run on a bank occurs when assets, such as investments a bank decides to make in home mortgages is less liquid than its liabilities.

    daleyrocks (bf33e9)

  68. #65. Do you understand Bank Law? I don’t but if you are right then go be a Trial Lawyer. You got money to make.

    Fraud? Yeah so many things are fraud then by that standard.

    Rodney King's Spirit (ca9e04)

  69. #68 Liquidity ….. another highly misused concept in markets but one appropriate for this discussion. I call it term mismatching + assignment option.

    Rodney King's Spirit (ca9e04)

  70. #63 Yeah good luck with that one. As a business owner, I find that view you have as very odd.

    So All Insurance is fraud too?

    Your pension is fraud too?

    What if every person took every single dollar and ran out to the grocery store and found out no more stuff is there to buy, is that fraud?

    They had money, money represent “an option to claim others work product” but then none exists?

    Don’t see your view point.

    I don’t see the analogy.

    Everyone in my organization will not, and cannot, reach retirement age at once. But all bank depositors might decide to withdraw their deposits all at once. Banks can hope they don’t. But if they promise depositors they can — and then don’t honor that promise when people take them up on it? It strikes me as fraud.

    I know that it’s commonly accepted, and that government allows it through regulation. I never questioned it myself until I read Rothbard. But it makes sense to me. The analogy to a pension doesn’t strike me as apt.

    To an insurance company? Still not analogous. Yes, it could go under due to a series of unexpected disasters. But with a bank, the supposed unexpected disaster is simply people deciding all at once to reclaim their money to the extent that they are contractually obligated to do so.

    Patterico (9c670f)

  71. Maybe you folks could try reading the Rothbard book I recently linked. It’s free, and I bet he says it better than I can!

    Patterico (9c670f)

  72. And it’s short.

    Patterico (9c670f)

  73. #71 Where the Bond Insurers guilty of fraud in 2008?

    I dunno but those pesky little clauses like Force Majeure and Acts of God come to mind before Fraud.

    The examples are the same idea — if eery claimant shows up at the same time (no matter how unlikely) can any business survive????

    You gave out coupons for free pizza and then you go bankrupt. Are customers showing up after you close able to allege Fraud? You promised a free pizza!

    Rodney King's Spirit (ca9e04)

  74. And Patterico, every depositor coming in and asking for their money all at once is a Black Swan.

    Just like a natural disaster putting an insurer out of business.

    Rodney King's Spirit (ca9e04)

  75. “It’s free, and I bet he says it better than I can!”

    Patterico – I doubt it. I’ve read some of his stuff and I think he’s a complete nut job.

    daleyrocks (bf33e9)

  76. @Patterico: Life insurance is a fraud because if all policy holders die at once the insurer cannot pay off the policies.

    How is that different from what you are saying about bank runs?

    Insurance companies structure their assets and liabilities to avoid that. Sometimes they fail, and go broke, but mostly they make lots of money for their shareholders.

    How is that different from what you are saying about bank runs?

    Gabriel Hanna (e1a347)

  77. 1. deliberate deception, trickery, or cheating intended to gain an advantage
    2. an act or instance of such deception
    3. something false or spurious: his explanation was a fraud.
    4. a person who acts in a false or deceitful way

    Not sure a Bank is committing fraud in the event of depositor bank run ………. not like when my Bank takes my deposit the bank says to me “in the event of financial armegeddon, your non-FDIC deposits are good.”

    Rodney King's Spirit (ca9e04)

  78. “So if you want to think of it a certain way ….. change the world gold for the word “basket of goods” and it is the same concept. ”

    Except a “basket of goods” is far easier to manipulate by the government. The market for gold is world wide.

    My original point seems to have been ignored. It is all about trust. If that exists, fractional banking works well. If it doesn’t, you get bank runs. We had pretty good trust after the FDIC was established until around 1986 when inflation destroyed the S&Ls. Read Nicole Gelinas’ book, “After the Fall.”

    MikeK (cd7278)

  79. Without fractional reserve banking we’d all be saving our pennies until we could buy a house for cash. The gold standard is simply a way for the market on money to be cornered.

    Kevin M (b357ee)

  80. #80 Gold standard applies a purely random value on a transitive nature of that gold.

    #79 A basket of goods already acts as our gold standard. It is called a grocery store and $100. But if you want to use your gold, go to the Pawn shop first, get the $100, get ripped off and then go buy food.

    Rodney King's Spirit (ca9e04)

  81. “Not sure a Bank is committing fraud in the event of depositor bank run”

    Rodney King’s Spirit – Can we accuse Chuck Schumer of fraud for creating a run on IndyMac?

    daleyrocks (bf33e9)

  82. #79 But yes trust is important, in any deal it is important. Not just fiat currency.

    Rodney King's Spirit (ca9e04)

  83. Oh. This thread is not about jewelry?

    elissa (770ecb)

  84. #84 I thought is was about cavity prevention and oral health.

    Rodney King's Spirit (ca9e04)

  85. #85 exceptionally rich.

    Rodney King's Spirit (ca9e04)

  86. Patterico — you want FRAUD?

    Short selling. Now that is fraud.

    Someone borrows your car, they sell it to some other dude to drive, then they buy it back after the miles have been racked up, and give you the car back.

    Short Selling is fraud.

    Rodney King's Spirit (ca9e04)

  87. In 1700, England was a pissant country, pretty much neglected by the continental powers (Louis XIV and Spain, mostly). Wealth was measured as it always had been: gold and land and people to work it.

    By 1800, England was a world power that fought a world war and won (except for the setback in America). How? By inventing finance and capitalism. They had no gold and yet they managed to build and produce and explore and conquer and win. Spain had all the gold and went bust 4 times between Columbus and 1800.

    By 1900, England ruled the world. Then, of course, England implemented their new economic socialism and everything fell apart. But even then, gold didn’t help.

    Gold is not the answer. There is nothing wrong with fractional reserve banking that can’t be solved by shooting some bankers from time to time.

    Kevin M (b357ee)

  88. But yes trust is important, in any deal it is important. Not just fiat currency.
    Yes, of course. But this is like gun control: you can point at all the bad guys with guns and say THIS MUST STOP. But the GUNS aren’t the problem; the bad guys are.

    Kevin M (b357ee)

  89. #88:
    *their new economic invention, socialism and

    Kevin M (b357ee)

  90. I think it’s been too long a day for me to be reading this. It reminds me of a D&D game years ago where the other players were trying to explain to my elf barbarian how “barter markers” (my term for the gold and silver pieces I kept getting) worked.

    If you’ll excuse me, I think I’m going to go kill a moose so I can trade the meat and hide for a new sword.

    malclave (1db6c5)

  91. Regarding “fraud” people often enter into contracts which they know they will be unable to fulfill in some circumstances without it being considered fraud. The contract could try to enumerate all the things that could go wrong but this is often not worth the trouble. People generally understand that bankrupts (whether people or businesses) are not likely to fulfill all their contractual obligations.

    In any case a bank would just have to put in some sort of “best efforts” clause in their contract to deal with the case where everyone wants their money back at the same time.

    James B. Shearer (9233b4)

  92. Hmmm . . . I think I see where the problem is.

    First though:
    “Well, it turns out that, over time, humans have always gravitated towards gold and silver as containing the best mix of characteristics to serve as a medium of exchange. Silver has typically been employed for smaller transactions, and gold for transactions involving higher values (because gold better provides the mix of characteristics needed for a medium of exchange).”

    That is not an economic absolute, mostly because of that “always” in there.
    “Often” or “usually” perhaps, “generally” is better, but not “always”.
    Also, the relationship is a lot more complex, and heavily dependent on factors including availability, amount of economic activity, stability of the government issuing the currency, and a few other factors, but enough that it is just not an absolute.

    That said, I think the core is looking at the issue of banking, particularly fractional reserve banking, from dramatically different perspectives.

    You, Patterico, are looking at the promises the banks make, and considering the deposits to be absolute and sacrosanct contracts, and concluding that banks are engaging in fraud.

    The problem is, those deposits are not (deposits).
    As others have noted, to truly “deposit” money in that sense in a bank you put it in a safety deposit box.
    Rather than earning interest on it, you pay the bank a fee to guard your money. (Or other valuables.)
    You can withdraw it at any time during regular business hours, and it is secure barring actual physical assault on the bank.

    Money that you deposit in a normal bank account is, functionally, a loan to the bank.
    That is why you get interest for it – the bank is paying you for letting them use your money to make a profit, generally by them lending it to someone else at a higher rate of interest than they are paying you. You can consider the difference in interest rates to be the agent’s fee you pay the bank for lending your money for you.
    As a loan, it is simply not 100% secure, no matter what the bank says. Like anyone else promoting their services, they exaggerate and use hyperbole. You can call that “fraud”, but then you are going to have to shut down virtually all advertising along with it. (Which I’m sure many want to, no matter the 1st Amendment.)

    You question whether this is how things were before the FDIC when we were on the gold standard and some have declared it would take us back to the stone age.
    It is not that bad – merely back to the transition between the Middle Ages and Renaissance.
    Yes, in fact, before then banks were merchants who merely offered to let strangers use their vaults in exchange for a fee while only using their own coin for speculative trading and lending. Then some genius banker got the idea of risking someone else’s money on those crazy loans they were making and the idea of bank “deposits” paying interest but not being as secure as a vault was born.
    One would also note that the idea of paper currency came into existence around the same time, although then only as “letters of credit” to be issued by one branch of a merchant company in one city, carried by a person to another city, and exchanged for reserves of the same merchant company in that city. That naturally grew into people trading the receipts, which became a form of bank checks, which gradually evolved into bank issued paper currency, which was finally nationalized.

    There really is a lot of history behind what has become our modern banking system going back several hundred to two thousand years depending on the particular element. It includes critical elements related to insurance, limited liability corporations, joint stock corporations, and more. (All primarily deriving from the principle of risk transference.)

    Now mind you, without all of that, looking at things from a purely direct, purely contractual, viewpoint you are using, you are correct – banks are engaging in some seriously egregious fraud.
    At least they would be if they were operating in that manner.
    They really aren’t, and they really can’t without doing really horrific things to our economic system.

    Finally I would note that your basic question “Why gold?” immediately explodes into dozens of other questions, which while interconnected all have extremely long answers of their own, with multiple digressions, which then have to be combined to answer the initial question. That makes it rather difficult to answer your question in a blog reply format. This is a long reply here to go with the one I did in the other thread, and they barely scratch the surface.

    Sam (e8f1ad)

  93. Sam,

    Interesting comment, thanks. The complexity made the post difficult to write as well as difficult to respond to.

    Patterico (9c670f)

  94. I still have a lot of learning to do. I’m not someone who pretends to be an expert on everything; I enjoy having my thoughts challenged — as long as people read what I am saying and respond to it.

    Patterico (9c670f)

  95. Bank runs have nothing to do with the gold standard or fractional standard or any standard. They reflect confidence in the bank to have your money.

    There were far more frequent bank runs, panics, recessions, and bouts of inflation and deflation in the 19th Century pure gold standard period, here and abroad, than after nations abandoned it.

    Estragon (ada867)

  96. No other business experiences a phenomenon like a “run.” No other business can be plunged into bankruptcy overnight simply because its customers decide to repossess their own property. No other business creates fictitious new money, which will evaporate when truly gauged.

    Excerpt From: Rothbard, Murray N. “What Has Government Done to Our Money?

    Patterico (9c670f)

  97. Estragon,

    You have made a pronouncement, to be sure, but I have argued that a gold standard without fraud means fractional reserve banking should not be allowed. That there is a relationship between the two as described in the post at great length. Do you have any arguments in response?

    Patterico (9c670f)

  98. The next step in the analysis is complex but deals with factors that restrain runaway inflation even with FRB. Guess what the restraining mechanism is per Rothbard?

    Gold.

    Maybe more on this tomorrow?

    Patterico (9c670f)

  99. As for your claim that inflation and deflation were worse in the 1800s, I am skeptical. To the extent that there were booms and busts, Rothbard blames “the governments’ monopolizing of the mint, legal tender laws, the creation of paper money” and the development of inflationary policies. More on this, and government interference with market mechanisms designed to keep inflation in check, tomorrow (if I have time).

    Patterico (9c670f)

  100. gold standard bo bandard banana fana fo fandard fee fi mo mandard

    GOLD STANDARD!

    Gold standards are for responsible countries what aren’t run by fascist whores.

    Maybe Canada?

    happyfeet (8ce051)

  101. I am like Patterico here: not an expert, but it’s sure fun to read all the idiots on here saying “Patterico is an idiot” (not those exact words) because they refuse to listen to what he’s saying. (That’s called irony and sarcasm.)

    I saw the name Krugman appear. Anyone who values Krugman econ does not value quality econ. Anyone who holds Krugman up for acclaim needs to lose his shirt.

    That is all.

    John Hitchcock (03342b)

  102. I think the answer to why gold is that it IS fairly stable, slowly increasing and hard to destroy. If you want to base your money on a commodity, it’s a good choice. It’s also shiny.

    Sam’s comment @93 is a pretty good explanation of why you don’t want to.

    Kevin M (b357ee)

  103. “Correct. I believe that interest rates, like everything else, are better set by the free market than by government overlords at the Fed.”

    One way the free market works is by altering the money supply with fractional reserve banking. It doesn’t seem like you believe in a free market for what is money, you want it to be fixed to the supply of gold and that is it. You still haven’t said why gold and not silver too, for example!

    cbuund (2cc14c)

  104. @Patterico: I asked you earlier if insurance is fraud–since they can’t possibly pay all claims at once–and you didn’t respond. Still thinking about it?

    It’s important to think through this and not just dismiss it, because you will get a lot more clarity by confronting what may be a contradiction.

    Now, I notice as well that when people bring up Spain or 19th century monetary hijinks you say that Rothbard says it was because the government was doing this or that so the example shouldn’t count.

    Doesn’t this prove, though, that what Rothbard says about gold cannot possibly be true? It simply does not protect you from government meddling in the money supply.

    It seems Rothbard’s gold standard, like a Marxist’s Communism, is too pure to ever have existed in practice and once we do it the “real way” it ought to work–it’s just that no one ever tried a “real” gold standard…

    Doesn’t that make you think a bit? If gold is so easy to mess with that no existing gold standard can be called a “real” one, then how does it do what Rothbard claims it will do?

    Gabriel Hanna (e1a347)

  105. 1. I have now and congratulations, its really a conceptual tour de force, the sort of thing I happen to respect a lot.

    I don’t think I know enough about some subjects to say such a thing, like Law, but money is like driving, we all have to be somewhat proficient.

    gary gulrud (e2cef3)

  106. And now it’s morning here and I see Sam did an excellent job of saying what I was trying to get across. Sorry if I cam across as harsh. I didn’t think I was saying you were stupid, I was just frustrated with my inability to get my point across. No harm intended, it’s just that (and don’t take this personal, I find it applies very broadly) when I encounter highly educated, successful people who don’t understand the basics, I fail to realize how wide spread this problem is. We have too many experts in their fields and not enough polyglots. Not that you’re not the latter in many other regards just, as you admit, not economics/banking.

    Sam, do you have your own website where you discuss such matters or a place where you hang out to do so?

    WTP (60406d)

  107. 105. The issue is rehypothecation, a zerohedge neologism.

    Using the same item of collateral to make multiple loans good. That is fraud, and legal in the EU banking system which is far larger than that of the US.

    This is not to be confused with liquidity, or the lack of same. A bank run, even against a bank meeting the letter of Rico’s more, will cause the bank to fail because it cannot meet the immediate need.

    Confidence in media of exchange is one thing, and in turn, relies on confidence in the economic system which issues the medium.

    The course of history is undeniable as exemplified by the sequence of Chinese dynasties, beginning at least with the Chin. At the beginning they use gold, then silver, then copper, then they punch a hole in the center of the coin, yada, yada. Dynasties are enlightened in the beginning, corrupt in the end, decadence and sloth burgeon. And then the end arrives and a foreign Dynasty, a barbarian culture takes over.

    gary gulrud (e2cef3)

  108. Our demographic crisis is hastening the end. We do not have enough jobs to employ the next generation. We do not have enough next generation to support the last.

    We suspend the rule of law to get around the inconvenience, open our borders, empty the prisons, close the court rooms,..

    Simultaneously, we multiply and trivialize the infractions, the trespasses to fund dysfunctional government and employ in obstructive, unaccountable uselessness an incompetent myriad corruptacracy.

    Fold ‘em Amerikkka, you’re busted.

    gary gulrud (e2cef3)

  109. @Patterico: I asked you earlier if insurance is fraud–since they can’t possibly pay all claims at once–and you didn’t respond. Still thinking about it?

    I guess you skipped over comment 90. Re-read it?

    Then refer to 97 as a supplement.

    Patterico (9c670f)

  110. One way the free market works is by altering the money supply with fractional reserve banking. It doesn’t seem like you believe in a free market for what is money, you want it to be fixed to the supply of gold and that is it. You still haven’t said why gold and not silver too, for example!

    I absolutely believe in the free market for money and said so in several comments. I said in one comment why silver is generally considered less valuable. Do me a favor and try to read my comments before saying I have not addressed an issue; maybe I did and you missed it.

    Where I do not believe in a free market is when fraud enters it.

    Now some of you think I am saying it’s STILL fraud. Clearly not, with the advent of deposit insurance.

    But before that, banks had immediate liabilities without the resources to pay them. I’m making the same point maybe 49 times which is an indicator that I am either saying it wrong or people are not reading all my comments.

    Patterico (9c670f)

  111. Money that you deposit in a normal bank account is, functionally, a loan to the bank.
    That is why you get interest for it – the bank is paying you for letting them use your money to make a profit, generally by them lending it to someone else at a higher rate of interest than they are paying you. You can consider the difference in interest rates to be the agent’s fee you pay the bank for lending your money for you.
    As a loan, it is simply not 100% secure, no matter what the bank says. Like anyone else promoting their services, they exaggerate and use hyperbole. You can call that “fraud”, but then you are going to have to shut down virtually all advertising along with it. (Which I’m sure many want to, no matter the 1st Amendment.)

    People seem to have coalesced around Sam’s 93 as the best objection, so let me take it head on.

    I agree with his observation that “always” is a slight overstatement when I say people have “always” gravitated towards gold. It should be obvious since I explicitly say other commodities have been used in the past, and since the 30s and definitely the 70s we have all abandoned it. But yeah, “always” is not quite right.

    As for this quoted passage: I already said this, but while a deposit is more like a loan, banks sell them more like a safety deposit box with benefits. They *could* say “you don’t get your money back for 3 months” and thus stagger the repayments, and indeed do with CDs, but they don’t with deposits. They pretend they are repayable on demand and then lend out the money hoping people won’t demand that they make good.

    You respond to that with “ain’t ya never heard of puffery?” but I don’t buy that. Promising someone their money back when you know you can’t make good if everyone takes you up on it is fraud, IMO, not puffery. See the Rothbard quote at 97 or 98, I’m on a phone and forget which, for an explanation as to why this is not like other businesses.

    Again: I’m not an economic sophisticate but them neither is much of my audience. If we’re missing something, tell us why.

    Patterico (9c670f)

  112. I should add that it’s great to see unfamiliar and intelligent commenters. I hope y’all stick around!

    Patterico (9c670f)

  113. One example, the Federal Reserve created bank reserves against loss by purchasing a couple trillion in MBS, toxic debt wherein bad mortgages were rolled in with good and sold as immaculate.

    Those reserves, forced to be held, are reimbursed at rate 0.25% per annum for their inactivity. They nonetheless are listed on the bank’s books.

    The banks are, in fact, employing those reserves, and have created margin using them as collateral for investments of their own.

    Now glosses are produced for every item in this travesty, but the sum is that we’ve a house of cards.

    gary gulrud (e2cef3)

  114. WTP, I’m working on educating myself. That said, I think we have a difference of opinion rather than simply an ignorant person (me) and the people who are right about everything. If I’m wrong, just make a plain-language argument as to why. You seem to sign onto Sam’s view; I just responded. Let’s talk it out. If I am ignorant and thus getting it wrong, educate me. Better yet: persuade me. I genuinely have an open mind on this but find myself unconvinced by the arguments I have seen so far.

    Patterico (9c670f)

  115. Gary: right. Someone up thread claimed banks don’t create money out of thin air, but they do.

    Patterico (9c670f)

  116. @Patterico: Your answer

    To an insurance company? Still not analogous. Yes, it could go under due to a series of unexpected disasters. But with a bank, the supposed unexpected disaster is simply people deciding all at once to reclaim their money to the extent that they are contractually obligated to do so.

    restates my point, but you seem not to be conscious of it.

    Like an insurance company, a bank promises to give you money under certain conditions. Like an insurance company, a bank lends out or invests your money and doesn’t actually have it. Like an insurance company, if too many people claim their money at one time they can’t pay. Like an insurance company, a bank takes care to structure its assets and obligations against the probability of customers claiming money.

    You seem to be saying the fundamental difference is that depositors can claim on a whim and insured people have to have something happen, and so in your view insurance is not “culpable”–but in both cases its a matter of probabilities how many people want money at once, and it can be planned for if the pool of customers is large enough. if I can’t get my money I don’t care what the reason is, or the intention. It doesn’t matter why people want their money–both banks and insurance companies cannot pay all obligations at the same time, and no one expects them to, and they go broke if they are made to, and they know that’s a risk of their business which they strive to minimize.

    So I ask again, how are they different?

    Gabriel Hanna (529091)

  117. Another game, previously alleged:

    November last we noted that the US Debt, owing to the prior ceiling, had gone up only $50 Billion over the limit. After the ceiling was raised, the Debt jumped $380 Billion overnight.

    In December, we suddenly see Belgium, home to the EU for most of the year, rapidly become the 3rd largest foreign repository of US Debt, jumping $140 Billion almost as quickly as the Debt rise.

    Does a paper trail even exist, or is this just a Schroedinger discontinuity?

    gary gulrud (e2cef3)

  118. 119. Note that the nation of Belgium hadn’t even had a government for 2 1/2 years until 2013 and has a public debt of 160% of GDP. Where the heck did they find the scratch?

    gary gulrud (e2cef3)

  119. 118. Liquidity crises are not fraud, and not Rico’s thrust.

    gary gulrud (e2cef3)

  120. Why gold, historically? The answer came to me as I looked at the gold leaf on the covers of my encyclopedia. Nothing can be pounded thinner and still retain all its properties. You can have a penny’s worth in a full-size cigarette’s paper, the whole thing shining as beautifully as your wedding band while you’re smoking it. It still glitters, it’s still gold, when it’s so little as to be worthless in comparison to the labor that went into pounding it that thin. Different than a wheelbarrow of Weimar marks for a loaf of bread?
    https://en.wikipedia.org/wiki/Gold_leaf

    nk (dbc370)

  121. Yes, I read the whole thing and enjoyed it. I would make a couple points.

    Conservatives/libertarians (including myself) sometimes fail to honestly and completely evaluate how the world has changed as we have grown to 7 billion plus and now have all this neat technology that allows us to speed around the world, talk to the Moon, watch stuff happening around the world in real time etc.

    Currency is a tool just as a gun or a hammer is a tool. Used the wrong way tools can create problems. The fact that the tool of currency untethered from gold makes it easier for government to spend doesn’t make currency itself a bad thing.

    Mark Johnson (df77f2)

  122. 121. Banks and insurance concerns are not congruent. Hedges, e.g., are allowed to sell policies, CDS, which they cannot cover were all to come in, because of risk analysis ‘guaranteeing’ low correlation between bets placed by unrelated positions.

    Life insurance policies, barring disaster, are reasonably considered free from the risk of a ‘run’.

    gary gulrud (e2cef3)

  123. Yes, I read the whole thing. And, in particular,…

    If society treated fractional reserve banking as the fraud that it actually is, and kept us on a strict gold standard, then maybe — just maybe — governments would not have the ability to borrow endlessly; to mask their debts and lessen their pain by causing runaway inflation; and to generally deprive people of the value of their savings.

    I could go on and on, but hopefully this gives readers a better idea of why humans might value gold, why fractional reserve banking is dangerous; and why going off the gold standard unmoors us from any fiscal discipline.

    …was exquisitely well-said. (Emphasis mine.)

    J.P. (bd0246)

  124. And one more thing, re: your beginning to study Austrian economics. To paraphrase a line from a Star Trek episode: Oh, I envy you, Patterico. You’re just at the beginning of the adventure.

    J.P. (bd0246)

  125. Fold ‘em Amerikkka, you’re busted.

    The only thing that’s preventing the house of cards from collapsing in on itself is that nations other than the US are in equally or far worse shape, economically if not also politically. So America, if only by default, is the “safe haven.” But “safe” within the context of countries like PRC China, much of the EU (ie, Italy, Spain, Greece, etc), or Mexico/Brazil, or Japan with its 20-year-long “lost decade.”

    Mark (99b8fd)

  126. ‘Rico, I’m hesitant to stomp on what Sam has said because he said it so well and with more tact than I have. I do this blog stuff during 5 minute downtimes during the day so I can be a bit abrupt rushing out a thought. That said ;) I feel we are conflating two issues. I’d like to put the Gold Standard aside for a while until we resolve the FRB issue. to your point…

    while a deposit is more like a loan, banks sell them more like a safety deposit box with benefits.
    I would kind of agree, but I’m pretty sure they have their legal butts covered in the account documentation. Presuming so, fraud is too strong of a word. And even given this, it’s my perspective that even moderately educated people understand where the money comes from that runs the bank and thus understand that a bank run is possible. It’s a known risk. It’s just the sort of thing no one wants to talk about. Kinda like the kind of people who get selected for juries. wink-wink.

    Where we get into trouble reserve-wise is where the Fed “buys bonds” (wink-wink prints money) which is a “loan” which then gets deposited in one bank, 90% of which goes out as a loan which, given bad economic conditions may simply get deposited in another bank because the borrowing entity wants to take advantage of the opportunity to get the money cheap and pay it back in inflated dollars so they put that money in another bank, with 90% of that getting loaned out. Then certain “economists” count these multiple deposits as an increase in overall wealth as not just x, but “x + .9*x + .81*x + etc” (I’d do a fancy sigma summation mathy thing here but, heh ascii) without accounting for the multiple leverages. Sam, help me if I’m saying this right.

    WTP (41d24a)

  127. “You respond to that with “ain’t ya never heard of puffery?” but I don’t buy that. Promising someone their money back when you know you can’t make good if everyone takes you up on it is fraud, IMO, not puffery.”

    I have a few related comments, but this is really the core of your reply so I will ultimately focus on that.

    I consider myself a socio-historian. I also consider the social “sciences” extremely disreputable. Too much of it is worthless propaganda driven by observer bias. I therefore make an extreme effort to distinguish which parts of my comments are impersonal observations and which are biased opinion, and to do the first ultimately means excessive pedantry that can easily appear as snobbery.

    As for understanding all of this, for myself I acknowledge that I barely do. To get as far I have required getting myself through the Wealth of Nations and Sowell’s Basic Economics, filtered past the rest of the general history I know. And then of course . . . I did my own extrapolations. Which means that yes, my conclusions are tainted by my personal bias, and not merely cannot but must not be taken as absolute no matter how forcefully I advocate for them.
    Yes, it is my projection, in some cases against the views of the people I am basing them on, that I absolutely believe that every currency, including gold!, is truly just a fiat currency, and therefore there is nothing to bar using just the “true faith and credit” of a government as a unit of measuring wealth. That is a critical point to keep in mind.

    So now to your statement.
    Well . . . you are a lawyer.
    I would expect you to look at it that way.
    More, I would expect you to have a more comprehensive understanding of the laws and precedents that distinguish typical Madison Avenue hype from criminal and civil liability.
    I am not capable of debating that with you, or even discussing it competently, without several months of study, and even then I doubt I would feel adequate.
    Therefore I am left with just saying that as best I understand it, it just isn’t that way, and what the banks are doing, however much it is overly florid hyperbole, Humpty Dumpty dictionary definitions, and Jedi level parsing “from a certain point of view”, it actually is legal.
    Could I be wrong?
    Easily.
    More relevant though is that I believe that banks must work in that manner for our economy to function on the level that it does, and that at best your view should only be used to require a superior disclosure statement from the banks about the risks involved with deposits. That however is more of the political realm than of the economic realm, and thus requires a massive digression to properly examine.

    Simply: I cannot say you are wrong, but I also cannot agree with your conclusion.

    Sam (e8f1ad)

  128. 127. Indeed.

    gary gulrud (e2cef3)

  129. 119, 120. The US engine of global growth has hit the wall. The petrodollar is endangered because 45% of world consumption is moving on.

    The Fed QE-Zeno’s Paradox is halved, now $45 Billion per month.

    The US consumer, traditionally 70% of the domestic economy is tapped out and suddenly experiencing a 5% 404Care income diminution.

    Be afwaid, be vewwy afwaid.

    gary gulrud (e2cef3)

  130. This is a fun party and thanks to Patrick for starting the ball rolling. As we used to say down home;”We ain’t had so much excitement since the pigs et the baby”. (no, I’m not from West Virginia, but you are close)

    Bar Sinister (b48c12)

  131. Chart-fu for the ages:

    http://research.stlouisfed.org/fred2/series/M2V/

    I will pay you Tuesday next, for a hamburger today.

    gary gulrud (e2cef3)

  132. “Then certain “economists” count these multiple deposits as an increase in overall wealth as not just x, but “x + .9*x + .81*x + etc” (I’d do a fancy sigma summation mathy thing here but, heh ascii) without accounting for the multiple leverages. Sam, help me if I’m saying this right.”

    Yes, but it is actually worse than that.
    A bank can:
    1. Take in deposits.
    2. Lend out 90% of that money.
    3. Have the people who borrowed it deposit the borrowed money in the bank.
    4. Lend out 90% of the money just deposited.
    5. Have the new borrowers deposit the borrowed money in the bank.
    6. Ad infinitum.
    They don’t need another bank, or the Fed, to do this endless shuffle.
    Of course it will not be that efficient in turnover, and having additional banks (aka “unindicted co-conspirators”) help out with cross-lending and depositing, not to mention other people selling debt derivatives, will accelerate and amplify the problem.
    And yes, some “economists” do treat this as “wealth creation”, causing considerable confusion in properly analyzing “actual” “wealth”, as well as causing an appearance of economics being a zero-sum game when the bubbles break, particularly in the minds of those who come out on the losing end.

    To be clear though, as you note, this is an issue with Fractional Reserve Banking regulation (and economists) and not a direct issue with the gold standard, or even with general banking, though it certainly impacts both.
    I think you will find very people outside of high risk investment managers who think it is a good thing, but you will equally have a difficult time finding more than a few people to agree on any particular “solution”.
    “It sucks, but this is the best kludge we have at the moment.”

    As for my own blog, I am too irregular in coming up with things to say to maintain one. (Not to mention being barely above the black box level of using a computer.) Generally you can find me here:
    http://navygentleman.com/cvn2/
    Where I operate under the nom du net of BronxZionist and post random rants and extended analysis like this there.
    You can find that name in other places from time to time, or my “secret ID” (aka, real name) when I post to places using my Facebook login.

    Sam (e8f1ad)

  133. Sam – Banks reallocate money from capital providers (savers) to capital users(borrowers). The idea long-promoted by Austrian economists that they create money out of nothing is wildly disingenuous.

    The following author starts heading down the right path:

    http://beyondmoney.net/2013/04/22/do-banks-create-money-out-of-nothing/

    daleyrocks (bf33e9)

  134. They don’t need another bank
    Well, true, but at least in your scenario the full amount of x is contained within the bank and the deleveraging or whathaveyou is self-contained. none of the money is lost unless the bank itself goes under for its own reasons and the only entity left holding the bag is the original depositor (or guarantor of that deposit, FDIC or otherwise). Unless, of course, each of those to whom the money was loaned use those deposits as collateral on loans from other banks. But in doing so they would themselves have to divulge their outstanding debts, which assuming they are honest they do and thus those deposits cease to be collateral.

    WTP (41d24a)

  135. “No other business experiences a phenomenon like a “run.” No other business can be plunged into bankruptcy overnight simply because its customers decide to repossess their own property.”

    Patterico at 97 – Rothbard would be wrong. Life and annuity insurance companies face the risk of runs, customers requesting the cash value of their policies or surrendering their annuities. Mutual Benefit Life of New Jersey in fact, viewed as a blue chip company for upper income people, went into rehabilitation in 1991 due to a run on the company by its customers. The issue was bad or illiquid investments, the same potential issue that would potentially prevent a bank from meeting a run, not fraud.

    daleyrocks (bf33e9)

  136. @daleyrocks
    “Sam – Banks reallocate money from capital providers (savers) to capital users(borrowers). The idea long-promoted by Austrian economists that they create money out of nothing is wildly disingenuous.”

    Yes, I understand that. It is one of the many reason why I really dislike the Austrian school.

    Explaining it, particularly to Austrian school advocates, particularly in a message board environment, is difficult to say the least.

    @WTP
    “Well, true, but at least in your scenario the full amount of x is contained within the bank and the deleveraging or whathaveyou is self-contained. none of the money is lost unless the bank itself goes under for its own reasons and the only entity left holding the bag is the original depositor (or guarantor of that deposit, FDIC or otherwise).”

    Right.
    I just wanted to highlight that it can be done alone.
    Doing it across banks and borrowers invokes a major synergy that is a key factor in bubbles and general recessions, as well as inviting bad economic theories and policies.

    Sam (e8f1ad)

  137. Somebody mentioned the 1857 panic in the other “standard” thread. This seems rather apropos, from my local paper: http://www.royalgazette.com/article/20140505/NEWS/140509862

    JP (66ce26)

  138. Comment by Sam (e8f1ad) — 5/6/2014 @ 9:35 am

    A bank can:

    1. Take in deposits.
    2. Lend out 90% of that money…

    That reverses the order.

    A bank can:

    1. Make a loan.

    2. Create a deposit equal to the value of the loan.

    The deposit is free to migrate from bank to bank. Not so the loan, so the bank must attract or keep deposits.

    I think there’s also something about a certain percentage of the deposit being held at the Federal Reserve at no interest, so it must charge at least 10% more interest than it pays. Probably I’m missing something.

    Loan first, deposit afterwards, not deposit first, loan afterwards..

    Sammy Finkelman (d22d64)

  139. “Yes, I understand that.”

    Sam – I saw that you did. My reply was more to amplify what you said.

    In many ways I view the Austrians a lot like Obama, using straw men, false choices and lying through omission to make their arguments. It all sounds great and persuasive until you really start thinking about it.

    daleyrocks (bf33e9)

  140. “Loan first, deposit afterwards, not deposit first, loan afterwards..”

    Sammy – I believe you have it backwards. The bank must capitalize itself, which does involve cash. After that it requires cash to lend out. It can’t lend what it does not have.

    daleyrocks (bf33e9)

  141. “Sam – I saw that you did. My reply was more to amplify what you said.”

    Okay, I thought I just hadn’t expressed it properly. I get the theory but I tend to stumble on the terminology.

    “In many ways I view the Austrians a lot like Obama, using straw men, false choices and lying through omission to make their arguments. It all sounds great and persuasive until you really start thinking about it.”

    Usually when I point out that similarity someone tries to teach me new drill sergeant words.

    Sam (e8f1ad)

  142. Rothbard’s piece on why we should just repudiate our government debt, because after all, it’s just like consumer debt, is a classic of that genre.

    You can read it and nod your head but then at the end pause and say to yourself did he just say what I think he said? The answer is yes, because he left out a lot of essential details about why government debt is not like consumer debt.

    daleyrocks (bf33e9)

  143. If Fractional Reserve Banking is Fraudulent, Why isn’t the Insurance Industry Fraud?

    That is the question never properly answered by opponents of fractional reserve banking (FRB), and a blatant logical contradiction in their anti-FRB position……….

    The argument that FRB is fraudulent merely because there are certain possible circumstances when the bank cannot fulfil its promise to pay all its clients on demand is utterly unconvincing…….

    http://socialdemocracy21stcentury.blogspot.com/2011/09/if-fractional-reserve-banking-is.html

    daleyrocks (bf33e9)

  144. My understanding of the value of gold (in this context) is that there’s a limited supply of it, and that that supply is kinda sorta indestructible.

    If those are gold’s two best features (in this context), what advantage does gold have over something like BitCoin?

    Is it that you can make fillings out of it?

    I would argue (against myself) that gold has the advantage of being able to survive the collapse of digital infrastructure… but when it comes to that, the only currencies that’re gonna matter are canned goods, potable water, and ammunition. Might as well enjoy the convenience of digital infrastructure while it lasts.

    Leviticus (1b8969)

  145. I like the color orange.
    Can we trade in oranges ?
    That way, we can say that money grows on trees. Or something.

    Elephant Stone (6a6f37)

  146. “If those are gold’s two best features (in this context), what advantage does gold have over something like BitCoin?”

    Leviticus – Chicks dig stuff made out of gold. You can’t wear BitCoin. D’oh!

    daleyrocks (bf33e9)

  147. All I can add to this discussion is that I once withdrew the funds from a 3 year cd before the maturation date and found that this action reduced my principle. The banker explained the this penalty for early withdrawal was provided for in the cd agreement.

    There are reasons banks offer different types of accounts which are governed differently. Think on this a moment: I tried to withdraw a large ($50,000)amount of cash in order to impress a bunch of poker people at a game -not the brightest idea I have ever had. The bank gave me hell (nicely, though), saying they did not keep that much cash on hand, but could have the cash for me the next day. Long story short, no money withdrawn. However, I had no problem transferring the same amount electronically to my trading account by way of my laptop.

    Maybe the problem of a run is tied to “cash”. Had debit cards existed in the movie It’s a wonderful life, it would have been a shorter movie.

    I am aware that there is a goal in government to get people to stop using “cash”, and that this goal prolly has nothing to do with preventing “runs”. There is a paradigm shift occurring as less people (including those on Uncle Sam’s teet) use cash.

    I imagine we will be experiencing a different kind of “run” when cards do not scan over entire networks. O.k., now I am aware of my babbling.

    felipe (098e97)

  148. Dear Felipe,

    So you’re saying my film was too long, eh ?
    I’ll have you know those snowy winter scenes were actually filmed during a heat wave in July.

    Signed,

    Frank Capra

    Elephant Stone (6a6f37)

  149. LOL.

    felipe (098e97)

  150. Leviticus, BitCoin is a Ponzi scheme. It’s just like you giving me a dollar and me giving you a cocktail napkin with “IOU $1.00″ on it. You’d have to find some other dummy who thinks my IOU is good to make good on it, and you’d have to some other dummy who also believes in BitCoins to make good on those. If you’re going to go that route, pick dollars. More people believe in them.

    nk (dbc370)

  151. “I absolutely believe in the free market for money and said so in several comments. I said in one comment why silver is generally considered less valuable. Do me a favor and try to read my comments before saying I have not addressed an issue; maybe I did and you missed it.”

    Sorry I searched the comments for “silver” and didn’t find it. But something else struck me. When you say “gold standard” you’re not talking about gold coins rights?

    cbuund (2cc14c)

  152. I like to eat those chocolate coins you can buy at the supermarket around Easter and Passover.

    Elephant Stone (6a6f37)

  153. I think Rothbard (and you) are making too much of the “fraud” involved in fractional reserve banking. Presumably there would be no fraud if the possibility you would have wait for your money during a bank run were fully disclosed. My bank provides a lengthy terms and conditions disclosure which I think it is safe to say most people do not carefully read before opening an account. It is true it does not explicitly mention the risk of bank runs. The closest it comes is:

    Circumstances beyond our control (such as fire or flood) prevent the transaction and we took reasonable precautions;

    But if they were required to add “bank run” to fire and flood this wouldn’t actually change anything, most people would still keep their spare cash in bank accounts rather than under their bed or something. So you are basically quibbling about the wording of a disclosure that no one reads anyway.

    James B. Shearer (9233b4)

  154. It is rather dismissive to say he is just quibbling about a disclosure.

    JD (3a4df6)

  155. 1. It is not an issue these days. We have FDIC.

    2. It is not beyond their control.

    Patterico (9c670f)

  156. JD, since when is James B. Shearer anything but rather dismissive?

    Patterico (9c670f)

  157. You still haven’t said why gold and not silver too, for example!

    Sorry I searched the comments for “silver” and didn’t find it.

    You’re right. I said it in the post, not a comment.

    Well, it turns out that, over time, humans have always gravitated towards gold and silver as containing the best mix of characteristics to serve as a medium of exchange. Silver has typically been employed for smaller transactions, and gold for transactions involving higher values (because gold better provides the mix of characteristics needed for a medium of exchange).

    Patterico (9c670f)

  158. What is the actual value of money, inflation has been up 400%, since the beginning of the 20th century,

    narciso (3fec35)

  159. Patterico – it is his “above the fray” schtick.

    JD (3a4df6)

  160. Read both posts, reading the paper. I’m told that the old-fashioned Swiss banks had deposits like that, where you paid 1% or so for them to hold cash. Modern “deposits” are more like loans to the bank. All “currency” is more or less fiat money of one sort or another; the government is guaranteeing that it’s not counterfeit by its mark, at one end, and promising the piece of paper has value on the other. Otherwise you’re back to weighing gold bits. Fractional banking and government manipulation of fractional banking are somewhat different things. What’s happening is that people are beginning not to trust the government, so they’re beginning not to trust money. The abstraction of money depends on trust (as does the allowing someone else to hold your gold.)

    htom (412a17)

  161. Banks do not issue warehouse receipts to depositors. From Investopedia:

    Warehouse Receipt
    Filed Under: Futures
    Definition of ‘Warehouse Receipt’

    A receipt used in futures markets to guarantee the quantity and quality of a particular commodity being stored within an approved facility.

    Investopedia explains ‘Warehouse Receipt’

    Rather than delivering the actual commodity, warehouse receipts are used to settle expiring futures contracts. Also referred to as a vault receipt, they are most often used when settling futures contracts that have precious metals as their underlying commodities.

    daleyrocks (bf33e9)

  162. What’s this like the fifth revision already?

    http://www.zerohedge.com/news/2014-05-06/q1-gdp-cut-06-goldman

    Two consecutive quarters of contraction define ‘recession’ and since consumers spent no more in April than March or February the direction has not changed.

    gary gulrud (e2cef3)

  163. Banks do not issue warehouse receipts to depositors.

    I know. Rothbard is conceptualizing the framework.

    Patterico (9c670f)

  164. As for Rothbard being kinda nutty:

    I’ve probably read the same stuff you’ve read, daleyrocks, and some of the essays are a little over the top — though not as much as they are portrayed by his enemies. I find his economic writing persuasive, though.

    Patterico (9c670f)

  165. Well, its probably not going to get much cheaper, its barely above the price of production.

    http://www.zerohedge.com/news/2014-05-06/and-first-thing-ukraine-will-buy-imf-money

    gary gulrud (e2cef3)

  166. “I know. Rothbard is conceptualizing the framework.

    I find his economic writing persuasive, though.”

    Patterico – As I said above, what he writes sounds great or as you say persuasive, until you pause to think about it. Conceptualizing a bank issuing warehouse receipts for deposits and then using the framework to claim banks are committing fraud by lending money is just nutty.

    daleyrocks (bf33e9)

  167. I always thought FRB was where the bank was permitted to loan out 90% of the cash deposited by it’s customers, which has been repeated here many times.

    But something I read on another message board a few years ago explained it this way:
    Customer opens bank account and deposits $100. Bank uses the $100 deposit as it’s 10% reserve, and loans out $900. Customer withdraws most of his money the next day, leaving the bank practically and secretly insolvent as the normal state of operation.

    Chris (0ba377)

  168. Two consecutive quarters of contraction define ‘recession’ and since consumers spent no more in April than March or February the direction has not changed.

    If only from a symbolic standpoint, I’ve long felt that the US entered its “Potterville” moment back in November 2008, or a time when a real-life version of the fictional banker from “It’s a Wonderful Life” took over the running of this nation. And I’m not referring to just the guy now in the White House, but to all the people in this nation who share his MO, who hock loogies on the “George Baileys” of US culture.

    Mark (99b8fd)

  169. “Bank uses the $100 deposit as it’s 10% reserve, and loans out $900. Customer withdraws most of his money the next day, leaving the bank practically and secretly insolvent as the normal state of operation.”

    Chris – Where does the bank come up with the $900 to loan out and the $100 to pay back the customer?

    daleyrocks (bf33e9)

  170. 157.1. It is not an issue these days. We have FDIC.

    FDIC insurance is limited to $250,000 (there are ways to raise this with multiple accounts). While the FDIC often covers uninsured accounts it is not obligated to do so. Uninsured depositors lost millions of dollars because of the IndyMac failure. Are people with uninsured deposits being defrauded?

    2. It is not beyond their control

    They would be required to take reasonable precautions as with fire and flood. I believe banks more often fail because they are insolvent (made a bunch of bad loans) than because they are solvent but illiquid.

    James B. Shearer (9233b4)

  171. Patterico,

    How on earth would the financial system even work under your plan? Where would banks get money to loan to people? This would massively constrict credit down to medieval level.

    Also, gold being the standard is just a tradition of the past. There is no reason not to use platinum, aluminum, titanium, copper, or even gemstones as a backing for a currency.

    OmegaPaladin (f4a293)

  172. “This would massively constrict credit down to medieval level.”

    OmegaPaladin – It would restrict the availability of credit, but fractional reserve banking was not an evil invented through the creation of the Federal Reserve or central banks. Its predecessors date back to Roman days.

    daleyrocks (bf33e9)

  173. Well, as long as everyone wants to talk banking, let’s add in the shadow banking, e.g., GMAC or whatever they call themselves these days.

    gary gulrud (e2cef3)

  174. “Silver has typically been employed for smaller transactions, and gold for transactions involving higher values (because gold better provides the mix of characteristics needed for a medium of exchange).”

    But what are these “characteristics” ? If you just want a standard that fixes the money supply any thing will do, including just writing into law that the supply of money will grow depending on the number of sunspots in a year, or the roll of a die.

    cbuund (74098c)

  175. 175. More than 90% of new credit in our descending staircase economy have going on two years been Student Loans and Car Loans.

    The former have kept Best Buy in business, the latter Somalians on the road. Dire Amerikkkan needs.

    Demand deposits and reserves against losses N/A.

    gary gulrud (e2cef3)

  176. Lines of credit, overnight loans between banks, money markets,.. Now that we’ve got the grade school heuristics down lets move on to the real world?

    Whattayasay?

    gary gulrud (e2cef3)

  177. All together now, to what degree does the following curve reflect your checking account?

    http://research.stlouisfed.org/fred2/series/M2REAL

    Anyone?

    gary gulrud (e2cef3)

  178. I unfortunately did not have a chance to follow up on this post last night, but I still intend to. Stay tuned!

    Patterico (9c670f)

  179. “But what are these “characteristics” ? If you just want a standard that fixes the money supply any thing will do, including just writing into law that the supply of money will grow depending on the number of sunspots in a year, or the roll of a die.”

    There is an answer to that, but it comes off as a bit of circular reasoning.

    Because of the different physical characteristics of gold, such as the ability to turn it into gold leaf as mentioned, it has a higher aesthetic appeal.
    Higher aesthetic appeal means higher demand.
    Higher demand means higher value.
    Higher value means more compact value.
    More compact value means greater suitability as a measure of “wealth”.
    Limited availability worked to increased the value.

    Or:
    “It’s pretty and everyone else wants it!”

    Now I am being deliberately flippant with that, but on a psycho-social level that is actually an extremely relevant reason for making something a measure of wealth, and thus a highly functional reason. Bear in mind, the reason why a fiat currency comes down to:

    “I trust the issuer!”

    With said issuer being either the robber baron, mega-corporation, or government.

    Preference for a form of currency is not so much because of the positive qualities of your choice but because of the negative qualities of the alternatives.

    Sam (e8f1ad)

  180. but on a psycho-social level that is actually an extremely relevant reason for making something a measure of wealth

    Definitely. But one thing being lost here, and especially amongst the alarmists, is that even given the pitiful state of the dollar due to the printing process, the US is still the world’s reserve currency for a reason. For all our faults, we are still far more reliable than the Chinese, Japan, etc. The EU has probably faired the best but it is subject to the whims of two dozen or so different countries/cultures. But putting all that aside…

    Not saying that this wouldn’t be a serious financial problem, but keep in mind that wealth can be measured in any denomination of currency. If our dollar were to become too unreliable the impact would only be during mediums of exchange that required dollar transactions. If I have a widget and I want to sell it and you want to buy it, you can pay me in Euros, bitcoins, piles of Paris Hilton’s panties, whatever. Granted at some point we get down to barter (of which I am not endorsing here but just for thought) which would be much easier in today’s digital economy than ever before. The currency risk only impacts things that MUST be denominated in dollars such as currently defined contracts (mortgages, bank deposits, etc.). So long as you keep your assets in wealth-generating institutions or hard (and diversified) commodities such as land or gold (heh, like that never loses value) or twinkies or bullets, what the fed does with printing presses is something the government should worry about more than us because (presumably) payments to the government would ALWAYS be in its own currency. It would be a death spiral for said currency and possibly the government to do otherwise.

    Just giving a worst case disaster scenario as a thought experiment, not for any other purpose.

    WTP (8894aa)

  181. 171. daleyrocks,
    “…Where does the bank come up with the $900 to loan out and the $100 to pay back the customer?”

    I’m not really sure. Perhaps the $900 is electronically distributed through its various destinations, never requiring a hands-on cash transaction until the end of its journey, whence only a small fraction of it is finally presented for cash.

    As for the $100 cash that the customer tries to withdraw the next day, I’m thinking something along the lines of a ponzi scheme, since the bank obviously has thousands of customers, each with at least a few bucks of cash still in the bank’s possession.

    But I tell you what, banks do NOT like to let go of the actual cash itself, obviously they don’t have a whole lot of it around. You’d think if something was that well guarded, rare, and in such high demand, the value of it would rise considerably. Funny how the value of cash still only goes downhill.

    Chris (0ba377)

  182. “I’m not really sure. Perhaps the $900 is electronically distributed through its various destinations, never requiring a hands-on cash transaction until the end of its journey, whence only a small fraction of it is finally presented for cash.”

    Chris – I’m not trying to pick on you and it’s fine if you don’t have an answer.

    I am pretty sure the bank can not lend out the same $100 nine times as suggested by the author of the post. That would be unpossible. That would suggest that banks can create money out of thin air like magic. I would pay to see that. Actual fresh money would have to come in to the bank to lend the $100 more than once if the borrower took the cash out of the bank, perhaps to actually buy something like equipment for a business or a house.

    The bank might be able to borrow the additional money to lend from the Federal Reserve. They could also borrow money to lend from other banks or sources of funds.

    The key is the spread, earning more income on the money they are putting to work (lending) at acceptable risk levels than they have to pay to attract savers (depositors, capital providers).

    daleyrocks (bf33e9)

  183. Ok daleyrocks, since I’m not really sure about the whole FRB thing. I’ve seen it explained both ways, and many times have heard the allegation that they’re creating money out of thin air, which readily occurs in the scenario I described.

    If the actual cash exists to underpin all the electronic transactions occurring throughout the day, then banks would not be so cash-poor. Where is all of this physical cash?

    Chris (0ba377)

  184. You’d think if something was that well guarded, rare, and in such high demand, the value of it would rise considerably.

    That’s the point of the post, Chris. That the government prints out money making it as worthless (exaggerating, I hope) as Xerox copies.

    nk (dbc370)

  185. “Bank uses the $100 deposit as it’s 10% reserve, and loans out $900. Customer withdraws most of his money the next day, leaving the bank practically and secretly insolvent as the normal state of operation.”

    What daleyrocks said, but keep in mind this happens every single day. The $900 was loaned out. Presuming the loan that specific $900 was included in, the money will be coming back in the form of payments on interest and principle. If the loan is bad, the bank will have likely made some of that money back, the remainder of which becomes part of the bank’s operating cost and is written off against profits made on the (hopefully) vast majority of fully or mostly solvent loans. In the mean time, a small sum such as $900 simply comes out of the 10% (or whatevs) fractional reserve.

    Now let’s say the sum is much larger, like something that will impact the required reserve percentage, the bank then can borrow money from another bank or banks or possibly even the Fed possibly due to a bank panic (something much wider than a run on a single bank we should remember).

    I should note, I’m not a banker and I’m speaking in general concepts so if someone with true expertise in this matter wishes to confirm or clarify, appreciated.

    WTP (fdec5d)

  186. Where is all of this physical cash?

    One time I read that the Federal Reserve Bank in Chicago has $11 billion in its vaults.

    nk (dbc370)

  187. “Presuming the loan that specific $900 was included in *is solvent*”
    FIFM

    WTP (fdec5d)

  188. many times have heard the allegation that they’re creating money out of thin air
    The Federal Reserve, yes (but they’re buying a “note”…the nut of the legitimacy here but it keeps some sort of paper trail to balance what they’ve printed), other banks, no. Not in modern times anyway, but back in the day, yes. See history of banking posts above.

    Where is all of this physical cash?

    One time I read that the Federal Reserve Bank in Chicago has $11 billion in its vaults.
    One wonders why they would have it sitting around in physical space unless we’re talking about what gets taken in and/or redistributed out to the various banks around the country based on the current M1 allocation.

    WTP (fdec5d)

  189. 188. nk,
    “That’s the point of the post, Chris. That the government prints out money making it as worthless (exaggerating, I hope) as Xerox copies.”

    Well yeah. I’m not a fan of fiat money in the first place, for that very reason. Not sure returning to the gold standard is the answer, but empty faith money certainly is not.

    Chris (0ba377)

  190. Patterico’s buddy Michael Hiltzik up to his usual idiocy, re: Obamacare.

    Icy (df73ef)

  191. “Where is all of this physical cash?”

    Chris – It doesn’t have to be physical. We settle most transfers electronically, but they do have to occur. A bank cannot lend out $100 nine times electronically if that is all the cash (physical or electronic) it has on hand.

    This is where the Austrians usually fall down in “conceptualizing” their description of fractional reserve banking and money creation. What they usually describe is not how the world works, which is why I likened them to Obama earlier in the thread.

    They sound great or persuasive until you think about what they are saying. Then you realize what they said is full of straw men, false choices, and lying by omission.

    Just my HO.

    daleyrocks (bf33e9)

  192. “Presuming the loan that specific $900 was included in *is solvent*”

    WTP – There can be a big difference between solvency and liquidity and the two concepts should not be confused when raising the spectre of bank runs.

    daleyrocks (bf33e9)

  193. This is where the Austrians usually fall down

    Daley, when you say “the Austrians” do you mean the larger group of the traditional Austrian school, a la Hayek, von Mises, possibly Freidman? Or do you mean only those fundamentalists specifically opposed to FRB and the Fed such as Rothbard? Reservations about the Federal Reserve system are one thing, but I believe one could be considered of the Austrian school without complete and total opposition to the Fed, let alone FRB.

    WTP (8894aa)

  194. WTP – I would include Mises and Rothbard. I don’t think Hayek or Friedman rightly belong in that motley crew.

    daleyrocks (bf33e9)

  195. The $900 is “created” by accounting. Bank gets a deposit of $100 cash from Joe. Bank’s records show that the bank owes Joe $100. Bank has $100 in cash. They loan $900 to Sam, making entries that show Sam owes the bank $900 and that Sam has $900 in his checking account. Sam spends the money and pays back the loan. The $100 that started the parade of events can stay in the bank, be returned to Joe, go up in flames, … doesn’t matter. Well, it matters if Joe comes to collect. If the bank has cash on hand, they can give Joe $100, or they can give him a check for $100.

    There are good reasons magicians don’t want their processes revealed.

    htom (412a17)

  196. WTP – There can be a big difference between solvency and liquidity and the two concepts should not be confused when raising the spectre of bank runs

    Agree, but depends on where you draw the line at liquidity. Outside of a universal panic, even a long-term loan of…let’s go with $900,000 instead of $900 for clarity, can be sold to another bank for cash to bring up the originating bank’s reserves. Again, assuming the loan is very likely to be paid back.

    WTP (8894aa)

  197. Daley,
    I consider Mises more instructive than practical and not sure how extreme his views were comprehensively. He’s out there AFAIC, but still rational enough to provoke thought. Not a fan specifically, more Hayek and Freidman myself. Rothbard (of whom I admit knowing very little but second-hand much like here) seems untenable.

    WTP (4090b3)

  198. “Outside of a universal panic, even a long-term loan of…let’s go with $900,000 instead of $900 for clarity, can be sold to another bank for cash to bring up the originating bank’s reserves.”

    WTP – I agree completely. In 2008, AIG as a whole had plenty of marketable securities and cash to move around to meet margin calls in its financial products division. The problem was the assets were in regulated companies and AIG has pissed off regulators so much with its securities lending antics, prior reserving fraud, and overall GFY attitude, that the regulators were watching them like a hawk and they had no ability to loan funds from regulated subsidiaries to unregulated subsidiaries and ask for forgiveness later. I believe that’s what Greenberg would have done if he had still been in charge rather than turning to the government.

    daleyrocks (bf33e9)

  199. The $900 is “created” by accounting. Bank gets a deposit of $100 cash from Joe. Bank’s records show that the bank owes Joe $100. Bank has $100 in cash. They loan $900 to Sam, making entries that show Sam owes the bank $900 and that Sam has $900 in his checking account.

    We’re speaking here as if the bank only has $100 to its name. This would be called “counterfeiting”, which is illegal. Except for the Fed ;).

    WTP (d553bf)

  200. “Sam spends the money”

    htom – Say Sam wants $900 of lap dances and needs to pay with cold hard cash. Where does the bank come up with the bills to give him? Please explain.

    daleyrocks (bf33e9)

  201. 204. daleyrocks,

    “Say Sam wants $900 of lap dances and needs to pay with cold hard cash. Where does the bank come up with the bills to give him? Please explain.”

    I already mentioned that all the other depositors provide enough cash to the bank for it to disburse it to Sam. However, Tina wants a $900 loan also, but the bank can’t give it to her in cash because the cash on hand is too low, so they write her a check instead. And if Tom comes by to withdraw most of his cash, the bank gives him a brick wall to lean on until they can scrounge it up from another bank, or a new deposit, whichever comes first.

    Chris (0ba377)

  202. Technically, it’s not counterfeiting, as the bank is not making currency.

    If the bank were to print 45 $20 bills to give to Sam for his $900 check, that would be counterfeiting.

    What the bank would do is to withdraw $900 in cash from its reserves to clear the check. If they did not have that much cash in their reserves, they would borrow that much cash from another bank. If they couldn’t, they’d have to default on the check, or delay acceptance.

    htom (412a17)

  203. 203. WTP,
    “We’re speaking here as if the bank only has $100 to its name. This would be called “counterfeiting”, which is illegal. Except for the Fed.”

    That’s where I get confused, because all banks are an arm of the Fed in one fashion or another, therefore all can counterfeit as much as they like.

    Chris (0ba377)

  204. What the bank would do is to withdraw $900 in cash from its reserves to clear the check. If they did not have that much cash in their reserves, they would borrow that much cash from another bank. If they couldn’t, they’d have to default on the check, or delay acceptance.

    Well if the bank has the money in reserves, it has a promise to pay from Sam, ugh…see my post #189. The bank can neither print money nor add zeroes to its accounts. The Fed can but the bank cannot. The Fed would shut them down immediately. Creating new currency, either via a printing press or electronically is the domain of the Fed. Banks buy and sell money to and from the Fed.

    WTP (fdec5d)

  205. “I already mentioned that all the other depositors provide enough cash to the bank for it to disburse it to Sam.”

    Chris and htom – Let’s stick to your original single depositor example because it is clean and simple.

    There is no $900 inside the bank. The bank can’t print money. It can’t counterfeit. It cannot create money out of thin air.

    Banks are members of the Federal Reserve System.

    daleyrocks (bf33e9)

  206. because all banks are an arm of the Fed in one fashion or another, therefore all can counterfeit as much as they like.
    No they cannot. They cannot, on their own authority add to the money supply. Where are you all getting this idea?

    WTP (fdec5d)

  207. Gold, coin, currency, money. Four different things. Coin and currency can be counterfeited, as they bear the mark of the State (in places where other than the State may mint coinage or currency, sometimes faking those other issues is also counterfeiting, otherwise it’s fraud.)

    Yes, a fake Treasury check is counterfeiting (or used to be.) Faking my check or your check or a bank check is not.

    htom (412a17)

  208. daleyrocks — The bank can create money. It can’t create gold, coinage, or currency.

    htom (412a17)

  209. Can the bank lend the same $100 deposit from Joe nine times to Sam to give him the cash he needs for lap dances along the lines conceptualized by Rothbard and Patterico in this post?

    Absolutely not. The world does not work that way. That would be unpossible.

    daleyrocks (bf33e9)

  210. No, the bank can’t do that (if it has only the $100 in currency.) Sam can give his check for $900 to the bartender, who will give him (since he trusts both Sam and the bank) 450 $2 bills in exchange.

    htom (412a17)

  211. Sam has a happy evening, managing to disperse the 450 $2 bills across a number of performers, waitpersons, a pickpocket, and the bartender. Each of them deposits their income in the bank, which now has $1000 in cash reserves (the $100 deposit, and the 450 $2 bills.) It owes Joe $100, and the other depositors various amounts totaling $900.

    The transactions have converted the bank’s created $900 of money into $900 of currency in its reserve. The bank did not create the $900 in currency, someone else did that for the bartender.

    htom (412a17)

  212. “No, the bank can’t do that (if it has only the $100 in currency.)”

    htom – Exactly ( your scenario assumes a leakproof or one bank system – not real world, sorry). If banks could do what Patterico was conceptualizing I would want to learn how to do it myself in the safety of my own home.

    daleyrocks (bf33e9)

  213. I made no assumption as to the number of banks (other than it was greater than zero, but this could have been the first bank.)

    Real world, in some eyes, is that the USA has only one bank: the Federal Reserve Bank. Unlike the bank in my hypothetical, the FRB can print all of the money it wants. It’s legal for it to print 45 $20 bills to give to Sam (it would print the bills and give them to the regional bank to give to the local bank to give to Sam, I suppose.)

    In our system the FRB can create both money (by fractional lending) and currency (by printing) and coinage (by minting.) It can’t (yet) create gold profitably.

    htom (412a17)

  214. “I made no assumption as to the number of banks”

    htom – My bad. Let’s revisit then.

    I’m having trouble understanding your scenario –

    The bank illegally did not actually fund Sam’s with good cash because it did not have the cash on hand so he illegally wrote a check for more than was in his account, which will cause the check to bounce when his buddy deposits it if the dancers do not deposit $800 of the cash back into the bank. The banks books will not balance by customer.

    Is that it?

    daleyrocks (bf33e9)

  215. ok…maybe our acronyms (and I’ll take this as my fault as I think I started it) are getting crossed up. I have been using FRB to refer to Fractional Reserve Banking, a concept/practice and not the entity known as “The Federal Reserve Bank”. For the latter I use “The Fed”.

    That said, a specific non-government bank, First Local Community Bank of Pleasantville let’s say, can NOT of its own free will and volition print up money, create blips in accounts, or in any other way conger up money because it wants to. The Fed can, yes. But FLCBoP buys and sells cash from and to the Fed. It does not create that money on its own.

    WTP (fdec5d)

  216. The bank (let’s call it Bank A) loaned Sam $900, remember? The check is fine. The check is money, it is not currency. Sam has withdrawn $900 in money and given it to the bartender (Sam owes Bank A $900.)

    The bartender deposits the check and Sam’s bar bill spending (currency) in Bank B. The dancers and waitpersons deposit their cash (currency) into Banks A, B, and C. The pickpocket is arrested and that cash (as well as other cash she had) now sits in an envelope in the evidence locker.

    I gotta go now, but you can follow the check from Bank B to Bank A, and it will balance out.

    htom (412a17)

  217. “The bank (let’s call it Bank A) loaned Sam $900, remember? The check is fine.”

    htom – No, the check is not fine if the bank does not have the funds to cover it. The bank cannot loan money they do not have. That is where your scenario is flawed.

    daleyrocks (bf33e9)

  218. Even that evil, dirty, no good, FIAT MONEY!!!!11ty!!!!

    daleyrocks (bf33e9)

  219. WTP — partly my fault. I learned FBR (Fractional Banking Reserves), FRB (Federal Reserve Bank, sometimes FRB -USA, -Swiss, -EU, … whichever), and The Fed for the Federal Reserve Banking System of which the FRB is a part. I’ll try to stay to your scheme of buzzwords.

    htom (412a17)

  220. daleyrocks — you have come upon the problem that’s being complained about in the opening posts. Bank A can do that, with fractional reserves. You’re imposing a non-existent requirement that Bank A have 100% reserves. They can loan MORE than they HAVE. (Note, you can have both a gold standard AND fractional reserves; they’re separate things.)

    htom (412a17)

  221. Money includes (but is not limited to) currency.

    Currency includes cash (paper money), some other legal tenders (postage stamps, maybe), and coinage.

    Coinage is precious metal (or a substitute, these days) made and struck by the Mint into denominations of specific weight and composition; sometimes (usually) there is a nominal value ($20 gold piece) or weight (10 grams gold eagle.)

    Gold is an element (79_Au ~197 169-205 AMU) one of the precious metals.

    htom (412a17)

  222. “Bank A can do that, with fractional reserves. You’re imposing a non-existent requirement that Bank A have 100% reserves.”

    htom – Yes they can, but please define reserves. A bank cannot lend more cash than it has on hand and that is where your modified scenario fails. Sam cannot withdraw the cash you claim the bank lent him because the bank does not have it.

    When people look at bank leverage or reserve leverage they are looking at things such as various measures of regulatory capital/risk weighted assets. They are not looking at deposit leverage, which is again where your analysis and Patterico’s breaks down.

    If banks can lend the same assets more than once, please explain how that is possible.

    daleyrocks (bf33e9)

  223. “Loan first, deposit afterwards, not deposit first, loan afterwards..”

    Comment by daleyrocks (bf33e9) — 5/6/2014 @ 11:39 am

    Sammy – I believe you have it backwards. The bank must capitalize itself, which does involve cash.

    It must have capital. That is, it must be able to absorb a certain amount of bad loans. The ratio of capital to liabilities is set by regulators.

    After that it requires cash to lend out. It can’t lend what it does not have.

    It can lend out X times the amount of capital.

    Basel II requires that the total capital ratio must be no lower than 8%. That would amount to 12 and a half times the value of its capital.

    And capital is not gold or silver nowadays, but money people owe to the bank or assets it can sell.

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

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

    Sammy Finkelman (d22d64)

  224. “It can lend out X times the amount of capital.”

    Sammy – Does the bank lend out pretzels or rubber bands or does it need dollars to lend out?

    daleyrocks (bf33e9)

  225. “It can lend out X times the amount of capital.”

    Sammy – That’s an asset to capital ratio as I pointed out in #226, not a liabilities to capital ratio.

    daleyrocks (bf33e9)

  226. “Definitely. But one thing being lost here, and especially amongst the alarmists, is that even given the pitiful state of the dollar due to the printing process, the US is still the world’s reserve currency for a reason. For all our faults, we are still far more reliable than the Chinese, Japan, etc. The EU has probably faired the best but it is subject to the whims of two dozen or so different countries/cultures. But putting all that aside…

    Yep.
    That is why I regularly sneer at predictions of the impending replacement of the dollar as the world’s reserve currency.
    Indeed, I paraphrase Churchill for it:

    “American fiat currency is the worst reserve currency there is except for all the others.”

    Sam (e8f1ad)

  227. daleyrocks, you can argue as long as you like about about this and it won’t change a thing. What banks can do — legally — is obviously different that what you think they can do. Whether or not it is wise for them to do so, or a moral good (or evil) to do so, or rational, or … does not matter. They can do this, and they do. It’s hard to blame them, they have to do this to stay afloat.

    Watch http://www.youtube.com/watch?v=KyDU4X8GSmE ; that’s part one of five, but you can skip part 5 as it’s just a repeat of the last part of 4 and the end titles. There are several other YouTube videos of very similar name; this is “Money as Debt – Fractional Reserve Banking” by YIRMASTER

    Yes, it’s a trick. There are none so blind as those who refuse to see.

    htom (412a17)

  228. “daleyrocks, you can argue as long as you like about about this and it won’t change a thing.”

    htom – There is no need to argue about Money and Banking 101. It’s basic stuff.

    I remember the Money as Debt videos from 2008 when the Nor Laup acolytes were pushing them. They were BS then. I referenced them near the beginning of the thread.

    If you can’t describe how the banks do the things you claim they can do, you have no credibility in my mind. So far, you have not been able to do that.

    daleyrocks (bf33e9)

  229. Maybe you should watch it again. (I’m not sure that the ones you saw are the series I linked.)

    This is (or was, in 1965) Honors Econ 201 and 202. That video describes how fractional reserve lending was invented and how it continues today. It’s not a Ponzi scheme (although it dies as a consequence of exponential growth, which some Ponzi schemes do.) Eventually, you have to survive the crash, and start it over. Or find some other way to make money (which, again, is not currency or coinage or gold.)

    They tell you how they work the trick. It is a trick. Right there in plain sight. If you will not believe the simple explanation … I don’t know.

    htom (412a17)

  230. daleyrocks,

    Are you saying that commercial banks don’t create money when they lend it? Because they pretty obviously do. htom is right about this.

    Perhaps this is where you and I are not seeing eye to eye on the wisdom of fractional reserve banking. Because it allows the creation of money, which obviously causes inflation. If you don’t believe that banks create money when they lend it (which they do) then perhaps you don’t see why the problem is a problem.

    Patterico (9c670f)

  231. 233.Maybe you should watch it again.

    Heh, this sounds like the Yoga master’s admonishment that “If it doesn’t hurt, you’re not doing it right”.

    daley, you’re not doing it right!

    felipe (098e97)

  232. I miss DRJ’s steadying presence.

    felipe (098e97)

  233. In the modern economy, most money takes the form of bank deposits. But how those bank deposits are created is often misunderstood: the principal way is through commercial banks making loans. Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.

    – From a paper put out by the Bank of England (.pdf)

    Patterico (9c670f)

  234. This surprised me when I first learned about it.

    Patterico (9c670f)

  235. I still say we should barter in oranges.
    That way we can say that money grows on trees.

    As Scarlett O’Hara famously said, “California will never go hungry (or bankrupt!) again !”

    Elephant Stone (6a6f37)

  236. The bank cannot loan money they do not have.

    Sure they can. They do it every day.

    Patterico (9c670f)

  237. Or as Eric Holder recently said, “No bank is too big to jail !”

    That’s like the pot calling the kettle….er, uh, nevermind.

    Elephant Stone (6a6f37)

  238. So I have been home a short while and have to get going, and have not had a chance to read every comment in this thread . . . but a quick skim seems to reveal that the defenders of fractional reserve banking all seem to believe that only the Fed can create money, and that commercial banks do not create money when they lend it out.

    Am I right, that this is your position?

    Because I do not believe that is correct.

    Patterico (9c670f)

  239. Eric Holder’s mustache deserves its own jail cell.

    Elephant Stone (6a6f37)

  240. TCM is showing June Allyson films on Wednesdays in May.
    Tonite, a couple with Jimmy Stewart…”The Stratton Story,” and “The Glenn Miller Story.”

    Elephant Stone (6a6f37)

  241. Here is a short video with bankers explaining how they create money when they lend it.

    Patterico (9c670f)

  242. Another video by one of the authors of the Bank of England paper linked above. The author explains that loans create deposits, not the other way around.

    Patterico (9c670f)

  243. Oh man, I totally fell in love with June Allyson!

    felipe (098e97)

  244. I’ve seen people argue against this by claiming that the leveraging involved in fractional reserve banking would lead to exponential and unsustainable lending to a degree that we do not see in the real world.

    But of course the amount of lending is restricted by the number of worthy borrowers. Banks aren’t going to lend to people unless they think they will be repaid.

    Patterico (9c670f)

  245. June Allyson was married to Dick Powell. They were good friends of Ronald Reagan.

    Elephant Stone (6a6f37)

  246. “But of course the amount of lending is restricted by the number of worthy borrowers. Banks aren’t going to lend to people unless they think they will be repaid”

    And there is the rub. If a law is passed that says banks have to make loans to unworthy borrowers, then we will see unsustainable lending. Not to worry, though, no one would pass such a law, would they?

    felipe (098e97)

  247. Apparently if one doesn’t know the cost of a thing:

    http://thehill.com/policy/healthcare/205471-gop-struggles-to-land-o-care-punches

    narciso (3fec35)

  248. 236. I’m with you, and I’m normally an instigator.

    gary gulrud (e2cef3)

  249. Are you saying that commercial banks don’t create money when they lend it? Because they pretty obviously do. htom is right about this.

    No. The video you presented skipped over where the wealth for the 100000 came from. It came from the 90% (or so) of the money deposited in the bank by depositors. If a bank were to put 100000 into a borrower’s account without moving 100000 from its books, the Fed would bust them for fraud. The Fed controls the money supply. It’s their reason for existing, for the most part. Why would they allow a bank under their oversight to undermine their own power? Now it is possible that the bank borrowed that 100000 from the Fed, yes. But the Fed is the originator of that money.

    WTP (0b94df)

  250. Ok, my video hung up just before the last guy spoke, however I still stand by my point that the deposits are not created without Fed oversight. They may have a line of credit from the Fed, but that doesn’t mean the individual bank created the money of their own volition.

    WTP (0b94df)

  251. 232. “If you can’t describe how [whatever I please] do the things you claim they can do, you have no credibility in my mind.”

    Gosh, that sounds so familiar. Deja vu all over again.

    gary gulrud (e2cef3)

  252. You will also note in your own provided video, the BoE one, that there is an IOU created and, I quote “in that sense it’s not really free money”.

    WTP (0b94df)

  253. 248. Worthy borrowers being other banks and the shadow banking system entities.

    Investment banks like Goldman Sachs and JPMorgan are not these mom & pop state banks our luddites are flogging.

    Wells Fargo was the largest originator of home mortgages, but that business has gone the way of the pony express. So out go thousands of loan officers, the guys you see on the street corners, panhandling.

    gary gulrud (e2cef3)

  254. I talked to a banker tonite and launched into the GDP collapse. But she was having none of it, “Business is strong, people keep coming in for loans”.

    That was not an opening to ask what sort of business she did, rather a taking of leave.

    The one business I know is doing well is buying interests on margin.

    gary gulrud (e2cef3)

  255. Is there enough gold in the world to cover a $17 trillion debt at today’s price of gold?

    Ag80 (eb6ffa)

  256. 259. Not even close, and a good reason to buy.

    gary gulrud (e2cef3)

  257. “If you can’t describe how [whatever I please] do the things you claim they can do, you have no credibility in my mind.”

    gary – Sort of like “You can argue all you want, but banks can really do this,” stomps foot, flounces?

    The difference is, I can actually and did describe how the system works. Worms such as yourself and the person I was discussing the matter with, htom, cannot.

    I should charge big money for these lessons. You are not worthy.

    daleyrocks (bf33e9)

  258. finance has a part in the economy, however, it cannot expand past the real economy, whose dimensions are really an educated guess,

    narciso (3fec35)

  259. “Here is a short video with bankers explaining how they create money when they lend it.”

    Patterico – Underpants Gnomes!

    Those bills in that bill counter did not exist before the loan was made. They were created out of thin air! Let’s watch that again more slowly.

    daleyrocks (bf33e9)

  260. 261. daley, m’boy, you’re the stupid FIB wallowing in a borehole.

    You are not worth my time to develop and open and shut case for an argumentative shyster who’ll just ignore it and disappear for a day.

    This is not my fight, I did not take it on, and your pissant sneers cannot move me.

    gary gulrud (e2cef3)

  261. and that commercial banks do not create money when they lend it out.

    I’m not sure if they’re creating money as much as they’re creating potential deadbeats, or people who, for whatever reason, end up never paying back what was loaned to them. In a way the money (ie, the debit) that’s represented in a revolving credit-card account is sort of a version of Monopoly money, so that can be a bit like money conjured up out of thin air.

    Or if banks aren’t creating money, then it can be said they’re running a variation of a Ponzi scheme, where they’ll dig up money for people at the front of the line, but have nothing leftover for the saps stuck at the end of the line.

    Mark (99b8fd)

  262. For example, I never understood the Lehman collapse, till I read the Valukas report, where
    their main asset was a development called Tishman/Speyer, a framework for another affordable
    housing project, name escapes me,

    Interestingly, Lehman’s oil analyst, Ed Morse, a former Washington bigwig, bet that the oil spike would be an acute fever, not a chronic infection,
    Whereas Goldman was focused on the spike, Lehman
    had to be taken out of the picture,

    narciso (3fec35)

  263. Lehman in turn was the jenga piece in the financial network, AIG was the next link, but to foreign enterprises,

    narciso (3fec35)

  264. “The author explains that loans create deposits, not the other way around.”

    Patterico – The link did not work for me. The speaker in the video says what you claim but does not explain how. My guess is the through the borrower using the proceeds of a loan to purchase something creates deposits somewhere else in the banking system as long as it is spent on a domestic purchase. The bank, however, needed deposits or borrowed funds to make the loan to the borrower in the first place didn’t it?

    daleyrocks (bf33e9)

  265. “This is not my fight, I did not take it on, and your pissant sneers cannot move me.”

    gary – I thought you initiated the soi pissant sneer at me. I know you don’t know what you’re talking about so you don’t bother me.

    daleyrocks (bf33e9)

  266. Daleyrocks, you’re missing that the money could also be coming from the Fed (or whatev central bank) or that the local bank is licensed, so to speak, to create the deposit on the Fed’s behalf, however the local bank is accountable to the Fed for that manufactured deposit.

    WTP (0b94df)

  267. “Am I right, that this is your position?”

    Patterico – My position is that banks do not create money out of thin air as many other commenters apparently believe.

    daleyrocks (bf33e9)

  268. “Daleyrocks, you’re missing that the money could also be coming from the Fed”

    WTP – Actually I’m not missing that. That is one of the ways apart from competing for deposits that banks can expand their balance sheets to have more funds available to lend. I suggested that in an earlier comment.

    Over the past several years banks have done land office business arbitraging borrowings from the fed against investing in treasuries rather than lending money out and having their loans second guessed by Obama regulators. That’s one reason why yields on checking and savings accounts are so puny.

    daleyrocks (bf33e9)

  269. “Sure they can. They do it every day.”

    Patterico – Can you give me an example of a bank lending money it does not have, please?

    daleyrocks (bf33e9)

  270. Agree, but it seems there’s some possibly willful obfuscation in the discussion. I missed your earlier reference to the Fed as a source but that’s where the other side of the argument is coming from. By that I mean they’re not seeing the Fed involvement. Or so I hope. Patterico’s video, the Bank of England one pretty much says this and I’m not sure what the argument could be unless this point is being missed or ignored.

    WTP (0b94df)

  271. “Perhaps this is where you and I are not seeing eye to eye on the wisdom of fractional reserve banking. Because it allows the creation of money, which obviously causes inflation.”

    Patterico – Sorry, I’m reading backwards up the thread. I don’t think we are at the stage of debating the wisdom of fractional reserve banking, I think we are haggling over making sure everybody has a common understanding of the mechanics. It is not something new. It or or its predecessors has been around for centuries as described in the links I embedded earlier.

    daleyrocks (bf33e9)

  272. Daleyrocks, Every loan they make that is an entry in the books rather than currency from their reserve. You have to let go of the idea that money is a synonym for currency and vice-versa. They are different things, although money includes currency as a subset (just as currency includes coinage as a subset.) All dogs are animals, but not all animals are dogs. Animals include dogs as a subset.

    htom (412a17)

  273. “Daleyrocks, Every loan they make that is an entry in the books rather than currency from their reserve. You have to let go of the idea that money is a synonym for currency and vice-versa. They are different things, although money includes currency as a subset (just as currency includes coinage as a subset.) All dogs are animals, but not all animals are dogs. Animals include dogs as a subset.”

    htom – It really doesn’t matter to me. What they have to have is assets that actually can be loaned out, otherwise they are committing fraud.

    daleyrocks (bf33e9)

  274. I have a paid-off home. I apply for a home equity loan. The bank approves a $100,000.00. It gives me a money market acount that I can write checks on up to $100,000.00. I think the bank turned my bricks and mortar into money. I think that it created $100,000.00 in that checking account. As long as the money stays in the account I can see that it can be counted as a deposit. Any money I withdraw is a debt I owe to the bank and I can even see that, in theory, the bank’s assets can be doubled — $100,000.00 in the mortgage’s value, backed by brick and mortar, and $100,000.00 on the worth of my siganture/credit/ability to pay off the amounts I have withdrawn. I can even see that when I have paid off the bank and closed out the account at the end of the six months I have made it poorer by $200,000.00. According to youse guys’ banking methods as I understand them. A reasonable person might say that I made it richer by the $3,000.00 I paid in interest in fees, and that’s all that happened. And I’m getting dizzy.

    nk (dbc370)

  275. Ok, so would credit card companies be creating money when they issue a new card with a $25,000 credit ,limit when the cardholder take out a cash advance?

    felipe (098e97)

  276. In the modern economy, most money takes the form of bank deposits. But how those bank deposits are created is often misunderstood: the principal way is through commercial banks making loans. Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.

    – From a paper put out by the Bank of England (.pdf)

    Comment by Patterico (9c670f) — 5/7/2014 @ 6:19 pm

    This is very worthy of a bureaucrat and sort of conflicts with your #246. Anybody who has sat around a closing table knows that no money changes hands until the paper work has been signed. The loan comes first and then the money. Not all loans, however, go on deposit in a borrower’s account. Most people borrow money because they have use for it rather than sitting idle in a deposit account while paying interest on it. Loans are frequently disbursed directly from the originating bank for their intended purpose, bypassing this silly depositary step. Perhaps they do things differently in England.

    daleyrocks (bf33e9)

  277. Nk, I don’t think the bank is going to let you close that account while you are still holding 100K of their money. They’ll own your house, first. Now if you borrowed $100,000,000 that might be another story.

    WTP (0b94df)

  278. felipe, 279, I would say that it takes on your debt to the merchants and pays them off counting on you to pay it (the credit card company) back plaus a little fee of 20 to 30 percent for its trouble, but what do I know?

    nk (dbc370)

  279. There are home equity loans and home equity lines of credit. I’m pretty sure nk’s description was a line of credit.

    elissa (770ecb)

  280. Filipe, the credit card company hasn’t created cash, it has created a credit to your account. You will either pay that off or the credit card company will take that as a loss. Either way, someone is accountable for that cash advance.

    WTP (0b94df)

  281. WTP, 281. I paid back any checks I wrote. Plus the the interest and fees. This is a real-life scenario that happens all the time with speculators and contractors that use their homes to finance their short-term ventures instead of goiing through the hassle of a commercial loan. I’m trying to see how it fits into the fancy bookkeeping you guys are discussing.

    nk (dbc370)

  282. “Ok, so would credit card companies be creating money when they issue a new card with a $25,000 credit ,limit when the cardholder take out a cash advance?”

    felipe – Not necessarily an easy question in my mind. Those are revolving lines of credit and the credit card operations of banks have a portfolio of individual borrowers with outstandings that are increasing and decreasing over time, but overall outstandings are trending up I believe. A lot of those operations used to be in separate non-bank subsidiaries to avoid potential usury complications, but I don’t know where they reside now or how they are funded.

    daleyrocks (bf33e9)

  283. Yes, nk, that is how I would look at it, and this makes more sense to me in the case of a loan.

    felipe (098e97)

  284. When nk takes out money on that line of credit, that money becomes a loan. If he never takes out any money, he doesn’t owe the bank anything, so when he closes the account, there’s nothing to account for.

    WTP (0b94df)

  285. So, nk when you paid the money back (with interest) the net balance was zero. The bank got all it’s money back, you closed the account, the lien against your house is dissolved.

    WTP (0b94df)

  286. If a person reneges on paying back the balance on his credit-card account, and there’s no collateral the bank is able to go after, that, in effect, means a bit of funny money was put in the pocket of the deadbeat (or a gift to him, if you will), and sort of represents cash created – voila! – out of thin air. I know personally of a person who pulled that stunt on a business, by rolling up a lot of expenses on a company’s credit card — which he originally had access to — which he never paid back.

    Mark (99b8fd)

  287. No, Mark. It may look that way to the skinflint but the credit card company ate that loss. This is why interest rates on credit cards (unsecured debt) is so high.

    WTP (0b94df)

  288. It really doesn’t matter to me. What they have to have is assets that actually can be loaned out, otherwise they are committing fraud.

    You got it! They are. They loan more than their assets. Currently they’re allowed to loan $125 for every $10 in their reserve (which they do not, in general, loan to anyone.) If you or I did this it would indeed be fraud, but they’re a bank, and by law they are allowed to do that.

    htom (412a17)

  289. And there was peace in the land. The end?

    felipe (098e97)

  290. but the credit card company ate that loss.

    Which, in turn — or at least in more than a few instances — is passed onto the US Treasury Department and their massive printing machines.

    Mark (99b8fd)

  291. but they’re a bank, and by law they are allowed to do that.

    Which illustrates Patterico’s contention that banks, in effect, are creating and handing out their own money.

    Mark (99b8fd)

  292. 279. felipe — Issuing the card doesn’t create money. After that it gets complicated. If you use the card to make a purchase, and pay the complete bill at the end of the month, no interest charge, I suspect there’s no money created. If you use the card to make a purchase and pay it off over two years (or two months), paying interest, the credit card company pays the business you purchased from with created money (this is why credit cards are always either associated with a bank or chartered as a bank, sometimes through a chain of companies.) A loan from a bank is almost always created money (loaning actual reserves lessens their power to create money.)

    htom (412a17)

  293. Thank you, htom, you may want to remember this portion of my hypothetical:

    “when the cardholder take{s} out a cash advance”

    felipe (098e97)

  294. 297. Some of those might be advances without charge by the credit card company but even then there’s money creation, I think.

    htom (412a17)

  295. Well, that was my question too. I think felipe’s is easier. A credit card cash advance is an unsecured loan from the bank on the face of the card, Chase, MB, Charter, etc., I would think. Visa or MasterCard on the bottom right-hand corner is just the intermediary.

    But in my home equity line of credit (thanks, elissa) did my bank turn my home into money? According to the bank bookkeeping rules you guys have been discussing? AND, if I keep the money in account do the bank’s books show $200,000.00 in assets — $100,000.00 evidenced by my promissory note and mortgage and $100,000.00 “deposit” in the credit line check book. And let’s stop there. Answer this and we’ll go on to how my “withdrawls” are treated.

    nk (dbc370)

  296. Using the present logic on the thread, pension funds, insurance companies and money managers create money too when they invest customer money in “new” investments and they don’t create the money out of thin air either, although the last part is my position.

    daleyrocks (bf33e9)

  297. Now that there is peace in the land, I am going to bed. It is almost midnight in Texas.
    Goodnight.

    felipe (098e97)

  298. 300. If they purchase the investments with the customer’s money, there’s no creation. If they borrow money to make the purchase, there would be creation by the lender. If they loan money to themselves to make the purchase, I suspect the SEC (and the IRS) will be after them.

    htom (412a17)

  299. insurance companies and money managers create money too when they invest customer money in “new” investments …

    I don’t see that analogy at all and I challenge you to find an economist who does. I have provided examples of economists who say banks create money when they loan it. It really is not hard to find support for that position.

    Patterico (9c670f)

  300. htom – It really doesn’t matter to me. What they have to have is assets that actually can be loaned out, otherwise they are committing fraud.

    Progress! I finally have my admission that a bank that loans assets it does not have is committing fraud.

    Now I need only convince you that this is what they are doing.

    It may not be easy, since I have already provided links to several bankers saying exactly that, and every source is airily dismissed.

    Doesn’t mean those sources are wrong. Again, this is a fairly commonplace observation.

    Patterico (9c670f)

  301. “I don’t see that analogy at all and I challenge you to find an economist who does.”

    Patterico – Pension funds, insurance companies and money managers invest in loans and stocks just the way banks do. They take in customer money and when it is not needs for other purposes, sitting in reserves or deposits, put it to work. Banks go through the same process.

    The money these institutions invest expands credit and winds up in deposits as well. I don’t care whether an economist you have read has made the argument, you tell me why they are different.

    daleyrocks (bf33e9)

  302. @htom
    “Every loan they make that is an entry in the books rather than currency from their reserve. You have to let go of the idea that money is a synonym for currency and vice-versa. They are different things, although money includes currency as a subset (just as currency includes coinage as a subset.) All dogs are animals, but not all animals are dogs. Animals include dogs as a subset.”

    That works both ways:
    IF you are insisting that a loan “record” is actually “money” despite not being physical currency;
    THEN you must accept that the debt “record” that was used to make that loan is also actually “money” despite not being physical currency, and that the bank has a “real” asset remaining to correspond to said loan.

    Functionally, what the bank just loaned someone is the IOU the bank was holding from somebody else.
    If it were more direct, it would be people signing over spontaneously divisible checks to each other.

    Now of course it would be absurdly inconvenient for a bank to up say “Never mind large or small bills; here is htom’s marker. Go and get your money from him, we don’t have enough cash in the vault right now.”
    In fact, that is pretty much what has happened with the recent housing bubble burst: people defaulted on their home loans, the banks defaulted on their bonds, the bond issuers defaulted on their derivatives, and some fifth party down the line was handed a bunch of deeds and told good luck with the foreclosures. (Or whatever the actual sequence is if someone wants to correct it.)

    This again brings us back the actual functioning of an economy versus economic theory.
    If you really want to completely shut down this kind liquidity all well and good, but understand that is precisely what you are doing, and that you will be imploding the economy back to pre-Federal Reserve levels at the least (about 1/20th of what it is today) with a hard gold standard, and probably back to pre-Industrial Revolution levels (somewhere down by 1/2000th of what it is today) because you are prohibiting ANY private “banknotes” (which wasn’t even done then).
    I’d say good luck with that, but I rather like living in the 21st century no matter how bad the economy has been lately.

    Sam (e8f1ad)

  303. Wow . . . that’s a lot of typos.
    Teach me to write replies at 2 AM. :P
    But I think people can decipher what I mean.
    (Hopefully.)

    Sam (e8f1ad)

  304. “Progress! I finally have my admission that a bank that loans assets it does not have is committing fraud.”

    Patterico – Absolutely not. He is merely making the distinction between physical and book entry, something with which I am very familiar. The assets still exist.

    I am eagerly awaiting your demonstration of how banks lend money they do not have.

    daleyrocks (bf33e9)

  305. “If they purchase the investments with the customer’s money, there’s no creation.”

    htom – But banks fund loans with customer money or borrowed money? Why is it different for these other entities?

    daleyrocks (bf33e9)

  306. “You got it! They are. They loan more than their assets. Currently they’re allowed to loan $125 for every $10 in their reserve (which they do not, in general, loan to anyone.)”

    htom – Not quite there. I think you’re missing something on how balance sheet’s work. Loans are assets so by definition a bank cannot lend out more than its assets. It has limits on its leverage ratios as Sammy pointed out earlier. Its ability to make loans depends on it funding – capital, deposits and borrowings.

    I’m willing to go through T accounts or journal entries if anybody is interested.

    daleyrocks (bf33e9)

  307. When banks lend money, they create deposits, which are IOUs. No currency need change hands and as long as the bank stays within regulatory requirements it need not have 100% of the cash on hand to fund these IOUs. It just creates them.

    The difference between these IOUs and IOUs from any other institution is that bank IOUs function as a medium of exchange and can be easily converted into currency.

    Try reading the article I linked. It’s not some description of banking in England only. It’s a description of banking all over te world.

    This is of course not unrelated to Fed activity because the Fed’s actions empower the bank to create the money (and of course the Fed creates money on its own as well). But it’s described in the article (and I believe a related article by the same folks that I can’t readily access but which you can probably Google or I can possibly provide tomorrow).

    Do me a favor. Read the article. (Or dismiss it with an ad hominem and a wave of the hand — but in the latter case don’t expect me to feel required to discuss this with you further.)

    Patterico (9c670f)

  308. “Do me a favor. Read the article. (Or dismiss it with an ad hominem and a wave of the hand — but in the latter case don’t expect me to feel required to discuss this with you further.)”

    Patterico – I did not dismiss it with an ad hominem and wave of the hand the first time around. I explained why I thought it was silly and after reading it my explanation still applies. Where my explanation comes in is Figure 2 of the article, when the borrower actually does something with the money they borrow from the bank. The article describes this as problematic for the lending bank because it reduces reserves and is unsustainable – exactly my point in this thread. Banks can’t lend what they don’t have. Once it’s out the door, it’s out the door. The article supports that position.

    The money creation portion according to the article is the increase, however temporary, in deposits created by a new loan. Loans or investments from pension funds, insurance companies and money managers can go into bank deposits as well. That’s new money according to the BOE. It’s just not originated by institutions that are part of our evil fiat fractional reserve banking system.

    daleyrocks (bf33e9)

  309. Re Mark
    Which, in turn — or at least in more than a few instances — is passed onto the US Treasury Department and their massive printing machines.

    While possible this is only the case because the Fed chose at some point to buy bonds. This result was NOT driven by the skinflint’s decision to walk away from the debt. Now, as in our recent crisis, masses of loans default the Fed must step in via the FDIC to back up the whole system. But this is a function of a systemic failure which is the nature of banking. Again, see Sam on why overall there are worse scenarios.

    WTP (066be7)

  310. From the article, emphasis added:
    Monetary policy acts as the ultimate limit on money creation. The Bank of England aims to make sure the amount of money creation in the economy is consistent with
    low and stable inflation. In normal times, the Bank of England implements monetary policy by setting the interest rate on central bank reserves. This then influences a range of interest rates in the economy, including those on bank loans.

    The central bank is the controlling factor. Individual banks do not have the power to willy-nilly create money. They are effectively borrowing from the central bank…who creates money.

    WTP (066be7)

  311. Possibly pertinent to the discussion:

    http://www.zerohedge.com/news/2014-05-07/how-middle-class-lifestyle-became-unaffordable

    The handling the real M2 money supply cast against the velocity of same, a measure of economic activity, money changing hands for goods and services, indicate the masses do not participate.

    gary gulrud (e2cef3)

  312. 304. Please do not construe my reluctance to pursue such an endeavor as disapproval or disregard.

    Convincing folks of what they will not accept is a tough row and requires resources.

    gary gulrud (e2cef3)

  313. 317. No ROI I’d be thinking. Parallel of Rwanda, but with oil.

    http://www.globalissues.org/article/86/nigeria-and-oil

    If it ain’t broke,..

    gary gulrud (e2cef3)

  314. I think the creation of credit is the lynch pin in this dustup over ‘money’.

    Consumer credit is teats up, but that is obviously not the story here.

    gary gulrud (e2cef3)

  315. Unfreaking sustainable:

    http://www.zerohedge.com/sites/default/files/images/user5/imageroot/2014/05/Tuition%20by%20state.jpg

    Where might the collateral for this leveraged investment reside?

    Anyone? Bueller?

    gary gulrud (e2cef3)

  316. htom – Not quite there. I think you’re missing something on how balance sheets work. Loans are assets so by definition a bank cannot lend out more than its assets. It has limits on its leverage ratios as Sammy pointed out earlier. Its ability to make loans depends on it funding – capital, deposits and borrowings.

    … so by regulation a bank may not legally lend out more than 12.5 times its assets … is perhaps what you meant to say? Because that is what the regulation is. The regulation says 12.5, not 1.0 (well, actually, it says assets must be at least 8% of loans, it just inverts the calculation.) I understand the regulation is not what you think it is, or what you expect it to be, or what it should be … but that is what it is. Setting the multiplier to 1.0 (the assets to 100%) would be a return to an asset-standard (a gold standard if gold was the only allowed asset.)

    htom (412a17)

  317. WTP says:

    From the article, emphasis added:
    Monetary policy acts as the ultimate limit on money creation. The Bank of England aims to make sure the amount of money creation in the economy is consistent with
    low and stable inflation. In normal times, the Bank of England implements monetary policy by setting the interest rate on central bank reserves. This then influences a range of interest rates in the economy, including those on bank loans.

    The central bank is the controlling factor. Individual banks do not have the power to willy-nilly create money. They are effectively borrowing from the central bank…who creates money.

    I agree that they cannot create money “willy-nilly.” They are constrained by the need to profit by finding creditworthy borrowers, and their ability to profit from lending is dependent in part on interest rate levels set by the central bank. But the article most assuredly does say money is created by the commercial banks through the act of lending. Further:

    Another common misconception is that the central bank determines the quantity of loans and deposits in the economy by controlling the quantity of central bank money…

    Patterico (9c670f)

  318. And it continues:

    http://www.zerohedge.com/news/2014-05-07/94-march-consumer-credit-was-student-and-car-loans

    The bigger account are loans for a service yet to be delivered, a product that may never pay for itself.

    The latter for one of inflated value that kills a small number of owners.

    gary gulrud (e2cef3)

  319. Patterico, OK so we are mostly on the same page here. As for
    Another common misconception is that the central bank determines the quantity of loans and deposits in the economy by controlling the quantity of central bank money

    Can we agree that this is true but only in the sense that the central bank does set parameters. To wit:

    1) They do not absolutely print/create/conjure up all the money they’re willing to put into the public space. They are allowing the local banks to determine this based on the demand for credit.
    2) The local bank does have an IOU or some such acknowledgement given to the central bank concerning how much they have loaned out, such that the central bank in the aggregate knows if/when/where the money supply is approaching the limit the central bank has set.

    And separately,
    FRB1) Fractional reserve banking does not have to absolutely depend on this central bank backup. FRB existed long before central banks. This setup makes FRB arguably safer in that the risk is now spread out amongst the existing currency holders.

    WTP (5ea774)

  320. I have a new post on this issue of commercial banks creating money. Since I set forth the argument more completely there, in a more centralized fashion than is possible in comments (although much of the post is cobbling together comments from this thread), it might be useful to move the discussion there.

    Patterico (9c670f)

  321. WTP,

    Your points all sound correct except the last: “This setup [the existence of a central bank] makes FRB [fractional reserve banking] arguably safer in that the risk is now spread out amongst the existing currency holders.” My disagreement with the central bank setup is teased at the end of the new post, but no time today to go into it.

    Patterico (9c670f)

  322. Do me a favor. Read the article. (Or dismiss it with an ad hominem and a wave of the hand — but in the latter case don’t expect me to feel required to discuss this with you further.)

    I won’t dismiss it, either with an ad hominem or wave of my hand.
    Instead I will accept it fully, even though I disagree with it, and jump right to pointing out the consequences.

    Banks should not be able to “create” “money” through debt, and everything should be based on actual, real, hard, currency.
    What does that mean?

    Well first off, no more credit cards. That’s right, cut them all up because they only function by letting the issuer lend you money then transfer that money to someone else’s banker, all on a theory that you, your credit card company, and the business taking the credit card will all make actual hard currency transactions at a later date.

    With no credit cards you can throw away all internet business.

    You can also forget about checks, which are of course IOUs, and are predicated on the person accepting it being able to go to his bank and exchange it for cash on the theory that your bank will send money to his bank, which of course operates on the theory that you aren’t engaging in check fraud. Well, we might be able to keep checks, but the time to cash them will go from days to weeks, and I really doubt anyone will turn over any goods or perform any service until your check has first cleared.

    You can also say goodbye to multi-location banking. If you insist on a bank having enough money on hand to satisfy all depositors no matter what, then the bank will only be able to give you your money back at the precise location you deposited it. To do otherwise they would need personal reserves of their own money they can store at multiple locations to cover the entire amount of deposits they have for everyone at each location at any time.

    Since loans will only be made with hard currency, and since iterative lending of IOUs will be pretty much impossible, you can expect collateral requirements to be severely tightened up. In fact loans may disappear entirely and all you will be able to do is pawn stuff – hand over the collateral directly in exchange for hard currency. And even that may require the lender be able to actively profit from the collateral during the term of the loan or require collateral greater than the value of the loan thus ensuring the interest will be paid. If actual lending does continue expect the interest rates will soar to levels that will make loan sharks and payday lenders redundant.

    Now consider all of your daily, monthly, and yearly transactions.
    What percentage do you make based on the spot lending and ledger shifting that would be done away with and what percentage do you make with direct, physical, transferences?
    How far would you have to travel, how long would it take, and how much would it cost to make all of your payments in person with hard currency?
    Granted, that is merely anecdotal, but to what extent would you expect that to apply to everyone else?
    To what extent do you expect that would affect the ability of all the merchants you do business with to profit at their current prices?

    Again, I am not challenging anything in that article.
    All I am doing is pointing out the consequences of not “creating money” in the way described in that article, and asking what you think about them, what effect you think they will have on your way of life, and what effect you think they will have on your standard of living.

    Sam (e8f1ad)

  323. Well he takes the teacher’s union to rave reviews:

    http://www.bloomberg.com/news/2014-05-08/christie-poised-to-match-record-for-new-jersey-downgrades.html

    Want whipped cream on that?

    gary gulrud (e2cef3)


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