RE: The Mathematics of Fractional Reserve Banking
Is this supposed to be a bad thing? You get that (at least in the US) excess reserves are held at the fed, and earn interest paid for by taxes, right?
Also, the reserve requirement doesnt really effect how much a bank can loan out. At least in the US, they can simply borrow from the fed if their reserves are short. Thats why when the fed hikes the prime rate, everyones consumer rates go up.
I dont really get why youre calling money loaned out "funny money" because its not sitting in a bank. If there is a problem with fractional reserves, its not that the loaned out money is "funny money" its that the balances of the account holders are funny money.
For example, when company A deposits 100M into the bank, then the bank loans out 90m, company A has an account allegedly worth 100M, but the bank only has 10M to cover it. But the 90M in company B's pocket is completely real (until he puts it in a bank).
THis is problematic if the bank is making irresponsible loans, like during the housing bubble. Because if the recipient of the loan isnt paying the loan bank.
At the end of the day, nothing is being created though... the assets and the liabilities always zero out. It just doesn't seem that way on your chart because youre ignoring the liabilities.
Your chart is basically just the missing dollar riddle, except times 90M
Also ftr the money multiplier effect is an absurd myth
here ill fix it for you so it makes sense sum
etc etc... nothing is being created, it all zeroes out... man charts are hard, but you get the point
What do you mean that nothing is created? Where was that 90% that is loaned out to begin with? I understand that it's a record in a balance sheet. But to claim nothing is created (even ever, as you state by keeping track of assets and liabilities --- you should aggregate reserve with assets, as these are still assets being held on hand by the bank) by using accounting tools is but another way to misguide people who do not understand mathematics.
Yeah... i get that the reserve is part of assets... i seperated it out to show where the money comes from.
As to your question, "where was the 90% tht was loaned out" It was on deposit. then it was loaned out. I dont really get what youre not seeing.
private school 5 or public school 5? couldnt help myself
Ill be honest with you, i really don't know how i can explain anything to you. If you believe that balance sheets are a scam created by the international banking conspiracy and basic accounting is just a fairy tale to exploit the disenfranchised masses, i don't even know where i could start.
Its like if i was trying to explain electricity to someone from the 5th century who thought that any explanation for natural phenonema that didnt involve evil spirits was a ploy of the devil... there has to be at least some kind of common ground.
Im not trying to talk down... i just don't see how someone can be convinced if hes willing to dismiss anything that doesnt agree with his preconcieved notions as some kind of sinister conspiracy.
I could put a bunch of big numbers in a chart and jump up and down yelling conspiracy! conspiracy! that seems like the kind of argument that might win over a five year old.
And explain to me like I am 5 how there is no money multiplier effect when the total amount that is loaned out and in circulation is more than the total amount that was originally borrowed from the Federal Reserve?
I don't really get what you're not seeing about how that isn't money multiplication ...
Not in a closed system, no. But the economy isnt a closed system. Lets say im SigmaBank, instead of Sigmajin. And i run the first national bank of steemsville. In steemsville, there is a 100% reserve, so i can't lend money on my deposit account balances. I have company B in my loan office and they want a 100000 steem loan. I want to write the loan. Im fucked, right? 100% reserve. My deposits are spoken for.
FOrtunately, I know complexring. Complex is rich as all hell and he has 300K steem on deposit. He has millions of dollars in steem that he cant possibly use all of. So i say to complex, "why don't you take 100K steem out of your bank account, and give it to me. Ill write you an IOU, lend it out, and well split the interest."
You know im good for it because im a fucking bank... its not like im going to run off. If you didnt trust me, you wouldnt have 300K steem on deposit in the first place.
So you give 100K and i loan it to company B, then i write you an IOU for 100K plusinterest and pay you back as they pay me. So you get the principle payments, plus half the interest payments, and I get half the interest. Yeah, you personally might not be down, but in the wider economic world, there are absolutely a huge number of rich people that are down.
Now lets say company B isnt using the whole 100K steem they borrowed, they can make the same deal with me that you did so i can write a loan to company C. The only difference between this scenario and the one you present is that the banks liabilities are now in the form of IOUs, not in the form of deposit liabilities.
But it gets even better... because you know that IOU i wrote you, you can actually sell that IOU to someone else. Its called a debt security... and as long as sigmabank hasnt fucked up its credit, youll be able to sell it for probably nearly full face value. So lets say the 100K steem was for a house, and the 30 year mortgage repayment was slated to be around 200K steem.... your IOU is for 100% of principle, and 50% of interest, or 150K... youll be able to usually get between 110 and 125K on it. Which, if i can find another borrower, you can just lend back to me.
Like your scenario, it depends on the idea that a company would be willing to borrow a lot of money, then leave most of it in the bank, so that the bank could loan it out again..... the only difference is now they are explicitly loaning it to the bank, rather than simply leaving it on deposit.
So ... how does this all relate to loaning money to a bank and the bank loaning it out to others with respect to money multiplication, as per the definition that it is any increased supply beyond the original amount borrowed from the central bank.
also note that the primary difference here is that you would consider your Steem as already part of the money supply, even though you arent actively using it. Whereas you consider central bank money as coming in from the outside.
But all youre showing at the end of the day is that if enough people are willing to borrow money, then leave borrowed money sitting in the bank, that the bank can make a killing lending out the same borrowed money over and over. The accounting is different with a 100% reserve, but it depends on the same thing... multiple companies being willing to let the bank hold money that they borrowed.
Further side note... this is why when the fed wants to decrease money supply, they don't hike up the reserve rate, they hike up fed interest rates... that way its more expensive for banks to borrow money, so they have to be more selective about who they lend it to (or they have to charge more interest) so the demand for loans decreases.
I can't reply to sigmajin because of nesting limits, but I don't think the Federal Reserve has the interest rate set next to nothing right now because they want to. Their quantitative easing plan was to make lending money cheaply to avoid a prolonged recession (or Great Depression 2.0) but now they can't raise rates again because the US government will not be able to pay up. Think of how much interest 20 trillion dollars will rack up with a higher rate.
@theabsolute yeah, they definitely want to... I dont think its wise, but its definitely policy. They spent most of the first half of this year banging the NIRP gong. Its dead now, but if trump wins, i doubt itll stay dead (and tbh i dont think hillary would necessarily be against it either)... right now, everyone is terrified of a recession... like if politicians thought it would help, or even thought that the electorate thought it would help, i could easily imagine them sacrificing people like in the shirley jackson short story. .
The ECB and japans central bank both have NIRP right now.
Excellent post once again.
You may as well assume that all cash loaned by the bank to one contractor is effectively put into a new bank account. The reason is that the contractor pays for services, employees, goods, etc. and that these other businesses in turn put the money in their bank accounts. So, you may as well think of it in aggregate.
Now, I will say that not everyone puts money in the bank, and that diminishes the effective money multiplier rate as that amount of money cannot be used for loans in the next cycle.
Explain to me how the money multiplier effect is a myth? Are you saying math is absurd? Often it is, but I don't see how in this simple example of an infinite geometric series.
The fact remains that there is more money available than the US Treasury Notes that assure the Federal Reserve the US will pay them back. US Treasury exchanges 100M US T-Notes for 100M FRNs. Effective supply is perhaps 500M (due to not every $ going back to the bank to continue in the next cycle). At the least, the effective supply is > 100M. How is that not a multiplier effect?
I want to make sure im understanding -- your beef with the system is that there aren't enough physical currency notes to cover the companie's debt/liabilities?
You avoid my question.
Also, I never claimed to have a beef or not have a beef with any system but rather prefer an informed populace when it comes to basic mathematics and how any system uses the ignorance of the majority of a population to benefit the minority who do understand it. Part of that is the educational system that we have and doesn't incentivize teachers to make students question everything.
ALso, as to the increase in money supply based on lending being based on a math phenonemon. It is, just not the one you think. Yes, absolutely, the money supply increases because banks lend out money. But that would be true even with a full 100% reserve. Lending creates money.
Take fractional reserve out of banking, and force banks to lend entirely on capital... do you know what you get? We do have a system like that in the US. 10 Steem to the first one that can figure out what it is.
missed your reply...
anyway infinite credit market.
Lets take your MM effect to its logical conclusion. The UK. No reserve required. The MM is infinite. Or nearly so. RIght. But they do not, in fact, have an infinite money supply. Why not? Because there are not an infinite number of qualified people looking to borrow in infinite amount of money. Because the amount of money lent vs the amount of money deposited is a function of the market for credit.
In the US, there are legal requirements for who banks can lend money to and how much they can lend to those borrowers. A bank will lend exactly the amount of money for which they can find qualified borrowers. Its a market equation that has nothing whatsoever to do with the required reserve.
So your bank zero, lets say it could find qualified borrowers to lend out exactly 90M. And lets say the RR is 10% and the bank has 100M on deposit. SO they lend out the 90M, just like in your example.
Now, lets say the RR is lowered to 5%. THat does not automatically create new borrowers. The fact is that theyll still lend out the exact same amount. 90M, the amount of money they can sell. The demand for credit has not changed... theyll lend out the same 90M.
Now, lets say that that the RR is raised to 50%. You know how much money theyll lend out? Still 90M. They'll borrow enough to make their reserve. If they have qualified borrowers looking to borrow 90M, its happening. Period. You could set a 150% reserve, and its still happening.
The required reserve rate simply has no effect on money supply. You think it does because youre not getting how moneylending works. You think the system is way less complicated than it really is.
TO put it another way, imagine that your first business,, the one that gets the $100M. Imagine that the CEO picks up the cash, is on the way to bank 0, when he gets overtaken and devoured by a pack of cannibals. They eat his flesh and burn his money with his bones.
SO the 100M deposit never happens. The loan officer in bank 0 is sitting at his desk. The next company ceo comes into bank zero. What do you think happens?
Do you think CEO B walks in, and the bank officer has a bottle of lube in one hand, a porno in the other, and he says "Well, im terribly sorry, but we didnt get enough deposits today. So, although youre perfectly qualified to borrow $90M, instead of lending it to you, which is the whole way my company makes money, im just going to spend the day masturbating?"
Of course not. Hes going to lend CEO B the goddamn money. Because thats his whole purpose. And this would be true regardless of the reserve or money on deposit. Because, say it with me, banks don't use deposits to fund loans.
Before someone points it out. Yes, those legal requirements are often poorly formed, laxly enforced and if they worked properly, the banks wouldnt have needed to get bailed out. I dont think the system is perfect, or even good. I just think its not as described in this post.
As I cannot reply directly to you, due to nesting comment limitations, let me say that the purpose of the headline was to be an attention grabber. Did I ever say that I (personally) had a problem with the system -- or was I relying on the marketing of the title to entice people who do have an issue with the current paradigm -- to take a peak. If the result is that I am able to teach some basic mathematics to people and how it applies in an area of society that affects them daily and let them draw their own conclusions ... then wonderful.
Regardless, if you can agree with that definition of money multiplication, as in any increase in the monetary supply beyond the initial amount borrowed, then, I can assure you that this increase in the monetary supply can be solely attributed to a mathematical phenomena.
I don't follow your claim that I assume an infinite credit supply -- or I am ignorant of the economic terms.
Please, enlighten me.
Also re beef with the banks. Fair enough but when youre calling them crooked, youre clearly trying to make a point... and clearly trying to inject a value judgement.
THat's fine, but using that language then retreating behind "oh im completely impartial. Im just doing math." is trying to have your cake and eat it too.
Tired of Jason having sex with beagles and molesting children?..
then read this completely unbiased article about math.
Yeah, im saying something about jason, even if im not saying it... and i think you know that.
@complexring and @sigmajin I'm almost sure you're both paying me 10 Steem. The system in the US that works "without Fractional Reserve", so with lending on capital: Credit Unions! Am I right?
Replying here due to nesting. No. Credit unions (at least ones in the US) fall under the same "depository institutions" category as banks... they have the same reserve requirements.
I gave up on getting an answer and answered elsewhere in the thread already. I would have accepted loansharks or payday loan places like the money store.
point being that if you want to get a loan thats not based on deposits, and comes directly out of the lenders pocket, its possible. But the terms are going to be way crappy.
Damn. Unfortunately I applied Fractional Reserve to my wallet and so I've already spent that 20 Steem on beer. :(
looks like you did alright on that post about the bankz guy
No, im not saying that math is absurd. I'm saying that the "money multiplier effect" is an absurd misinterpretation of mathemtatics. And economics. and banking. And pretty much everything. Similar to the absurd misinterpretation of mathematics that lead the poster above to pose that the sum of all positive integers is -1/12.
The model is simply flawed. You make a whole bunch of assumptions that aren't true (an infinite credit market being the most grievous). This is a popular gong to bang for the occupy wallstreet set, so numerous detailed explanations of why this model is bunk have been written time and again.
If you google "money multiplier effect idiotic sophistry" or "money multiplier effect myth" youll find quite a few of them
Being that my -1/12 comment is thrown in here, I would like to (for the sake of respectful argument) ask why is it that you think you know the correct interpretation of mathematics? Zero divided by zero is equal to what? Explain how Euler's identity (e^iπ=-1) makes sense. Hell, I even read the article you mentioned from Scientific American and it doesn't really dismiss the importance of the -1/12 answer to the sum of positive integer problem. It's kind of like Bill Clinton debating the definition of "is" is. If somehow that answer is popping up in quantum mechaics or the Casimir force, then it isn't something you should just throw out as being nonsense. Maybe it's incorrect to say that it "equals" -1/12, but it does seem to be interesting. I'm not a banker, but my argument of investing $500 vs. sitting on it is valid, and that $500 could have a ripple effect through the economy.
I think I ran into my limit of replying to replies on this thread, but I would like to add @sigmajin that yes I am still defending that solutions to infinite series are not nonsense. We all learn math like we learn science. You probably learned that atoms were the smallest thing, maybe then you learned that those were made up of smaller things, then possibly you learned about quarks and the rest of the known subatomic particles. Did you tell your science teacher that they were wrong because you previously learned that atoms were the smallest thing? Or did you accept that maybe you were given the best way to understand what you needed at the time you were learning it and now you were going a little deeper in the way the world works? The same with infinite series. How could you pass calculus without being at least a little humbled by what you think makes sense and what the numbers show don't always line up? You're basically adding an infinite number of rectangles with zero width when you integrate, but you get the right answer. Fractional reserve banking means that banks can loan out more money than deposits they take in. When the economy grows, then the bankers are happy. When people spend money, it has a positive effect on the economy. But, when people (or businesses or governments) are unable to pay their bills because they don't have enough savings and there isn't enough new money coming in, then you have a collapse. People and businesses may file for bankruptcy. Governments may try to print their way out of it, but it ultimately can make the damage much worse. Pretend I'm a bank. I loan money to my friends. I only loan the amount of money that I have in savings. I charge them 10% interest on my loans. I can only get back my $100 plus the $10 interest. Say I'm a fractional reserve Bank. I have $100. I can loan $1,000 to my friends because I can have IOU's. Money comes in different forms. There is not nearly the amount of paper (or coins) that there is in debt and 1's and 0's in the economy. Some wouldn't even call the dollar money anymore because it isn't backed by a physical commodity like gold, silver, oil, etc. It's fiat currency because the US government says that it has value.
Im actually not a huge math guy.... I took business calc and have some specialized stat knowledge from my years as a poker player, but its not like im good will hunting or anything.
But i think a good place to start is understanding that its not a matter of interpretation.
Another good place to start is not using quotes around the word equals like its subject to multiple meanings or interpretations.
OMG youre not really defending that still are you?
Yes. Its exactly like that. Thats why bill clinton looked so silly and evasive. Because he was posing that there were multiple interpretations to word with such a clear cut and obvious meaning.
So for example, if i say "The some of a series of positive rational integers is always going to be a positive rational integer"
ANd you say "that might be true, it all depends on what your definition of is is. WIth the right definition of is, the sum might be a negative fraction" then yeah total absurdity follows.
I duck duck go'ed the money multiplier effect myth. From mises.org :
This is the type of misdirection that keeps the public ignorant in understanding that any money multiplication effect, as it occurs from lending without usury, makes no difference if the reserve requirement is met a priori or a posteriori.
In other words, the effective mathematical difference is zilch, if a loan is made from deposits (as in my example) or from bankers making rational banking decisions as to creating loans and then loaning from a Central Bank to meet reserve requirements.
The money multiplier effect still exists in either scenario and is based on the mathematically sound principles of convergent series whose elements in the sequence are finite partial sums.
Now even if this is not a perfect infinite geometric ratio in the real world, the implications of how this model can be easily seen with how money is created, regardless if loans are done via rational business decisions vs. loaning of new deposits, are readily seen by any casual observer.
Well, it can't be a fringe theory, it comes from the mises institute...
The mises article is actually supporting the MM effect as a real thing... I posted a list of links that included that one for the sake of fairness, as its the best one that actually supports the money multiplier theory.
The Mises article quote is a characterization of the claims of what those who advocate the myth of MM ... my apologies for not making that abundantly clear.
Regardless, the fact of the matter is that you did not adequately address my concerns of money multiplication, due to a posteriori or a priori meeting of reserve requirements, and how this relates to a limiting value in an infinite sequence, in which there are an infinite elements of the sequence, each of which is a finite partial sum.
Let us define money multiplication to be any increase in the monetary supply that is beyond the initial amount borrowed from the Federal Reserve.
Can you agree to that definition?
If all of the money is created by making bank loans then all the money in the economy is never enough to pay back all the loans plus interest, right? It's the interest that really kills it. The bank puts a milion into the economy but expects to be paid back 1.1 million. This can never be balanced out. Thus the banks are always foreclosing on property and growing richer (thriving on booms and busts) while individuals and small businesses go bankrupt.
Yes. The interest on loans makes it so that the total sum doesn't add up to 0 and as such is not a zero-sum game. Assuming everyone is honest and pays back the banks for any loans, they always have a net gain (minus losses paid to employees).
and interest paid on deposits.
Its deeply tragic, i know. In a perfect world, banks would just operate at a loss. then again, why just banks? grocery stores could operate the same way. they could sell food for exactly the amount of money that they bought it for, pay employees and rent and other expenses out of pocket and operate at a loss too.
oh to live in such a nirvana.
No, i mistake your statement that the banking industry is crooked as an indictment of the banking industry.
You have made no observation of fact. You created a hypothetical scenario where the money supply is multiplied by FR banking that was based on a misunderstanding of how banks lend money to consumers, businesses and oneanother.
And there's no talking you out of it, because you think accounting is a scam.
Its really a shame that posts like this end up on the front page (and will be pinned there for weeks now)...
I've never seen any academic claim that asking a question is the same as making a statement.
I reject your hypothesis that I made any blanket claim about the banking industry being corrupt.
All I did was ask if others are tired of it being corrupt.
That question does not necessarily preclude the assumption that I think the institution is corrupt, but rather anyone who answers the question in the affirmative, i.e. "Yes. I am tired of the corrupt banking institutions."
I never stated such a claim.
I think you mistake my observation of facts, and how they relate in an algebraic-geometric fashion to how reserve requirements operate, as an indictment on the banking industry.
It's a way to expect yourself or future generations to pay for things now. So long as the bill is passed down (with some interest, late payments, & fees tacked on) then it grows and grows. It makes people a little uneasy, because we (or some) think America is different. We hear stories about Greece, Venezuela, Weimar Republic Germany, and think those are small countries, they aren't the United States. They had (or are having in the case of Venezuela) a financial crisis, but that can't happen here because of how strong our economy is. I certainly don't hope for financial problems for us (or any other country you might be living in) but I would remain cautious. Maybe it will happen in 10 years or maybe 500 years, but a system that is trying to be controlled by the Fed (or other centralized powers) is prone to failure just like everything else.
"At the end of the day, nothing is being created though... the assets and the liabilities always zero out."
Not true. An asset and a liability are created. During 'normal' conditions they do zero out. But if the party with liabilities defaults then the party holding the 'assets' will experience real losses.