Writing the unthinkable in the Telegraph

[Little John]

Show me the FRB regulations that limit the capacity of commercial banks to lend money they don't have

Sorry I missed this request Steve.

The BIS Basel 3 regulations should have that covered.

Thanks JSD.

I have drawn up a table:



The above table is based on each bank having a fractional reserve requirement of 20% and splitting the amount they can loan back out equally (50%) between domestic customers and other banks (who each have their own 20% fractional reserve requirement).

Based on the above analysis;

The total amount held on deposit by all of the banks in the table = £333.33

The total amount lent out into the economy by all of the banks in the table = £666.66.

The total loans into the economy + the total held on deposit by the banks = £1000 (give or take a penny due to round-ups).

So, if the entire banking system is limited to a given fractional reserve of say, 20% then there can be no more money in the system (held in both deposits and money lent into the economy, than was the case in the beginning.

Additionally, it doesn't matter what the fractional reserve is set at, the money on deposit plus the money on loan always adds up to the £1000. All that happens is more or less of it is on deposit or loan. It also doesn't matter what the ratio of lending from banks is with regards to other banks or domestic customers, For example, if the fractional reserve is set to 10%, the numbers come out thus:



However, this still begs the question of how the money supply increases over time since it is demonstrably larger than it was, say, 50 years ago or even 20 years ago.

Well, one way that happens is if national banks borrow off other banks from overseas to raise their deposit on account (and fractional reserve), thus allowing them to lend more out to domestic customers). This means that international money can end up being concentrated in one particular region of the world, thus fuelling debasement of the value the money in that region if that money does not have a suitable home to go to in the economy.

Another way is for banks to borrow it off their central banks. If the central bank raises their money via government bonds, then this is just another way of transferring money form overseas and concentrating it in another given region. They then promise to pay back their international creditors in due course.

All of which does not explain how the global money supply rises over time. All that has happened in the above analysis is that money has been sloshed around within an economy via banks and across economies via banks and central banks.

So how has the money supply actually risen over time JSD?

If anyone else cares to comment on these tables, I'd be grateful

[RogueMale]

The banks have kept $100 + $90 + $81 + ... on deposit, a total of $1000. Meanwhile, out of thin air, they have created $900 + $810 + ..., a total of $9000. Not only that, but they're charging interest (let's say 5% APR) on the $9000 they lend, so they get $450. And they pay, say 4% interest on deposits, i.e. $40. That's a net profit of $450. A nice little earner.

I meant to write "That's a net profit of $410."

JSD, if I've misunderstood anything, I'd like to know what it is. It's in agreement with the Wikipedia article (which has a different reserve requirement): http://en.wikipedia.org/wiki/Fractional_reserve_banking.

Banks have to have money deposited with them before they can offer loans

Quite correct, though as the above reasoning shows, it doesn't mean they don't create additional money when they lend it to borrowers.

Contrast with full reserve banking (http://en.wikipedia.org/wiki/Full-reserve_banking).

[vtsnowedin]

All those fractional reserve banking charts look very clever until you add in the percentage of loans that go sour. Move up that percentage a bit caused by higher fuel prices or a jump in unemployment or one leading to the other and they become a house of cards about to fall down.

[Snail]

Steve:

Your tables are all good and show:

So, Banks can't directly create money (physical or electronic money in narrow/base sense) out of thin air. Only the BoE can do that. (Indirectly they can force BoE to create more base money via Interbank). I don't think people were saying this anyway. The physical amount of £1000 remains.

But what they do to is speed up circulation. Non M0/narrow money or credit money. Banks create relationships between borrowers and lenders, assets and liabilities. Banks create credit money. They don't print notes, but do create credit.

Your tables show this: total amount lent out is greater than original amount. Credit>narrow money supply always. Expanding credit forces expanding notes.

So how has the money supply actually risen...?

The BoE/central bank has created the money. Why? Forced by banks to, government spending to redistribute wealth, prop up failing economies in various ways etc. Increasing the money supply helps to lubricate the economy and allows more credit. A good thing until things go wrong as said by vtsnowedin.

Banks and insurance companies are the same thing. How does an insurance company which pays out on death start. By targeting first young people and then progressively older folks. Both are ultimately ponzi schemes.

edit: bugger this. I'm not sure about your tables now. Why 50% to other banks. Why couldn't bank B have £800. Am I having a blond moment? Am I a dunderhead? Credit should be greater than the £1000 but your table doesn't show that. I give up on this financial stuff.

edit2: For some reason you've assumed a currency drain of 50% which is distorting everything.

The total loans into the economy + the total held on deposit by the banks = £1000 (give or take a penny due to round-ups)
&
So, if the entire banking system is limited to a given fractional reserve of say, 20% then there can be no more money in the system (held in both deposits and money lent into the economy, than was the case in the beginning.)

Assuming you mean bank reserves, this is wrong. Total loans+total reserves=total amount of deposits.

Loans and reserves are created out of deposits. The total amount lent out will be greater than the initial deposit. The £1000 is still there in existence and hasn't physically changed, but total loans are greater as are total bank deposits. It's the total bank reserves which don't change and stay at the original amount of £1000. Your tables show this but the 50% currency drain is distorting things. And I think you are misinterpreting what the tables are telling you:

there is more 'money' in the system (bank deposits&loans), than was the case in the beginning. Central bank money has remained the same, but the money supply HAS increased. M0 (narrow or base) stays the same, M4 (broad money) increases. The only question with money supply is whether it is reserve-driven or loan-driven.

This is stuff I've studied years ago and only relatively recently have become interested in relearning it again. I might've gotten confused, so not having a go or anything. Reread your post, and I think you've just mixed up some terms:reserves&deposits. I'm probably repeating what you've been saying all along. If I'm wrong please someone tell me.
--------------
edit 3:Can't stop thinking about this! The reason you've got this:

The total loans into the economy + the total held on deposit by the banks = £1000 (give or take a penny due to round-ups).

is because the 50% loan to other banks (last column) is effectively part of the banks reserves as it's not lent out. So, when the 2 bank reserve columns are added, the total is £1000. Which fits with the fact that total bank reserves don't change. The table really suggests a 60% reserve requirement.

[kenneal - lagger]

JSD, how can we have record high levels of lending while we have record low levels of saving if the banks have to have more in the vaults than they lend out? The loan to saving ratio is mammoth at the moment.

[kenneal - lagger]

None of this alters the fact that the government can print as much money as it wants, subject to inflationary pressures, and should be doing so now to make up for the fact that we have a falling money supply as repayments of loans are greater than new lending.

[extractorfan]

None of this alters the fact that the government can print as much money as it wants, subject to inflationary pressures, and should be doing so now to make up for the fact that we have a falling money supply as repayments of loans are greater than new lending.

Agreed.

Still a massive economic problem, and IMO the money should not be used to support failing businesses such as irrisponsible banks. We should either have free market or a manged economy, not a pretence of one and the practice of another.

[Little John]

Steve:

Your tables are all good and show:

So, Banks can't directly create money (physical or electronic money in narrow/base sense) out of thin air. Only the BoE can do that. (Indirectly they can force BoE to create more base money via Interbank). I don't think people were saying this anyway. The physical amount of £1000 remains.

But what they do to is speed up circulation. Non M0/narrow money or credit money. Banks create relationships between borrowers and lenders, assets and liabilities. Banks create credit money. They don't print notes, but do create credit.

Your tables show this: total amount lent out is greater than original amount. Credit>narrow money supply always. Expanding credit forces expanding notes.

So how has the money supply actually risen...?

The BoE/central bank has created the money. Why? Forced by banks to, government spending to redistribute wealth, prop up failing economies in various ways etc. Increasing the money supply helps to lubricate the economy and allows more credit. A good thing until things go wrong as said by vtsnowedin.

Banks and insurance companies are the same thing. How does an insurance company which pays out on death start. By targeting first young people and then progressively older folks. Both are ultimately ponzi schemes.

edit: bugger this. I'm not sure about your tables now. Why 50% to other banks. Why couldn't bank B have £800. Am I having a blond moment? Am I a dunderhead? Credit should be greater than the £1000 but your table doesn't show that. I give up on this financial stuff.

edit2: For some reason you've assumed a currency drain of 50% which is distorting everything.

The total loans into the economy + the total held on deposit by the banks = £1000 (give or take a penny due to round-ups)
&
So, if the entire banking system is limited to a given fractional reserve of say, 20% then there can be no more money in the system (held in both deposits and money lent into the economy, than was the case in the beginning.)

Assuming you mean bank reserves, this is wrong. Total loans+total reserves=total amount of deposits.

Loans and reserves are created out of deposits. The total amount lent out will be greater than the initial deposit. The £1000 is still there in existence and hasn't physically changed, but total loans are greater as are total bank deposits. It's the total bank reserves which don't change and stay at the original amount of £1000. Your tables show this but the 50% currency drain is distorting things. And I think you are misinterpreting what the tables are telling you:

there is more 'money' in the system (bank deposits&loans), than was the case in the beginning. Central bank money has remained the same, but the money supply HAS increased. M0 (narrow or base) stays the same, M4 (broad money) increases. The only question with money supply is whether it is reserve-driven or loan-driven.

This is stuff I've studied years ago and only relatively recently have become interested in relearning it again. I might've gotten confused, so not having a go or anything. Reread your post, and I think you've just mixed up some terms:reserves&deposits. I'm probably repeating what you've been saying all along. If I'm wrong please someone tell me.
--------------
edit 3:Can't stop thinking about this! The reason you've got this:

The total loans into the economy + the total held on deposit by the banks = £1000 (give or take a penny due to round-ups).

is because the 50% loan to other banks (last column) is effectively part of the banks reserves as it's not lent out. So, when the 2 bank reserve columns are added, the total is £1000. Which fits with the fact that total bank reserves don't change. The table really suggests a 60% reserve requirement.

It doesn't matter what the fractional reserve is and it doesn't matter what the ratio of lendings is to other bank or to domestic customers. The total held on reserve by the banks as a whole + the total lent out into the economy by the banks as a whole always = £1000

All that manipulating the fractional reserve or manipulating the ratio of lendings does is to change the ratio of the amount lent into the economy as a whole and the amount held on reserve. The £100 pounds total remains the same though.

See below for a couple of tables where i have changed the ratio of lending to 80-20 and 20-80:



For this first one, based on a fractional reserve ration of 10%, the percentage of what they are allowed to lend has been split between domestic customers and other banks on a ratio of 20-80. Consequently, the total held on reserve by the banks is £357.14 and the total lent into the economy is £642.85. This comes to a total of £1000 (give or take a penny due to round-ups)



For this second one, also based on a fractional reserve ration of 10%, the percentage of what they are allowed to lend has been split between domestic customers and other banks on a ratio of 80-20. Consequently, the total held on reserve by the banks is £121.95 and the total lent into the economy is £878.05. This also comes to a total of £1000 (give or take a penny due to round-ups).

The total amount of money in the system stays the same (£1000) whatever happens to the fractional reserve and whatever happens to the ratio of lending between domestic customers and other banks.

What does change, of course, depending on the fractional reserve ratio or the ratio of lendings to other banks or to domestic customers, is the amount of money in circulation. This will have a direct effect on inflation. However, it is is limited effect because it is emanating from a fixed base.

[Little John]

Steve:

.......Can't stop thinking about this! The reason you've got this:

The total loans into the economy + the total held on deposit by the banks = £1000 (give or take a penny due to round-ups).

is because the 50% loan to other banks (last column) is effectively part of the banks reserves as it's not lent out. So, when the 2 bank reserve columns are added, the total is £1000. Which fits with the fact that total bank reserves don't change. The table really suggests a 60% reserve requirement.

Are you saying that the money that a bank lends to other banks can still be recorded as a part of its fractional reserve?

If you are saying that, and you are correct, it changes everything.

If true, then banks really do increase the money supply.

[Little John]

oh wait...I think I get it

The money that a bank lends to a domestic customer is placed, by that customer, in his own bank account as a deposit.

These deposits are lent out again by his bank.

That will definitely multiply the money supply up from its initial base of £1000.

In other words, the problem with the my last tables is that I made the assumption that once money had been lent into the economy, it could not be used to lend again and that this only happened to money that was lent to other banks. I was wrong. All of the money is continually lent until there is no more left to lend (based on the fractional reserve ratio). In other words, it will continue until infinity is approached.

I'll run another table to simulate that.....

[extractorfan]

I'll run another table to simulate that.....

I don't know how you factor it in but a lot (most??) loaned money gets invested in ventures that are not bank accounts. Still in the hope of making a return of course, but not simply loaned out again.

If my business was to take out a loan for example, that money would be spent on equipment, new premises, maybe a couple of new sales people etc.. Assets that we'd hope paid for themselves by attracting new customers.

[Little John]

In this table, using a fractional reserve ratio of 20%, the multiplier effect means that the total money supply in circulation has expanded fourfold.

However, the multiplier effect still has a ceiling on it based on the fractional reserve ratio.

[Little John]

JSD, although you would appear to be right in stating that central banks control the amount of money that is in circulation by setting the fractional reserve ratio, you're wrong in asserting that only the central banks actually generate that money.

Banks really do magic money out of bugger all.

[Little John]

I'll run another table to simulate that.....

I don't know how you factor it in but a lot (most??) loaned money gets invested in ventures that are not bank accounts. Still in the hope of making a return of course, but not simply loaned out again.

If my business was to take out a loan for example, that money would be spent on equipment, new premises, maybe a couple of new sales people etc.. Assets that we'd hope paid for themselves by attracting new customers.

Yes, but the people who you paid for your equipment are going to deposit that loaned money of yours into their bank account.

Guess what happens to it then?

One way or another, the banks get hold of all of the money and repeatedly lend it out until they reach infinity within the limits of their fractional reserve requirements.

[Snail]

Yeah, that scans better i think. If bank reserves are considered like cash, then total reserves aren't changed. Cash is still £1000. The loans made are £4000. And bank deposits should add upto £5000.

Reserves=assets, loans=assets, deposits=liabilities. Assets=liabilities. So accounting equation is balanced.

Your 1st table, half the potential loans 'disappeared'. So it was like cash being burned. It didn't make sense. Either the banks would use it to make loans or store it to build up reserves.

The money supply includes these different types of money. All ious. People have access to £5000 in deposit for eg. Even though they could.only all withdraw a total of £1000. In theory, you could have one bank with different people and the table would look the same. So there's always pressure within the system to create credit, which the CB satisfies by birthing base money. This is why there's continuous inflation. It's chicken&egg scenario.