Central banks fight credit crisis

RogerCO · Post by **RogerCO** » 14 Mar 2008, 12:15

Ah, yes the ?10 becomes ?97 magic comes from successive uses of the fractional reserve.

Bank starts with ?10 on deposit.
It can lend an additional ?9 (which it can create as script - promises to pay - the ?10 remains in the vault)
That ?9 gets used and ultimately deposited in (another) bank
That (possibly different) bank can then lend ?8.10 out into the community
That ?8.10 eventually ends up in a bank which can then lend a further ?7.29

and so on

This series converges on approx ?87 of invented loan money, plus the original ?10 giving the ?97 - or nearly ?100 of money in the system.

It doesn't matter whether the first ?9 gets deposited in the original bank or a different one - it can still be used to generate more money under fractional reserve.

So yes you are right that the first bank can only lend out ?9 of the original ?10 deposited, but the system as a whole can generate ?87 of invented money.

Thus the system which started out from the observation that typically only one in ten depositors wanted to take their money out at a time spirals onwards.

No wonder we are in a mess really...

[edit] - I just put the numbers into a spreadsheet and it does actually converge on 89.99999r which plus the original ?10 does make ?100 [/edit]

SILVERHARP2 · Post by **SILVERHARP2** » 14 Mar 2008, 12:28

http://globaleconomicanalysis.blogspot. ... horse.html

Mish did a piece on it. would need to reread

Blue Peter · Post by **Blue Peter** » 14 Mar 2008, 12:33

RogerCO wrote:Ah, yes the ?10 becomes ?97 magic comes from successive uses of the fractional reserve.

Bank starts with ?10 on deposit.
It can lend an additional ?9 (which it can create as script - promises to pay - the ?10 remains in the vault)
That ?9 gets used and ultimately deposited in (another) bank
That (possibly different) bank can then lend ?8.10 out into the community
That ?8.10 eventually ends up in a bank which can then lend a further ?7.29

and so on

This series converges on approx ?87 of invented loan money, plus the original ?10 giving the ?97 - or nearly ?100 of money in the system.

It doesn't matter whether the first ?9 gets deposited in the original bank or a different one - it can still be used to generate more money under fractional reserve.

So yes you are right that the first bank can only lend out ?9 of the original ?10 deposited, but the system as a whole can generate ?87 of invented money.

Thus the system which started out from the observation that typically only one in ten depositors wanted to take their money out at a time spirals onwards.

No wonder we are in a mess really...

That's true, but I think that you need to include the fact that with each lending there is a deposit and the sum of the deposits outweighs the sum of the lendings.

I.e. Deposit 10 lend 9
Deposit 9 lend 8.1
...

So the thing can unwind in an orderly fashion. A bank never lends out more than it has received in,

Peter.

Post by **adam2** » 14 Mar 2008, 12:40

"trust Greg Preston, trust his petrol notes"

Or perhaps that should be "trust adam2, trust his petrol notes" *

probably better than paper money at present!

*Also trust his baked bean notes, for smaller transactions.

RenewableCandy · Post by **RenewableCandy** » 14 Mar 2008, 14:02

Bear Stearns bailout...

RogerCO · Post by **RogerCO** » 14 Mar 2008, 14:33

Blue Peter wrote:That's true, but I think that you need to include the fact that with each lending there is a deposit and the sum of the deposits outweighs the sum of the lendings.

I.e. Deposit 10 lend 9
Deposit 9 lend 8.1
...

So the thing can unwind in an orderly fashion. A bank never lends out more than it has received in,

Peter.

err, no ?
The only real deposit is the original ?10
Even if the first bank actually gave out nine of the original 10 gold pieces then there would only be 1 left on deposit (which, remember is representing 10 bits of gold that an investor left in the safe keeping of the bank to start with - so we are relying on him not wanting his gold back)
In this model the sum on deposit would be 1 + 0.9 + 0.81 + ....

In practice Mr Banker realises (and is allowed to by the central bank and govt) that borrowers are just as happy with paper that they believe represents the value of 9 gold pieces. All the ?10 in gold stays in the first bank's vault. When the ?9 is deposited (at another bank) it is as paper, and the second loan of ?8.1 is more paper against this paper 'deposit'

Net result ?10 in gold and ?90 in paper claiming to be as valuable as gold.

It might be possible to unwind this so long as each bank was prepared to accept paper back to pay off the loan but there are two further problems. The first, which we see at the moment ,is that it relies on banks (and everyone else) continuing to trust the paper. If this trust starts to evaporate then the whole house of cards is at risk. If anyone in the system refuses to accept paper money and demands real physical value then it can grind to a halt. Which is why undermining the currency is about the most treasonable act possible in a capitalist system.

That wouldn't be too bad if it were not for the additional factor of interest.

The first bank that loaned the original ?9 of paper is actually demanding ?9.90 back (10% say), and so on down the line so the whole system is actually demanding that an extra ?9 get created in addition to the ?90 that has been lent. This has to come from resources outside the system - stuff, or work, or energy or whatever you can convince the banking system is worth ?9 of new gold.

I think the analysis presented in Money As Debt is pretty solid.

oh dear...

RogerCO · Post by **RogerCO** » 14 Mar 2008, 14:43

And then it gets worse...

The sum of the ?0.9 + ?0.81 + ?0.729 + ... in interest (at 10% to keep the figures easy) ends up as deposits in the banking system.

So now we have a fresh ?9 on deposit which can generate a fresh ?80 odd of new money as debt to be repaid at interest.

If you let this run for a couple of centuries at a modest rate of interest (shall we say 3% - I have my costs to cover you know...) then you will end up pretty much where we are today.

PaulS · Post by **PaulS** » 14 Mar 2008, 14:46

Spot on Roger.
I wonder if I converted enough of that paper money into solid gold!

Blue Peter · Post by **Blue Peter** » 14 Mar 2008, 15:03

This certainly isn't my specialist subject, but I'll try to make a defence of things.

You have decided upon the system you want (gold as money) and are judging every system against that. You're obviously entitled to do that, but people should recognize that you have chosen your system as the gold standard (pun intended

), and necessarily every other system will not live up to it, because they aren't the gold standard.

But the gold money system also has its problems. It still relies upon trust - you have to trust that gold represents value. It has problems with economic growth, because the money (gold) supply can't necessarily increase at the same rate as which the economy grows.

Basically, money is trust. It's saying that I will deliver goods/services of a certain amount now, or I will deliver do a certain amount of work in the future to pay the interest (and capital) which I borrow now. Provided it is tied to sensible practices, it doesn't matter whether money is physically or notionally backed, since in the end even if it is physically backed, there still has to be a notional backing to that physical material to make it work.

Given that, all the deposits are real deposits, since they are all backed by the same trust. If that trust goes, then the system goes, but that would apply to every system.

How about that?

Peter.

RenewableCandy · Post by **RenewableCandy** » 14 Mar 2008, 15:10

@Peter I think I can can see what you mean but in that case, in order for that to work, everyone has at least to trust that the system wll grow. Forever.

Blue Peter · Post by **Blue Peter** » 14 Mar 2008, 15:17

RenewableCandy wrote:@Peter I think I can can see what you mean but in that case, in order for that to work, everyone has at least to trust that the system wll grow. Forever.

Now we really are out of my league. I think that this is a problem with any interest-bearing money (or perhaps the problems vary with the money system). But, as I say, here I know nothing,

Peter.

Aurora · Post by **Aurora** » 14 Mar 2008, 15:52

BBC News - 14/03/08

US bank Bear Stearns has got emergency funding, in a move that raises fears that even the top Wall Street names are suffering amidst the credit crunch.

JP Morgan Chase will provide the money to Bear Stearns for 28 days with the Federal Reserve of New York's backing.

JP Morgan is also trying to get long-term financing for Bear Stearns.

Article continues ...

BBC News - 14/03/08

President George Bush has attempted to restore confidence in the US economy, amid the deepening financial crisis.

Speaking at the Economic Club of New York the President acknowledged that growth had slowed but said that the economy is basically sound.

He said the economy was "obviously going through a tough time."

Article continues ...

emordnilap · Post by **emordnilap** » 14 Mar 2008, 16:48

Aurora wrote:
BBC News - 14/03/08
... the President ... said that the economy is basically sound.

So it really is fecked.

RogerCO · Post by **RogerCO** » 14 Mar 2008, 19:57

Blue Peter wrote:Basically, money is trust. It's saying that I will deliver goods/services of a certain amount now, or I will deliver do a certain amount of work in the future to pay the interest (and capital) which I borrow now. Provided it is tied to sensible practices, it doesn't matter whether money is physically or notionally backed, since in the end even if it is physically backed, there still has to be a notional backing to that physical material to make it work.

Given that, all the deposits are real deposits, since they are all backed by the same trust. If that trust goes, then the system goes, but that would apply to every system.

How about that?

Peter.

Yes, that I think is quite right. It doesn't of course matter what token you use for money - gold, paper or beads - it does depend on trust that I can redeem the notional value of the token I hold when I choose.

There have been cases where the token used to represent value is something quite common like a pebble (or a bit of paper). Give me your chicken and I will give you 10 pebbles which represent the chicken. Ultimately you can come back to me and give me the ten pebbles and I will give you back a chicken. The system works so long as no unscrupulous person decides to pick up some extra pebbles and claim that they represent another chicken that doesn't really exist. It also depends on me not eating your chicken and refusing to give you anything back for your useless pebbles - trust is fundamental.

The primitive money system is simply barter where some tokens of no intrinsic value are used as an intermediary in a chain of barter transactions based on mutual trust.

This is where the fractional reserve system of creating money falls apart - the banks are simply picking up extra pebbles that do not have any intrinsic value and lending them out as if they represented real chickens.

So I still think there is a problem with banking - not with using paper to represent value, nor with the system being based on trust, but with allowing the banks to create additional money that represents value that does not yet exist.

And the there is a separate problem about usury (lending money at interest).

So very good point about trust being a key part of the system, and that if you have trust then you can use tokens that don't have any intrinsic value.

I guess the attraction of gold is that you can't simply go and pick up some more - you have to dig a dirty great hole in the ground and crush and sift rock to find it, and if you have got some you can use it for other things (jewelry, dentistry,...) as well as a token - so it has some embodied value.