The Creation of the Federal Reserve System (Part 2)

Then you didn't read it carefully.

That is, its deposits.

But the bank pays check out of its assets, not its liabilities. It's liabilities are what it owes. Assets are what it has. It can't pay a check out of an obligation it has to someone (ie a deposit account).

This is where your error lies. Read step 6 of MMM.

The money to pay the loan proceeds comes out of reserves.

When the bank credits its customers account, it creates $9k in deposits matched with $9k in loans receivable. The bank's reserves do not change. There are no reserves created. The amount of reserves is still $10k.

But when the borrower spends that $9k by withdrawing cash or writing a check, the banks reserves are decreased by $9k (it can't pay the check with a loans receivable). That leaves the bank with $1k in reserves, and $10k in deposits. It cannot loan more money until it gets more deposits.

Read steps 4-6 of MMM.

What is created on the asset side? Just loans receivable. But a banks cannot spend loans receivables.

The Fed can create money any time it spends it for anything.

But the Fed's create reserves. The bank loans create more deposits.

 

No, it is the requirement that the bank has to pay the loan proceeds with its reserves that limits the amount of loans a bank can make.

Your position that bank can create all the money it wants out of thin air is what is stupid beyond words. If that were the case, why was there a credit crisis? Why did the Fed and Govt bail out the banks? Why didn't the banks simply create more money out of thin air?

Your words are fine. It's your explanation that is wrong. So instead, let's refer to MMM which we both agree is an accurate source. Review steps 1-6 and look at happens with reserves, which is cash/base money the Fed (and only the Fed) creates. Then we can refer to MMM in your explanations.

 

You are looking at this all wrong.

The total money in the system is still $19,000 because of the deposit expansion process. The fact that it is paid out of both reserves and deposits matters not. The new money was created and increased the total money supply in the banking system by $9,000 dollars.

Deposits can also be classified as reserves. What if the bank is not within The Federal Reserve System? The fractional reserve process applies to them in the exact same way...only instead of "reserves" they simply create money in this way based upon their deposits.

Your inability to read between the lines is really hindering your understanding of this process.

That is, reserves with The Fed.

And? It has still increased the money supply within the overall banking system by $9k. It has created this money from thin air by simply having a piece of paper that states soemone will pay it back at interest.
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That is not the point.

The Fed needs a piece of paper saying someone will pay the money back just like banks.

Deposits are reserves.

You need to look at the banking system as a whole.

Where did I say that? I simply said they can create money out of thin air...which is proven. They create money within the banking system because someone agreed to pay it back at interest.

They did. Why do you think there was a credit crisis in the first place?

So you don't agree that the money supply within the banking system increased by $9k in my example?

 

The total amount of deposits have increased to $19k.

Nothing is paid by a bank out of deposits. Deposits are liabilities, obligations of a bank.

A bank pays for things with reserves (cash/base money) like everyone else.

See step 6, MMM.

Absolutely not true. Where in MMM does it say this?

It does work the same way. Nonmember banks use correspondent banks (members of the FR system) for reserves.

Rather than baseless insults, reference to language or sources that are reliable, like the MMM, would be far more persuasive.

Correct, the $10k reserves are on deposit with the Fed or in cash. Reserves are equivalent to cash.

Depends on how you define the money supply. If you use a broader measure that includes the amount on deposit (ie M1), yes that is true, because deposits have increased, as I've said all along.

However, if you are talking about a narrower definition of money (M0) -- reserves/cash, the money supply has not increased at all by the bank's loan.

Therein lies the fundamental difference. The Fed can expand the amount of cash/reserves (as well as deposits). Banks can only expand the amount of deposits.
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Of course it is the point. Because when the bank pays for that $9k loan, it has to use reserves.

That is its usual method. But it could buy assets, gold for example, and you'd get the same result.

Your statement is inconsistent with MMM. Re-read it.

Deposits are a bank's liabilities, its obligations. Reserves/cash are a bank's assets.

They are quite different. A bank (like everyone else) pays a check with reserves. It does not pay a check with deposits.

See MMM step 6.

We can look at look at whatever you want, but it is helpful to understand what is happening on an individual bank level as well as the system as a whole.

And my statement is completely accurate. The bank pays loan proceeds with its reserves, which is what limits how much a bank can lend (and thus create new deposits).

You said "The idea that the requirement of a 10% reserve means banks cant create money is so stupid it is beyond words."

If that is not true, why can't a bank simply create as much money as it wants? What is stopping it?

Now to support your position you're denying that the subprime mortgage credit crisis ever happened?

Reality check, dude. Maybe you should reconsider whether your understanding is accurate.

But why didn't you answer my questions?

Why did the Fed and Govt bail out the banks? Why didn't the banks simply create more money out of thin air?

See above re discussion on it depends on what you mean by money supply.

 

Deposits are money are they not?

So if I were to go deposit 10k into my bank right now you are telling me they cannot issue a loan for 9k based upon reserve requirements?

MMM can't cover everything.

In your previous post you stated yourself that a bank could write more loans once it got more deposits. If a bank does not pay out of deposits this could not be the case UNLESS deposits are also counted as reserves. You seem to think that the only way banks can make loans is via new Federal Reserve cash being created. This is obviously false.

So no banks can ever make loans without corresponding Reserves with a FR bank? Is this your position?

Semantics. Is it or is it not money that can be spent?

Ok, if I were to go deposit $10k of my own money into my bank, could it then write a loan for $9k?

It is purchasing gold with the idea that it could sell it for currency should it need to(Someone agreed to pay it back).

MMM is dealing SPECIFICALLY with interactions involving the FRB. It is not the end all be all. If banks only paid out of reserves and deposits were not reserves then no bank loans could take place without FRB say so and this simply is not the case.

Deposits are also reserves.

So youa re truely trying to argue that because a bank does not have unlimited ability to create money out of thin air that the money it DOES create is not really creating money?

Am I mistaken in the idea that mortgages are written by banks with money created via the deposit expansion process?

You first.

See above. If I was told I could only make $1 million dollars appear out of thin air because of "the rules" that does not mean I do not have the ability to create money out of thin air.

 

Roon is definitely on the right side on this one. However, I must clarify that banks DO NOT need reserves before they make loans. They do not need you to deposit $10k before they can lend $9k. They make loans first to any one who meets their qualifications than they go out an borrow reserves from the fed funds market. This is how the Fed controls the money supply.

If they raise the amount of reserves in the Fed Funds market, than it is cheaper to borrow and one can lower their rates. If they decrease the reserves, than the opposite happens.

But banks DO NOT need your deposit in order to loan money.

In fact at the end of MMM it goes in to this in detail...

 

Depends on the definition of money you are using. They are not money for the definition of money reserves/cash/base money (M0).

They could, because when you deposited 10k, the check you deposited resulted in a transfer of $10k reserves from the bank upon which the check was written to your bank. Now your bank has $10k more reserves upon which it can make a loan.

The flip side is that the bank upon which the check was written has $10k less in reserves and therefore cannot make a loan (unless it has other excess reserves).

It covers what we are discussing. You were the one who cited it as a source explaining the transactions.

The fallacy in your argument is that when a bank gets more deposit of money from another source, reserves are transferred to the bank and it is those new reserves upon which it can make more loans.

Reserves or cash. Same thing. That is correct. How else could it pay the loan?

The money supply definitions I can are not semantics at all. They are defined ways the money supply is measured.

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

Sure. See above. By making the deposit, you are transferring $10k new reserves into the bank, and the bank can use that to make new loans.

The fallacy in your argument is that the FRB has to approve loans. That is not the case.

MMM explains the transactions for all banks. The Federal Reserve system is the clearinghouse for all checks.

Source?

Your statement completely contradicts MMM. Look at the transactions in steps 1-6.

Deposits are liabilities, obligations it owes the depositor, recorded on the liability side of the T account. Reserves are assets, cash, records on the left side of the T account. A bank can spend or pay cash. It cannot spend or pay a deposit account.

A bank can (and usually does) have far more deposits than it has reserves. It only has to have reserves equal to 10% of the amount of deposits. That is the "required" reserve.

Your are getting confused by labels. A bank does not have unlimited ability to create loans (which creates deposits) because it must have the reserves/cash to pay for the loan, and must retain 10% cash/reserves of the amount of deposits it has.

The money used to make the loans are reserves that are transferred via the multiplier effect of lending money.

I've cited to the MMM for every statement I have made.

Feel free to demonstrate any of my statements that are inconsistent with MMM.

I don't understand what you mean by "if I was told..." No one tell anyone they can make money appear out of thin air ... except the Fed can do it.

That is how it controls the money supply.

How does that answer my question? Why couldn't the banks just create money out of thin air to avoid the problems with the subprime mortgage crisis?

 

Tag you're in, my head hurts from pounding it against the brick wall named Iriemon.

 

Fed's create reserves our of thin air, banks create deposits out of thin air.

The fact that they have limits of how much money they can create out of thin air does not mean they do not create money out of thin air.

Sure it has limitations. The Fed can not create more reserves that exists than deposits/savings BECAUSE the only way they can create reserves is by purchasing a security which is already being represented by a deposit.

Like I say over and over again. The Fed creates a "form" of money to represent another form of money that has already been created.

 

I'll give it a try, but wholly cow it is gut wrenching. I don't know if there is anything that could convince Iriemon that he is wrong. Even if we got a banker to come in and tell him face to face that they do in fact create money out of thin air. He will still tell them they are wrong.

 

MMM Specifically states that an equal amount of reserves MAY be transfered...it does not say that they ARE. What if you have 2 credit unions operating wholly outside of the FRB network?

It is a source, but it is not the ONLY source.

No, MMM says they MAY be transfered....it is hardly a requirement.

Deposits are reserves, deposits are also cash. A bank must only have 10% of its total deposits on hand at any one time. Fractional reserve banking ftw?!

Money does not need multiple definitions. It can either be spent and is in the system, or it is not.

Not neccessarily.

It has to supply the reserves to create the loans according to you. If it supplies no reserves then no loans take place. Ergo, it approves the loans.

Let me rephrase that for your ultra literal self. Cash money that is DEPOSITED in a bank are also reserves for that bank.

I never stated it has unlimited ability to create loans.

My point is that you have created a straw man.

I never claimed what you are saying that I claimed.

 

We've already established this. Money being in a deposit account doesn't necessarily mean it's in circulation. I can put money in the bank for 50 years and never touch it. We wouldn't consider that to be in circulation, now would we?

I know. The fact that you are bringing this up shows that you have absolutely no idea what I'm trying to tell you.

They do not create any money that ever goes into circulation.

This is a vague generalized statement. It depends on what you mean by "with money out of thin air". I agree that, at some point in the past, the Fed created money out of thin air to buy the govt securities off of someone and the money ended up being used by the bank in the future to buy more govt securities. But the bank did not create any money on the spot for the purposes of buying govt securities.

 

If the Fed credits the bank's reserves, 90% of that is still considered Excess reserves. They're called excess because they exceed the required reserve ratio of 10% that the Fed sets. You are incorrect in saying that 100% of the bank's reserves are "Excess reserves".

There is not $100 circulating in the economy. There is only $100 worth of deposits sitting in the bank. If all depositors tried to withdraw that $100 to get it to circulate in the economy, the bank would fail because the $100 in reserves do not actually exist.

Please explain how banks borrowing existing money from each other amounts to money creation.

 

Banks can make limited borrowings from the Fed. But except for times of crisis, they rarely do that.

But MMM explains the normal process where deposits are the basis for what a banks can lend.

Depends on the Fed funds rate. In times of recession, the Fed makes rates loan to encourage credit activity. But when the economy is growing, the Fed raises the rates.

They do need reserves, however. Ultimately deposits are the primary source of their funds.

Exactly. If the bank expects to obtain funds (ie reserves) to pay its customers checks it can make additional loans. The source of those funds are generally deposits but as explained in that section of the MMM (pp 36-3
banks make short term loans of surplus of reserves to banks that have short term deficits.

But these are short term transactions that don't change the fundamental process of how money is created, as is explained in MMM.

 

And I could put cash in my safe and we wouldn't consider that to be in circulation, now would we?

You keep saying deposits are not real money, so if you are now saying deposits are real money than I do not have an idea what you are trying to tell me.

Sure they do. Unless you want to make up your own definitions of what is in circulation. You are just making anything up to fit your ridiculous theory. Any knowledgeable person in banking or economics understands that deposits are money.

Sure they did. That's why the Primary Dealers were established in 1960.

You can call it whatever you want. Let's say the Primary Dealers create "claims" out of thin air. What does it matter? Those claims end up in the Govts account, which then end up in our accounts, which then end up going to purchase real goods and services in the real economy.

So even your claims theory doesn't change the fact that Primary Dealers fund the Govt which gives us our "claims" before we ever need to "fund" them.

 

The brick wall you're hitting against is the MMM, which you yourself cited as an authority.

All I have done is point out your misunderstanding and inconsistencies with your own source.

 

I don't believe it is I that has the misunderstanding.

 

Lol, banks use the Fed Funds market all the time. That is how the Fed controls the money supply. Banks do not need deposits in order to make loans. They just have to borrow the amount of reserves necessary for the deposits they have.

Correct

Ultimately this is 100% incorrect. They do not loan deposits, deposits are the primary source of nothing for the banks. Banks can give out loans with out ever needing a deposit.

Yes, but they do not need your deposit to this. They will make a loan depending on the Fed Funds a rate and their expectations of being able to borrow these funds. It has nothing to do with waiting for someone to deposit $10k in to their account.

Money creation is a short term process, it happens every day. Just because you look at the consolidated numbers at the end of the year doesn't mean that's when money is created. It is an ongoing process that happens every day.

 

Banks as a group create deposits based on loans that are paid by reserves. So its not quite the same as creating it out of thin air.

It is the fact that they have to pay loans with reserves that limits the amount of loans (and thus deposits) that can be created.

That doesn't make sense. A US Govt bond, for example, is not represented by a deposit.

The Fed's ability to create money is only limited by its concern of creating too much inflation.

The Fed creates reserves that have not already been created.

 

All you need to do is explain how the process of money creation set forth in MMM is wrong.

 

You are reading it wrong.

They define that deposits are money
They define that banks create money by creating deposits
They define that banks can create far more deposits than they have in reserves

I have no clue how you are coming to the conclusions you are coming to.

 

It was numbers entered into a computer representing money under no official authority other than they had met the reserve requirement.

But they still create the money on nothing but their own authority and create it out of thin air.

The Fed does not buy government bonds from the government. They buy them from primary dealers where it is represented on their books.

Not true, if nobody on earth wanted US dollars The Fed could not create money.

Also not true, the money has already been paid for US treasuries for example. The Fed creates NEW reserves by purchasing them from primary dealers.

 

They create deposits. The trading of reserves amongst banks have nothing to do with the amount of money the banks create.

No, what limits the amount of loans is how much it costs to obtain the amount of reserves necessary to satisfy the requirement.

Sure it is. It represents Govt spending. They issue a bond, acquire funds for it, and then disburse those funds to real individuals in the form of deposits.

This is 100% incorrect. The Fed's can not create money with out taking on a security that exists which was previously purchased with money. You are wrong once again.

Of course... but they don't create deposits that have not already been created.

 

This is basically Iriemon's theory. He takes the view of an individual bank. So he says that when a bank creates a loan and that loan is deposited in a another bank that the lending bank must transfer it's reserves over to receiving bank.

So therefore banks do in fact loan reserves.

On top of this, he believes that since they do have to transfer an equal number of reserves that deposits simply create a "claim" on these reserves.

The reason this is wrong is because the reserve system has nothing to do with the private sector. You can use your deposit anytime you want to purchase anything you want. The bank does not need the appropriate amount of reserves in order for you to make your purchase. You will not be denied your purchase if the bank does not have enough reserves.

After you make your purchase and the deposits of the bank decline, the banking system than "trades" their reserves within their own system. As in regardless of the bank having the reserves or not they will be in a deficit to the central bank if they do not have enough reserves. Therefore they will have to go acquire these reserves.

The reason why deposits are money to the private sector is we are not dependent on banks reserves. Only banks are dependent on their reserves. Reserves are simply a mechanism to control how much money banks can create.

 

People don't generally borrow money just to have it sit in their account. They borrow money to spend it on something.

They transact with the Federal Reserve system through correspondent banks.

Feel free to cite any other reliable source supporting your position.

You were the one who claimed MMM described the process. Now you are trying to back away from it because it contradicts your position.

If the loan proceeds are spent by cash or check, reserves are transferred out of the bank.

This is a fundamental misconception on your part, easily disproven.

From step 4 in MMM, which is after the bank makes a loan to its customer by crediting the customer's account at the bank:

Assets
Reserves with F.R. Banks + 10,000
Loans + 9,000
Total + 19.000

Liabilities
Deposits:
Initial + 10,000
Stage I +9,000
Total + 19,000

If deposits are reserves, then the amount of reserves the bank would have would be 19,000. But in fact, its reserves are still only $10k, the amount it had before the loan.

Deposits thus cannot be reserves. And they are not. Deposits are a liability, reserves are an asset.

This is a fundamental misconception on your part. There are many different measurements of money. See the Wiki article I posted.

How are you making a deposit?

I've said no such thing whatsoever. The reserves a bank needs to fund loans can come from many different sources, including the deposit you made. It doesn't have to come from the Fed and I never said or implied such a thing.

That is true but not complete. A check drawn on another bank that is deposited results in a transfer of reserves that are reserves for the bank where the check is deposited.

If it can create money out of thin air why couldn't it? What in your view limits the amount of loans it can make?

What straw man? I'm simply asking why, under your view that banks create money out of thin air, cannot they simply create as much money as they need or want?