Neo-Talk: Federal Reserve System
Jimmy -Jimbo- Wales
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From: Jimmy -Jimbo- Wales <jwa...@mars.mcs.com>
Subject: Neo-Talk: Federal Reserve System
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I believe that a clear and honest understanding of a complex issue
will often require several days of thoughtful reflection. Since Sam
seemed so insistent that my presentation of the essence of fractional
reserve was wrong, I decided to consult the reference he gave
directly, to find the root cause of our disagreement.
I walked over to the Federal Reserve Bank of Chicago (basically across
the street from my office) and picked up a copy of _Modern Money
Mechanics_. This is the Fed's own publication explaning "the basic
process of money creation in a 'fractional reserve' banking system."
You may obtain a copy of this from:
Public Information Center
Federal Reserve Bank of Chicago
P.O. Box 834
Chicago, IL 60690-0834
[312]-322-5111
I don't know if they charge postage, but _Modern Money Mechanics_ is
available free of charge if you walk into the bank.
Now, as to the discussions we've been having here. The key issue
under consideration, recall, was whether fractional reserve banking
as it is practiced in this country is a process as I have described
it (with banks loaning out a percentage of checkable deposits, thus
creating money through a process of loan-->deposit-->loan-->deposit),
or if something else entirely is going on (i.e. banks fraudulently
just making up money and loaning it).
After a careful reading of the entire booklet from front to back,
I see that my original position was correct, and that it is explained
clearly and competently throughout the Fed's own workbook.
It was interesting to see that the Fed uses essentially the same
example that I did. They use an example with a 10% reserve
requirement and a sequence of transactions involving an increase
of $10,000 in the monetary base generating an increase of $100,000 in
the money supply. This happens, as illustrated by their t-accounts,
through a sequence of loans and deposits throughout the banking
system.
If I had to put my finger on the single error that Sam was making, I
would say that it was his misinterpretation of a single paragraph.
I'll quote that paragraph below, and then explain it in the context
and language of the surrounding materials and examples. (If you
don't have a copy of the booklet, or if you haven't been following
this debate, this won't be as useful to you as if you had -- I'm
explaining this primarily for Sam's benefit.)
"If business is active, the banks with excess reserves probably
will have opportunities to loan the $9,000. Of course, they do
not really pay out loans from the money they receive as deposits. If
they did this, no additional money would be created. What they do
when they make loans is to accept promissory notes in exchange for
credits to the borrowers' transaction accounts. Loans (assets) and
deposits (liabilities) both rise by $9000. Reserves are unchanged
by the loan transactions. But the deposit credits constitute new
additions to the total deposits of the banking system."
The first thing to understand about this paragraph is that we are here
talking about the operation of the *banking system as a whole*. The
point is that if a single bank made a single loan, and the recipient
of the loan just took the money and put it into a mattress, *no
additional money would be created.* That would be the end of the
process. Of course, this is not what actually happens. From the
perspective of the banking system as a whole, virtually all of the
money loaned out is immediately *re-deposited* into the system. So
the banks do not "pay out loans from the money they received" because
the "pay out" is almost always immediately redeposited.
There is absolutely nothing fradulent about this process. If I
deposit 1000 dollars into a bank, I do so under the *explicit
agreement* that the bank will be loaning out 90% of the money to
someone else.
There also seems to be some confusion about what happens if there is a
change in bank reserves as a result of public demand for currency.
That is, suppose I go into a bank and deposit 1000 dollars. What
does the bank do? Does my bank then loan out 900 dollars of it?
Or does my bank loan out 9000 dollars based on my 1000 dollar deposit?
The answer is: my bank loans out 900 dollars, i.e. a *fraction* of
the money I have deposited. BUT (and this is important) from the
point of view of the banking system as a whole, my initial deposit
of 1000 will result in $9000 in additional loans as the money works
its way through the system.
But my bank can't just skip the steps of the process and suddenly loan
out $9000 from a $1000 deposit. To see why, you'll want to work
through the t-accounts as presented in the workbook. A bank that is
already in equilibrium (i.e. at the reserve limits) which receives a
cash $1000 deposit will have excess reserves of $900 -- *not* $9000.
I am available, as usual, to answer particular questions on these or
other financial matters. I enjoy writing about this type of thing
because *I am a professional trader and researcher*, and working
through these basic principles benefits my ability to make quality
decisions in the marketplace -- i.e. increases my bottom line.
There *is* something wrong with our current financial system at a
very deep level. But it is't fractional reserve banking, which is
the only rational system of banking for a sophisticated economy (for
the reasons that I gave in an earlier post). The problem is that the
"monetary base" is *paper*, giving the government absolute control
over the value of the currency -- a power which in the long run they
are destined to use for no good purposes.
--Jimbo
--
Mark Myszak
This post has been forwarded to alt.neo-tech from the Neo-Talk Mailing List.
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From: Mark Myszak <zakin...@rocketmail.com>
Subject: Neo-Talk: Federal Reserve System
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>
> The excess reserves of $900 will result in loan expansion that
> will reach $9,000 at it's upper limit. The first loan will be for
> $900, as you've said. And, the way that loan works is as follows:
> A credit is issued to the borrower's transaction (deposit) account
> for $900, and that amount is loaned to the borrower. The bank has
> merely created a sum equal to their excess reserves and loaned it
> out. They have not loaned out their excess reserves, but continue
> to hold the original $900 in the system.
The Bank loans out the 900 really. It is expanded when it is
redeposited. I posted this in a very simple example earlier .
Let me see if I can explain this in another way.
I have 100 dollars in my pocket.
I am not going to use that 100 dollars for 100 years.
You want to use 90 dollars.
So I take 90 out of me pocket and you put it in your pocket.
Fearing theft or some other circumstance you decide to place your
90 dollars with me.
Now I have 10 dollars cash,a 90 dollar note, and 90 dollars cash.
Can This be any clearer?
Perhaps, a misunderstanding of what inflation is and where it comes
from is the stumbling point.
>
> If you think this is a fair explanation, then we are in agreement. If
> you disagree, please post the quotes which disprove my explanation.
>
>
>
> Sam
>
>
>
==
Mark Myszak
http://freecar.home.ml.org
Stop by the Mall for a free Gift
Looking for affordable Web Hosting?
http://www.adgrafix.com/info/mmyszak
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