Money creation through bank lending... help!

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CharlesHarris's picture
CharlesHarris
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Money creation through bank lending... help!

As Martenson says, this is a very difficult concept for us economic
ludites. He suggests I may have to watch a few times, but it's just not
going to help me:

You know, the example where Bob gives his $1000
to Bank A who loans $900 to Judy who gives it to Mary who puts it in
bank B, who loans $810 to Frank.... etc, until you have $10,000.

I've
seen this over and over and I just don't get it. I simply don't get
this. As far as I can tell, it's still $1000. If you replace "banks"
with "people", then it is still just $1000.

If I loan $1000 to my dad, who then loans $900 to my uncle.... that doesn't mean there is suddenly $1900!

I mean, it seems to me the dollar amounts below each person or bank are
misleading. For example, the first bank has $1000 under it. As far as I
can tell, this is the not the amount it has in its coffers, or the
amount it has given out. It is therefore the amount it owes. Now the
first guy has $900 underneath him. That makes sense, because he owes
$900. But wait! The next guy has $900 underneath him, but he was simply
paid the money by the other guy. He doesn't owe anything! See what I'm
saying?

I know I'm wrong, and I just don't understand, but can someone please explain to my why I'm wrong...

rmurfster's picture
rmurfster
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Re: Money creation through bank lending... help!

Watch this video:

Money As Debt (47 minutes):
 
Or, you can watch it broken down into 5 segments:
 
Money as Debt - Part 1:
 
Money as Debt - Part 2:
 
Money as Debt - Part 3:
 
Money as Debt - Part 4:
 
Money as Debt - Part 5:

Hope this helps,

Richard

CharlesHarris's picture
CharlesHarris
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Re: Money creation through bank lending... help!

Thanks for the tip. I've watched this before, and am watching it now again, just in case it does jog my understanding.

 

However, a simple explanation would be worth a lot more. As I posted above, it would probably be helpful to just have a ledger in which you add up all the money that comes out to $10,000. The dollar amounts shown below the icons in Marenson's video don't seem to be consistent.

 

Again, if A loans $1000 to B, who loans it to C, and so on all the way down to Z, it's still $1000!

 (this is before we get into interest, which is a separate subject).

rmurfster's picture
rmurfster
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Re: Money creation through bank lending... help!

Charles,

The problem is that A, B, and C still owe the full amount of what they have borrowed.  A owes $1000, B owes $900, C owes, $800, ....  So when all the money is paid back, it doesn't add up to $1000, but $1000 + $900 + $800 ....

Richard

CharlesHarris's picture
CharlesHarris
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Re: Money creation through bank lending... help!

Ok, can someone please carefully spell out this concept?

 

I'll try: A loans 100 to B.

 B keeps 10.

B loans 90 to C

C keeps 9.

C loans 81 to D.

D keeps 8.1.

D loans 72.9 to E.

 

STOP.

 

E has 72.9.

D has 8.1.

C has 9.

B has 10.

 

72.9 + 8.1 + 9 + 10 = 100. Together they all have 100!! WTF am I missing?

gyrogearloose's picture
gyrogearloose
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Re: Money creation through bank lending... help!

Ok. lets change some numbers.

Say we run with a fractional reserve of 90%  ( banks have to retain 90 % )

Of Bobs original $1000, Judy can only borrow $100 to give to Mary who puts it in bank B......etc

Under this  it only tallies up to $1111. not the $10,000 at 10% Fractional reserve

Not many people get to borrow under this scenario, less money floating around

Think of it not as how many notes that are floating around, but as how many times they are used.

There are just as many physical notes around, but to Judy there seems to be lots if the reserve ratio is 10% but vely little if it is 90%.

 

Now on to the NASTY part of FRB . If say at the end of the year everyone who has money at the bank decided to take out all their cash to go on holiday say ;-)  the banks would have to ask every one who they lent money to for it back.

If by some miracle all the borrowers happened to have the money because they worked hard all would be fine. 

The NASTY bit comes in if there is interest..... in that case there is not enough money, because at say 10% interest Bob for example should end up with $1100, but he can't because there are not enough notes.

CharlesHarris's picture
CharlesHarris
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Re: Money creation through bank lending... help!

I get the crazy insane infinite interest rate concept. Please let's everyone assume there is no lending at interest right now, as this is the premise of Chapter 8's example anyway.

 

I don't know.. you kind of just adjusted the fractional reserve rate there and showed a smaller amount of money creation.

 

I'm saying that I don't see money created in the first place. Money has been moved around, and there are a lot of people owing a lot of people money, but at the end of the day, it can all be unwound and you have the same amount of money.

 

Can someone please address this:

 

Ok, can someone please carefully spell out this concept?

 

I'll try: A loans 100 to B.

B keeps 10.

B loans 90 to C

C keeps 9.

C loans 81 to D.

D keeps 8.1.

D loans 72.9 to E.

 

STOP.

 

E has 72.9.

D has 8.1.

C has 9.

B has 10.

 

72.9 + 8.1 + 9 + 10 = 100. Together they all have 100!! WTF am I missing?

 

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Kjalnot
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Re: Money creation through bank lending... help!

 

Ok, imagine this.

 You give me 100 dollars, because I promise to give you 5 dollars a year as long as I can keep the 100 dollars.

 You can collect them whenever you wish. 

 What you don't know is that I have in fact given those 100 dollars to my mother.

 You perception is that you have 100 dollars (but in the bank). My mother's perception is that she has 100 dollars (the bill in her hand).

 Now there exist a total of 200 dollars in this example, from 100. 

 As long as you dont't collect your money it will work.

 

Magnify this by 1000000000000000000000 times and you will have modern banking :)

(this is not accurate, but should help you to understand)

rmurfster's picture
rmurfster
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Re: Money creation through bank lending... help!

Charles,

I'm not an economist, but I think your problem is that B doesn't loan directly to C.  Here's the scenario as I understand it:

Bank 1 loans $100 to A ($100 total loaned out)

A buys a car with the $100 loan.  The car lot deposits $100 in bank  2

Bank 2 now loans $90 to B (there is now $190 total loaned out)

B deposits $90 in bank 3

Bank 3 loans $81 to C (there is now $271 total loaned out)

...

Richard

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Reuben Bailey
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Re: Money creation through bank lending... help!

Charles,

   Take a look at my post on your other thread by this title and see if it helps.

All the best

gyrogearloose's picture
gyrogearloose
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Re: Money creation through bank lending... help!

"72.9 + 8.1 + 9 + 10 = 100. Together they all have 100!! WTF am I missing?"

 They don not "Have" the money, they have HAD THE USE of the money and now only "have" a liability or an asset

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cmartenson
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Re: Money creation through bank lending... help!

Charles,

let me try here.

The problem is that you are not adding the money up for all parties correctly.

First, it does not matter if there is an A bank and a B bank or a D,E,F,G,H,I, or J bank.  They story works exactly the same regardless of how many banks there are.  So let's just simplify this and just use one bank.  Further the bank has no other money in it as it has just opened its doors.

Step 1:  Person A deposits $1000 in the bank.  They look at their checkbook and they see $1000 in there that belongs to them. 

Step 2:  The bank, having $1000 on deposit, loans $900 to Person B who then gives it to Person C in payment for something.

Step 3:  Person C deposits that money back in the bank, looks at their checkbook and sees that they have $900.

STOP

We could continue with this for many more 'revolutions' through the cycle but we can already see the issue.

We started with $1000 but there is now $1900 in money floating around in town (person A & C's checkbook accounts added together), and $900 in bank debt owed byPerson B.

Final tally: $1900 in money and $900 in debt.

If we continue this through all the possible revolutions we would find that for every $1000 deposited, $9000 of new money can be loaned out meaning that $1,000 --> $10,000

Mathematically this is easily defined by the dividing deposited money by the reserve ratio, which was 10% in this example.  So $1,000/0.10 = $10,000

If the reserve ratio was 0.004, for example, $1,000 could be loaned into $250,000.

Why did I pick 0.004?  Because that is our current effective reserve ratio.

Hope that helped.

Chris 

CharlesHarris's picture
CharlesHarris
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Re: Money creation through bank lending... help!

Mr. Martenson, Thanks for taking the time to help me get this.

 

After "STOP":

B owes $900 to the bank.

C is owed $900 by the bank.

 [this cancels out]

A is owed $1000 by the bank.

The public has a surplus of $1000.

 

The bank, which BORROWED $1000 from A and LENT $900 to B and BORROWED $900 from C... if you replaced, borrowed/lent with minus/plus, you get -1000. The bank owes the public $1000.

 

It seems like you are not accounting for the fact that B is in the red bigtime. He paid $900 to C and owes the bank $900. If you ignore this fact, then yes, money has been created. But of course you can't ignore that! A and B look at their checkbooks and see that they have a total of $1900! Yes! But B looks at his and is $900 in the red! Money has just been moved around, and we're back with the $1000 that A brought onto the scene in the first place.

 So if we're using examples, why bother include C at all? Why not have the bank loan the $900 out to B, and have B deposit that back in the bank? The only purpose of C seems to be so that we can forget that the money was actually spent...

 

I mean, the culmination of your example seems to be A seeing $1000 and C seeing $900 in their checking account, with B $900 in the red. 

 

I can get there this way:

 

A stuffs his money in his mattress: he has $1000.

B loses a bet to C, and pays him $900.

C buries $900 in his yard.

 

These three guys are equally rich, and you wouldn't say money has been "created". 

 

Surely, there is some basic fundamental concept I am totally missing!

Reuben Bailey's picture
Reuben Bailey
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Joined: Mar 17 2008
Posts: 138
Re: Money creation through bank lending... help!

Charles,

The reason that B and C are important is that B has paid C with the money and now has to go and earn it from somewhere such as his job to pay back the bank.   This means that there are two checking accounts at the bank, totalling $1900.  If A and C were to both withdraw their money, the bank would have to pay out $1900.  The loan to B does not cancel out either of the two deposits, partly because there is a chance that B will default and never repay the loan.  

Clear as mud, right?

All the best.

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