"Fiat Money" Explained in 3 minutes

Despite every effort by governments, the gap between rich and poor continues to grow. It is now the biggest it has even been in history. All sorts of reasons for this have been proffered, but few, however, seem to realise that is a simple, inevitable consequence of our system of money and credit. This video, a shorter version of which appears in the film The Four Horsemen, explains ...
Written and narrated by Dominic Frisby
Animated by Pola Gruszka
Produced by Renegade Economist
www.fourhorsemenfilm.com
www.dominicfrisby.net
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siftbotsays...

Self promoting this video and sending it back into the queue for one more try; last queued Monday, September 26th, 2011 2:27am PDT - promote requested by original submitter blankfist.

davidrainesays...

>> ^crotchflame:

Literally everything they're harping about here is true for any medium of exchange...be that fiat money or gold.
So what is it they're calling for here?


I don't think they're calling for anything -- Simply explaining. Also, the point is that everything they point out is *not* true for any medium of exchange. The hallmark of fiat currency that makes it true is banks' ability to conjure money out of nowhere, which starts the inflationary and speculative balls rolling. With a fixed money supply, this can't happen.

crotchflamesays...

>> ^davidraine:

>> ^crotchflame:
Literally everything they're harping about here is true for any medium of exchange...be that fiat money or gold.
So what is it they're calling for here?

I don't think they're calling for anything -- Simply explaining. Also, the point is that everything they point out is not true for any medium of exchange. The hallmark of fiat currency that makes it true is banks' ability to conjure money out of nowhere, which starts the inflationary and speculative balls rolling. With a fixed money supply, this can't happen.


There's nothing about inflation or speculation that requires fiat money. You could argue that bubbles are made worse by fiat but they aren't avoided completely without them and a fixed money supply leaves you no monetary policy to readjust (this adjustment can both expand during a recession and contract to slow a bubble - which Greenspan famously didn't do). Most of the problems cited in this video are very real, but they're not directly the result of fiat but rather bad policy. It's like saying because people occasionally steer into things, cars shouldn't have steering wheels.

siftbotsays...

Self promoting this video and sending it back into the queue for one more try; last queued Monday, September 26th, 2011 2:40am PDT - promote requested by original submitter blankfist.

bmacs27says...

>> ^davidraine:

>> ^crotchflame:
Literally everything they're harping about here is true for any medium of exchange...be that fiat money or gold.
So what is it they're calling for here?

I don't think they're calling for anything -- Simply explaining. Also, the point is that everything they point out is not true for any medium of exchange. The hallmark of fiat currency that makes it true is banks' ability to conjure money out of nowhere, which starts the inflationary and speculative balls rolling. With a fixed money supply, this can't happen.


Fractional reserve banking has nothing to do with the medium of exchange. Banks have engaged in fractional reserve banking since long before the abolition of the gold standard. A better argument is that the securitization of debt (deregulation of finance) has caused massive inflation by encouraging the underwriting of bad debt by allowing the risk to be sold off.

Further, the video doesn't seem to explain that in our current system I can use my wages to purchase gold at market, and can thus use it as a store of value (if I actually believed it to be fairly valued against e.g. wages or real estate). In the government price fixing system you are proposing that wouldn't be possible, and the value of my gold would be subject to systemic risk (bad policy) just like currency is today.

marblessays...

>> ^crotchflame:
There's nothing about inflation or speculation that requires fiat money.


Huh? That's what inflation is--the expansion of the fiat monetary base. WTF are you talking about?

Without a system built on fractional reserve debt, there is no method to engage in fraudulent speculation. There is no bubble, there is no artificial expansion in debt.

NetRunnersays...

>> ^marbles:

>> ^crotchflame:
There's nothing about inflation or speculation that requires fiat money.

Huh? That's what inflation is--the expansion of the fiat monetary base. WTF are you talking about?
Without a system built on fractional reserve debt, there is no method to engage in fraudulent speculation. There is no bubble, there is no artificial expansion in debt.


Inflation is an increase in the price level, not expansion of the monetary base. That's why we have separate terms for them.

Also, "Without a system built on fractional reserve" means a world without banks.

Speculation has nothing to do with debt, or even banking. It's gonna exist as long as we have markets and contracts. Fraud will also exist as long as there is property.

And all debt is artificial, as is all money.

crotchflamesays...

>> ^marbles:

>> ^crotchflame:
There's nothing about inflation or speculation that requires fiat money.

Huh? That's what inflation is--the expansion of the fiat monetary base. WTF are you talking about?
Without a system built on fractional reserve debt, there is no method to engage in fraudulent speculation. There is no bubble, there is no artificial expansion in debt.


Inflation is a rise in general price levels. Just because the price of gold is fixed with a gold standard doesn't mean everything else is. But to be fair, inflation did tend to be lower under fixed currencies with little threat of runaway inflation and the long-run prices determined by gold mining activity. BUT this came at the cost of a more serious threat of deflation and bank runs, which you can easily argue is much worse.

What's the difference between speculation and investment? It seems people are always certain which is which after the fact, but a full reserve banking system would reduce both activities. It's a matter of degree, there are no magic bullets.

NetRunnersays...

To give a response to the video at large, I think it's intentionally trying to get people to misplace blame.

Why doesn't inflation cause wages to go up? Why do corporations get to raise prices, but labor never gets to raise the price of their labor? Is it because labor is in a weaker bargaining position?

Why is that? Could it have anything with decreased union membership?

Also, it sorta ignores the fact that the worst decade for the middle class in our lifetimes was 2000-2010, which also was a period of the lowest average inflation we've had since WWII.

Now let's get real about cui bono from inflation. If the bulk of your wealth is in assets like houses, stocks, commodities, etc, inflation doesn't hurt the real value of your holdings. Hell, in straight dollar terms, it makes your bottom line go up.

But what if you're an investment bank, and most of your wealth is comprised of debt owed to you? In this case, inflation is bad, very bad. Debts are issued in fixed dollar amounts for a fixed interest rate. Inflation means the dollars coming back into you are worth less than the dollars you doled out at the start of the loan. If inflation exceeds the interest rate you issued, you might actually lose money on the loan!

So it turns out that the bankers very seriously want hard money. If they could get away with it, they'd prefer to see deflation all the time, because that means the money coming into them is worth more than the dollars they paid out!

The only logical reason to think fiat currency might be helping redistribute wealth upwards is if you believe capitalism is a rigged game from the get go. But the answer to that isn't to get people mad at the government, it's to get people mad at the founding building block of capitalism -- banks.

marblessays...

>> ^NetRunner:

Inflation is an increase in the price level, not expansion of the monetary base. That's why we have separate terms for them.


Thanks Peabody, but I'm pretty sure everyone knows that inflation is the increase in prices. (We have separate terms for that too, you know) So... where does this increase in price level (i.e. inflation) come from...? Oh yeah, from expanding (or inflating) the fiat monetary base!

Inflation: a persistent, substantial rise in the general level of prices related to an increase in the volume of money and resulting in the loss of value of currency

>> ^NetRunner:
Also, "Without a system built on fractional reserve" means a world without banks.

LOL Says who? It may be a world without corrupt banks. If you or I can't loan money we don't have, why should a bank be able to?

>> ^NetRunner:
Speculation has nothing to do with debt, or even banking. It's gonna exist as long as we have markets and contracts. Fraud will also exist as long as there is property.
And all debt is artificial, as is all money.


Meanwhile, our system uses the power of the state to reward fraud and gambling of the largest banks and biggest corporations while extracting wealth from the poor and middle-class.

marblessays...

>> ^NetRunner:
Why doesn't inflation cause wages to go up? Why do corporations get to raise prices, but labor never gets to raise the price of their labor? Is it because labor is in a weaker bargaining position?


Mostly because wages, like all other prices, are artificially set. Better question: Why does inflation occur to begin with?

>> ^NetRunner:
Also, it sorta ignores the fact that the worst decade for the middle class in our lifetimes was 2000-2010, which also was a period of the lowest average inflation we've had since WWII.

You're sorta ignoring the fact that inflation numbers are intentionally manipulated (like excluding food and energy costs) to keep cost-of-living numbers low.
Also inflation numbers following WWII were manipulated by using tax withholding in paychecks to "mop up" excess purchasing power.

>> ^NetRunner:
Now let's get real about cui bono from inflation.


That's kinda obvious isn't it? The ones that can create money from nothing and then extract that monetary value from those that actually worked and earned their wealth.

NetRunnersays...

>> ^marbles:

So... where does this increase in price level (i.e. inflation) come from...? Oh yeah, from expanding (or inflating) the fiat monetary base!


Well, prices are set by market forces. You know, supply and demand. It's not necessarily the case that the Fed expanding the monetary base will lead to inflation.

Again, look at the last few years. Bernanke expanded the monetary base radically, but inflation has stayed low, and is on a declining trend.

>> ^marbles:
>> ^NetRunner:
Also, "Without a system built on fractional reserve" means a world without banks.

LOL Says who? It may be a world without corrupt banks. If you or I can't loan money we don't have, why should a bank be able to?


Oy. Okay, so here's how a bank works. People like you and me have some money. The bank offers to "hold" that money for us in an account, and at least used to pay us some small amount of interest on that money as incentive for us to keep our money with them.

But the bank doesn't just take our money and stick it in some vault for safekeeping, they lend that money out to other people, at a higher rate of interest than they offered us.

Problem is, we're allowed to withdraw our money from the bank whenever we want, so the bank has to keep some cash on hand (aka in reserve). However it will only keep a fraction of the total deposits in reserve, because otherwise it wouldn't be able to loan out money. That's what fractional reserve banking means.

>> ^marbles:
Meanwhile, our system uses the power of the state to reward fraud and gambling of the largest banks and biggest corporations while extracting wealth from the poor and middle-class.


I agree. Provided by "our system" you mean laissez-faire capitalism.

The banks take our savings and gamble them on risky, potentially profitable investments. That's sorta key to the functioning of capitalism though. Without that, the whole system crashes almost instantly.

NetRunnersays...

>> ^marbles:

>> ^NetRunner:
Why doesn't inflation cause wages to go up? Why do corporations get to raise prices, but labor never gets to raise the price of their labor? Is it because labor is in a weaker bargaining position?

Mostly because wages, like all other prices, are artificially set.

Artificially. You keep using that word. I don't think it means what you think it means.

Prices are set by market forces, and according to free market advocates this is perfect/moral/only way they can or could ever be set, or else we'll go to hell be socialists.

If the cost of a corporation's inputs goes up, then they raise the price of their goods. If a laborer's costs go up, why can't he raise the price of his services?

No matter what your answer to that might be, it's obviously not "because the Federal Reserve won't let employers pay their employees more."

>> ^marbles:
Better question: Why does inflation occur to begin with?


Different economic models hypothesize different answers. I tend to think the Keynesian story is right -- it's aggregate supply and aggregate demand. When you have a shift in either one that would lead to a higher equilibrium price, then you see "aggregate price" (aka the CPI) rise.

Which is to say, you can get both inflation and deflation without the Fed doing anything. To stabilize inflation, you actually need the Fed constantly adjusting the monetary base so neither inflation or deflation get out of kilter. Look at pre-1913 interest rates if you don't believe me.

>> ^marbles:
You're sorta ignoring the fact that inflation numbers are intentionally manipulated (like excluding food and energy costs) to keep cost-of-living numbers low.


Well, then don't take the government's word for it. Take the market's.

>> ^marbles:
>> ^NetRunner:
Now let's get real about cui bono from inflation.

That's kinda obvious isn't it? The ones that can create money from nothing and then extract that monetary value from those that actually worked and earned their wealth.


Now you're just repeating assertions without responding to what I'd had to say.

But I'll just echo my closing line from the last comment. I agree, if by "the ones that...extract value from that actually worked and earned their wealth" you mean any and all business owners, investors, and so on who have done nothing but collect interest on wealth they already own.

davidrainesays...

First, to my original point, a fixed money supply does not allow for fractional reserve banking -- By definition, fractional reserve banking varies the supply of money. Second, I don't remember massive inflation caused by the sale of unregulated securities, though I do remember a massive speculative bubble bursting and an economic crash.
>> ^bmacs27:


Fractional reserve banking has nothing to do with the medium of exchange. Banks have engaged in fractional reserve banking since long before the abolition of the gold standard. A better argument is that the securitization of debt (deregulation of finance) has caused massive inflation by encouraging the underwriting of bad debt by allowing the risk to be sold off.

First, I'm not proposing anything -- I was just pointing out that inflation and speculative bubbles could be largely mitigated making the supply of money fixed. Second, a fixed money supply does not presuppose (or require) price fixing, so you can still use various property as a value store.
>> ^bmacs27:

Further, the video doesn't seem to explain that in our current system I can use my wages to purchase gold at market, and can thus use it as a store of value (if I actually believed it to be fairly valued against e.g. wages or real estate). In the government price fixing system you are proposing that wouldn't be possible, and the value of my gold would be subject to systemic risk (bad policy) just like currency is today.
>> ^davidraine:
I don't think they're calling for anything -- Simply explaining. Also, the point is that everything they point out is not true for any medium of exchange. The hallmark of fiat currency that makes it true is banks' ability to conjure money out of nowhere, which starts the inflationary and speculative balls rolling. With a fixed money supply, this can't happen.

mgittlesays...

@davidraine @NetRunner @marbles

I think these videos explains it better:
http://www.youtube.com/watch?v=Dc3sKwwAaCU
http://www.youtube.com/watch?v=rCu3fpg83TY&feature=related

They're much longer and the animation is terrible, but they have better content, IMO.

As for banking without a fractional reserve system...you could have a system that utilized self-issued credit traded on an exchange. Money and credit could be based on the amount of valuable goods and services you (or a company) can provide rather than based on promises to pay back debt.

Yeah, it's the same guy's video, but you can learn about the idea here:
http://www.digitalcoin.info/

The problem with fractional reserve systems using fiat currency is their reliance on growth. It should be obvious even to children that "growth" cannot be sustained indefinitely in a closed system (the planet Earth). You can argue technology will fix our problems before nature fixes them for us, but that's gambling, IMO.

The biggest problem with growth, IMO, is a moral and philosophical one reflected by its influence on our culture. People talk about growth and progress as being some sort of universally good thing. *cough*AynRandobjectivism*cough* Growth needs to be a means to an end, not an end in itself. The problem with growth and progress being an end in itself is that we cannot have a conversation about what we're growing into or why we're even bothering to grow in the first place.

marblessays...

>> ^crotchflame:
BUT this came at the cost of a more serious threat of deflation and bank runs, which you can easily argue is much worse.


That's a false argument. You can't have deflation without first having inflation. And your argument is well we have to suffer inflation otherwise we might suffer deflation. That's illogical. Deflation is mostly good for us and bad for banks. Deflation would mean lower food and commodity prices. When a bubble pops, it's essentially canceling out that bubble's expansion of the monetary base. The realized inflation in prices is caught in an imbalance. If left to a natural correction, prices would fall and reach an equilibrium. But the government and central bank usually step in with a monetary solution to "stabilize" the economy. This is just horseshit excuse to keep the inflation from the bubble and pass on the cost to the tax payers.

marblessays...

>> ^mgittle:
The problem with fractional reserve systems using fiat currency is their reliance on growth. It should be obvious even to children that "growth" cannot be sustained indefinitely in a closed system (the planet Earth). You can argue technology will fix our problems before nature fixes them for us, but that's gambling, IMO.
The biggest problem with growth, IMO, is a moral and philosophical one reflected by its influence on our culture. People talk about growth and progress as being some sort of universally good thing. cough AynRandobjectivism cough Growth needs to be a means to an end, not an end in itself. The problem with growth and progress being an end in itself is that we cannot have a conversation about what we're growing into or why we're even bothering to grow in the first place.


You're talking about economic growth. I don't see the planet Earth being a limit like you're describing. That's more of a close-minded assumption. We've always been able to invent and innovate with the opportunity. Putting a limit on that, is denying ourselves that opportunity. Surely a 100 years ago, people never envisioned our present world. And a 100 years from now, I hope people can say the same about us.

The problem with fractional reserve systems using fiat currency is that it's fiat. Even if you could match inflation with economic growth (which you can't), you would still have an elite class collecting interest from loans of magically created cash.

marblessays...

>> ^NetRunner:
Well, prices are set by market forces. You know, supply and demand. It's not necessarily the case that the Fed expanding the monetary base will lead to inflation.

Again, look at the last few years. Bernanke expanded the monetary base radically, but inflation has stayed low, and is on a declining trend.


And price changes from an increased "supply" of currency is called inflation.

Bernanke expanded the monetary base of the US dollar (ie world reserve currency) and people all over the world are in the streets rioting over the increased cost of living. PPI in the US has gone up 7.2% the last 12 months. And if you're referring to QE, most of that money is either parked at a bank or was used to buy toxic debt (to counter deflation). But when those TRILLIONS do reach the marketplace, inflation will be realized. That's why precious metal prices have blown up. The US dollar has lost 98% of it's purchasing power against gold the last 40 years.
>> ^NetRunner:
Oy. Okay, so here's how a bank works. People like you and me have some money. The bank offers to "hold" that money for us in an account, and at least used to pay us some small amount of interest on that money as incentive for us to keep our money with them.

But the bank doesn't just take our money and stick it in some vault for safekeeping, they lend that money out to other people, at a higher rate of interest than they offered us.

Problem is, we're allowed to withdraw our money from the bank whenever we want, so the bank has to keep some cash on hand (aka in reserve). However it will only keep a fraction of the total deposits in reserve, because otherwise it wouldn't be able to loan out money. That's what fractional reserve banking means.


That's what one would presume fractional reserve banking means, but it's not.




>> ^NetRunner:
I agree. Provided by "our system" you mean laissez-faire capitalism.

The banks take our savings and gamble them on risky, potentially profitable investments. That's sorta key to the functioning of capitalism though. Without that, the whole system crashes almost instantly.

LOL. The state stepping in to reward and cover up fraud is not laissez-faire capitalism. I don't get it. You defend the system, then you try to shift blame on free market capitalism?

>> ^NetRunner:
Artificially. You keep using that word. I don't think it means what you think it means.

Prices are set by market forces, and according to free market advocates this is perfect/moral/only way they can or could ever be set, or else we'll go to hell be socialists.


There are plenty of unnatural "market forces" in our current system. Even inflation itself. Hence, prices are artificially set.


>> ^NetRunner:
Different economic models hypothesize different answers. I tend to think the Keynesian story is right -- it's aggregate supply and aggregate demand. When you have a shift in either one that would lead to a higher equilibrium price, then you see "aggregate price" (aka the CPI) rise.
Which is to say, you can get both inflation and deflation without the Fed doing anything. To stabilize inflation, you actually need the Fed constantly adjusting the monetary base so neither inflation or deflation get out of kilter. Look at pre-1913 interest rates if you don't believe me.

John Maynard Keynes on inflation: "By this means government may secretly and unobserved, confiscate the wealth of the people, and not one man in a million will detect the theft."

What you're talking about makes no sense. Prices in a market with sound money still go up and down. That's the way a market works. Calling it inflation and deflation doesn't make it so.

>> ^NetRunner:
I agree, if by "the ones that...extract value from that actually worked and earned their wealth" you mean any and all business owners, investors, and so on who have done nothing but collect interest on wealth they already own.

Maybe before you start going after people who are collecting interest on the wealth they presumably earned honestly, you will stop defending those who collect interest on money they created from nothing. Deal?

mgittlesays...

@marbles

I agree with your assessment of fiat currency, I guess I think the problem runs deeper because I'd rather not just gamble and assume technology will save us from ourselves.

There are quite a few problems with going back to a fixed-supply currency. Maybe I'm not studied up on all the current real-world solutions for moving back to the gold standard or whatever other flavor one might advocate, but gold can be debased, bars can be shaved, currency can be hoarded...the list is fairly long.

That's why we need a value-based monetary system rather than a debt-based one.

NetRunnersays...

>> ^marbles:

And price changes from an increased "supply" of currency is called inflation.


Before I get into the rest of what you said, I want to just highlight this part because it's an example of the root problem with your entire reply.

You seem to have this habit of making tautological arguments that hinge on asserting that the premise you wish to prove is baked into the very definition of some word, and therefore you don't need to actually make an argument for said premise.

I've been here with you before, about a word whose definition is much fuzzier than inflation (liberty), but now you're doing it with a word whose definition is very specific, and clearly does not contain the premise you want it to contain.

This is also my answer to your disagreement about the meaning of fractional reserve banking.

This is also my answer to your disagreement about what modern-day Keynesian monetary theories say. I'll also add that your quote isn't a Keynes original, it's Keynes quoting Vladimir Lenin.

As to your very last bit, you have a funny idea of what "earned honestly" means. Supposedly you resent banks gambling with our savings. Did they honestly "earn" our savings?

NetRunnersays...

>> ^mgittle:

The problem with fractional reserve systems using fiat currency is their reliance on growth.


I haven't watched the documentary you linked, but the only part of what you said I'd really contest is this part.

How is fiat currency reliant on growth?

Perhaps you meant it the other way around -- that fiat currency is just one more tool that's used to cajole the human race into participating in this "growth" whose value has become increasingly dubious?

That's how I see it, at least on the days when I see the face and not the vase. Most days I still see markets and capitalism as a positive net influence on the welfare of the human race, but their most fervent advocates sure do work hard at making me think otherwise.

crotchflamesays...

>> ^marbles:

>> ^crotchflame:
BUT this came at the cost of a more serious threat of deflation and bank runs, which you can easily argue is much worse.

That's a false argument. You can't have deflation without first having inflation. And your argument is well we have to suffer inflation otherwise we might suffer deflation. That's illogical. Deflation is mostly good for us and bad for banks. Deflation would mean lower food and commodity prices. When a bubble pops, it's essentially canceling out that bubble's expansion of the monetary base. The realized inflation in prices is caught in an imbalance. If left to a natural correction, prices would fall and reach an equilibrium. But the government and central bank usually step in with a monetary solution to "stabilize" the economy. This is just horseshit excuse to keep the inflation from the bubble and pass on the cost to the tax payers.


Netrunner's already pointed this out, but this is special pleading. You say that prices go up and down in the market with a fixed currency, but that's not inflation because inflation is expansion of the money supply. You're saying that inflation only happens under a fiat system, therefore a fiat system is the only way we can have inflation. It's not very interesting. Inflation can only be measured as an aggregate of general prices, like the billion prices project. If all the prices are going up, that's inflation; down, that's deflation. Arguing which came first is a chicken and egg question.

The rest of what you say doesn't address the link I gave to why deflation is worse.

mgittlesays...

>> ^NetRunner:

>> ^mgittle:
The problem with fractional reserve systems using fiat currency is their reliance on growth.

I haven't watched the documentary you linked, but the only part of what you said I'd really contest is this part.
How is fiat currency reliant on growth?
Perhaps you meant it the other way around -- that fiat currency is just one more tool that's used to cajole the human race into participating in this "growth" whose value has become increasingly dubious?
That's how I see it, at least on the days when I see the face and not the vase. Most days I still see markets and capitalism as a positive net influence on the welfare of the human race, but their most fervent advocates sure do work hard at making me think otherwise.


Yeah, well put rearding the "fervent advocates". I did kind of mean it the other way around. Thank you for actually taking a second to understand my meaning rather than arguing literal points only (the literal-only thing being my definition for nerdiness).

It's not fiat currency alone that makes our economy reliant on growth. I should have been more specific, but such is life when you have to get to sleep...haha. Fiat currency just a part of the whole Fractional Reserve banking + legal tender law + fiat currency system. In my mind, the growth thing is probably tied most to the fractional reserve system. Hopefully none of this sounds condescending because I'm not sure how much of this you already know, but here's my understanding:

Because the money supply is variable and dependent on debt, an expanding economy is extremely good and a contracting one is extremely bad. Because banks are allowed to loan more money than they possess *and* charge interest, you run into a problem. Where do individuals get the money needed to pay the interest on their loan if it was created from nothing? You have to get it from the overall money supply, which is made up of money created by banks from other peoples' promises to pay.

Thus, with every new credit card swipe, mortgage signing, etc, more money is owed to banks than actually exists at any given time. It's only the time lag between borrowing and repayment that keeps the entire system from collapsing. This means that unless the total amount of debt continually increases at a sufficient rate, it's impossible for everyone to succeed in paying back their loans...there must be foreclosures. This is why people constantly get offers of new credit, *and* why recessions are such a bitch. It's very hard to get things growing again after the money supply decreases.

The system is also one in which individuals paying off debts have more money (less income goes to paying interest), but everyone paying off their debts leaves society with no money. Therefore, anyone who pays off their debt to increase their own personal financial security actually hurts the overall economy. It makes no sense for markets to rely on rational individuals' decisions if their individual decisions are bad for the economy in aggregate. For this reason alone, the system is extremely fragile.

Hope all that makes some sort of sense. Maybe I'm wrong in parts. I'm partially regurgitating the videos I linked earlier while adding in stuff I've learned from other sources. I've nor heard anyone refute the premise of the video, but I'm sure it's not infallible in its interpretation. I'd love to hear what other people think. It got sifted long ago but there was little discussion.

As for your comments about markets being a net positive, I don't disagree with you at all. It's when people rely on markets to solve every problem (including moral ones) and don't realize that there are some places markets ought not go that there becomes a problem. (Should courts enforce a custody contract between an infertile couple and a surrogate mother? ...and and endless list of other similar questions)

NetRunnersays...

@mgittle I think we agree in the broad strokes, and overall conclusion, but I think you have some of the minor details wrong.

You and others here have asserted that banks can "loan out more than they have". This is false, according to everything I've ever read or seen happen in my own work life (in financial services).

Here's my own version of a logical proof. If I want to take out a loan from the bank to buy something, the bank actually has to give real money to someone. But, the Federal Reserve is the only agency that can create dollars legally. Therefore, the bank must have enough dollars in some account in order to pay out the initial loan amount, or it can't issue the loan.

So where do banks get the money to lend out? Well, for a traditional bank, it comes from the checking and savings accounts of regular people, as well as out of capital accumulated from profits. This is that "some account" whose name is actually the bank's "reserve account" at...the Federal Reserve. To cover withdrawals from those savings accounts, banks are legally required to keep a fraction of their total capital in reserve -- hence the name "fractional reserve banking".

So, how does the Fed inject new money into the economy? It anonymously buys government bonds from banks, using freshly created money. What if the Fed wants to take money out of the economy? Well, it sells government bonds, and destroys the cash it gets in return for the sale. No physically currency really gets created or destroyed, of course, it's just adding and subtracting numbers from the relevant reserve accounts.

Here's wikipedia's explanation of the Fed's monetary policy process, which is more detailed and authoritative than mine.

You also make the case that paying off debt hurts the economy because it shrinks the money supply. That's true! Which is why right now the economy is seriously in need of the Fed expanding the monetary base. Right now everyone's trying to pay down their debts (deleverage, in the financial lingo), and it's sucking all the money out of the economy. The Fed needs to work overtime to pump more money into the economy to take up the slack. Unfortunately, the banks have been wanting to keep way more than their usual in reserves -- they aren't loaning out the money the Fed is creating, they're just piling it up in their account at the Fed.

Because of that, it's never leaving the building, much less entering into the economy where it might potentially cause inflation. That's why I've been trying to tell marbles that monetary base expansion != inflation...they're two different terms for a reason!

It's also why I think abolishing the Fed or returning to a gold standard just makes things worse for everyone. One can argue that the Fed is pursuing the wrong monetary policy (for exmaple most liberal economists say it's been too timid about expanding the money supply), but this whole attempt to make the whole seem like some sort of illegitimate scam grates on me.

Without the Fed trying to expand the monetary base, you'd get something like 20% unemployment, and outright deflation, rather than just a low and declining rate of inflation.

mgittlesays...

@NetRunner

See, that is indeed where our understanding differs. Any bank may create money, not just the Federal Reserve. The Fed is the only agency that can literally create it from nothing. All other banks in the system create demand for it based on the fractional system. They may only loan money based on the reserve ratio.

So, yes, banks want depositors because the amount of loans they can issue (and therefore the amount of incoming interest they can collect, which further becomes more money they can lend) is partly based on deposits. But, as your Wikipedia link points out in #6 of the process, "when a loan is granted, the person is generally granted the money by adding the balance to their bank account." They don't mean "instead of giving them cash or gold". They literally mean "granted the money"...the money is created in their account. Money which did not exist prior to the loan agreement.

So the bank gives you $10,000 while holding $1000 in reserve (10% reserve requirement). The bank also creates a $10,000+interest hole for you to fill and generates a monthly payment bill. At no point did the bank have $10,000 to give to you...as in, if you marked every dollar in the economy with a serial number dependent on who created it, they would all say "i was created by the Fed at the request of bank XYZ to pay out loan money to someone because they don't have it on hand". When you pay back your loan, the bank destroys the "hole" it created for you, but keeps the interest on the bank's balance sheet.

When someone cashes your $10,000 check, the bank then transfers $10,000 to that person's account, but that $10,000 is available partially because of deposits and partially because of incoming interest payments from people with outstanding loans...or other bank profits from investment or whatever. If the bank has $1M on deposit, they can create $10M in loans TODAY, and if each of those people all request cash immediately, the bank will not have it on its balance sheets. But, the Fed is allowed to create cash from nothing to pass on to the bank for the purpose of fulfilling these withdrawal requests. Yes, it does seem incredible. Yes, this is why people don't like fractional reserve banking.

So, even though the Fed is the one supplying the actual cash, it is the banks who are creating the demand for the newly created money. This is how banks loan more than they have...based on how much they have on depost with the local (or central, in the case of commercial banks) Federal Reserve branch.

We're saying a lot of the same things, but there is a difference.

EDIT: this is also the reason I belong to a credit union

NetRunnersays...

@mgittle I don't dispute that we have different understandings, I dispute your insistence on saying your understanding is superior.

Think about the kind of accounting banks have to do.

Where in there is the line item where they can just erase a number and write a new one at will?

If a bank with no money gets a $1,000 deposit, it can loan out $900, and keep $100 in reserve. That's still creating money, because on paper, the depositor still has his $1,000, and so does the guy who took out a $900 loan.

But if that depositor needs to withdraw even a single cent, that bank is going to have to borrow money from someone. If it can't, then the bank is going to die...well, at least get restructured by the FDIC.

If private banks could just literally create money out of nowhere, it'd be impossible for them to ever run out of money. They also wouldn't need to take deposits, or borrow money, or loan money, they could just print it and pay it out to their shareholders...

mgittlesays...

@NetRunner

I don't think I'm trying to say my understanding is superior...at least not in terms of how things actually work. I don't work at a bank, and I only learn about monetary systems in my spare time to educate myself, so if I don't understand how something works I'd like to be corrected.

What we're obviously free to differ on is our interpretation of the effects the system has. Reading your posts here and on other video threads as well as seeing your videos leads me to believe there isn't a whole lot of difference.

So, I think when people say "banks create money", they're either ignorant and parroting something someone else said or simplifying the system to save a ton of words. If the bank in your latest example can't satisfy withdrawal demands, it probably borrows money from a commercial bank, which can request money from the Fed to cover the difference. The private bank is still liable for it, of course, but it allows them to pay it back gradually (as originally planned). If the Fed deems it necessary, it creates new money and supports the system with it. So, yes, the bank is not literally creating the money on its own, but it seems to me that banks granting loans for more money than they possess at any given time is the most significant reason for the Fed to have the ability to increase the money supply. So, while they're not literally the ones creating it, the process is the *reason* for its creation. Tough to separate.

So, I'm not saying individual banks are balance sheet wizards, but they are a big reason we have a magical money system. It's that money system that requires constant growth to function well as I talked about earlier.

These two videos are far shorter than the ones I linked earlier (around 8min each)...they show that it's possible to imagine workable systems of credit that aren't reliant on debt and interest the way our current system is. Systems that don't have the fragility of our current one...

http://www.digitalcoin.info/The_Essence_of_Money.html
http://www.digitalcoin.info/Digital_Coin_Introduction.html

NetRunnersays...

>> ^mgittle:

If the bank in your latest example can't satisfy withdrawal demands, it probably borrows money from a commercial bank, which can request money from the Fed to cover the difference.


Change the word "request" to the word "borrow" and that's correct.

>> ^mgittle:
So, yes, the bank is not literally creating the money on its own, but it seems to me that banks granting loans for more money than they possess at any given time is the most significant reason for the Fed to have the ability to increase the money supply.


Again, banks aren't granting loans for more money than they posses. In the example above, they have $1,000, they can loan out $900, because they're legally required to hold 10% reserves.

Now, their balance sheet shows the following:

+$100 cash on hand as reserves
-$1000 owed to depositor
+$900 in debt owed to them by borrower
+$X in interest on debt owed to them by borrower

Which nets out to +$X interest in net worth.

There are two big risks with this arrangement:

#1: The depositor wants to close his account before the loan matures. The bank doesn't have the money to cover the withdrawl, and will need to borrow funds from another bank. If the borrowing costs are higher than the expected return from its loan, the bank is insolvent, and is gonna die. On conventional banks, the government will step in and cover the depositor's accounts up to some arbitrary dollar amount (I think it's still $250k), but the bank owners will be fired, and they'll seek out someone else to buy the bank and take over future operations.

#2: The borrower defaults on his loan. Since we're talking about only 1 depositor and 1 borrower, this single failure is the equivalent of 100% of the bank's borrowers defaulting at once. This too will result in the government stepping in, covering depositor's accounts, and restructuring the bank and selling them off.

What happened with the US financial crash was that a big, non-insured bank (Lehman Brothers) got hit by scenario #2, and since it was not a traditional, FDIC-insured bank, they just let it go bankrupt, and let the investor accounts get wiped out.

That started a panic, and led to lots of people pulling money out of other similar banks, leading to widespread cases of #1 happening, which had the effect of making banks default on loans they'd taken out with other banks, starting a new wave of #2...

That's why this system is fragile, and none of this has anything to do with monetary policy yet. This is all fiscal and regulatory policy.

What happened was that even after TARP stopped that domino effect of #2 leading to #1 leading to #2 again, banks were worried that all debt was much risker than they'd formerly believed, and so they raised the costs of borrowing (the interest rate) to sky-high levels, which severely curtailed the amount of people borrowing money to invest in real-world business activity.

That drop in investment led to a drop in production, which led to a drop in employment, which led to a drop in consumer demand, which led to a drop in production...

So now, the Fed is stepping in with monetary policy, and trying every trick in the book to stuff the banks with reserves, so they'll lower interest rates. They've had some success, but it isn't really doing the whole job, because unemployment is already so high, and consumer spending is so low, nobody wants to invest in expanding their business, no matter how cheap borrowing costs are...

That's what monetary policy is really about, stabilizing the interest rates and the overall flow of goods and services in the economy. When the economy slows, the Fed pumps money into the economy to try to make it go again. When it starts overheating (and leading to inflation), it siphons money out of the system to slow it down a bit.

Fiat currency doesn't really depend on growth -- if anything, growth depends on fiat currency, and the application of good monetary policy.

mgittlesays...

@NetRunner

I think the difference in our concept of what's going on is that my understanding is that commercial banks can make a reserve deposit at any Fed branch and then make loans against that. From what I can tell, there isn't any math done like you're describing. Maybe if you want to make a new bank or long ago when some of these banks were created there was math like that, but there isn't anymore. There is simply a minimum number required to have on reserve deposit or in vault cash compared to how much you have loaned out. This is all not to mention that there are types of deposits which have exceptions to the reserve requirement. That alone makes sure banks are loaning more than they have (if they want to take the increased risk).

http://en.wikipedia.org/wiki/Reserve_requirement#United_States

I mean, if putting $100 in a Fed reserve bank and loaning out $900 based on someone's promise to pay isn't creating money, I don't know what is. You don't have to start out with $1000 to make the $900 loan once you're already a commercial bank. That's the point. If you make money on some investment, you can make loans and collect interest against your increased profits. You don't have to have the money and then hold 10% back. (Glass-Steagall, anyone?)

Plus, the money that comes in as interest is money that never existed in the money supply before the loan was created. Someone else has to borrow money to pay you in order for you to be able to pay your interest. This is why growth is required to pay interest and avoid foreclosure and default. If the money supply does not increase and more people aren't promising to pay interest, other people won't be able to fulfill their promises to repay. That's why the system requires growth to function well.

Legal tender law and fiat currency make sure that everyone must participate in the system at some point, or your contracts won't be protected by the courts and you won't be able to pay your taxes, since both only deal in dollars.

NetRunnersays...

@mgittle I'm sorta at a loss of what more to say to you. I've linked you a few places where they do out the math of how fractional reserve banking works where they show the $100 deposit results in $90 in loans, not $900.

Nothing you've linked me has challenged that premise, they've just said that this ultimately means banks will wind up with $90 in loans with only $10 in reserve, but that means they're holding $100 in deposits, not $10.

Again if banks could create money, why bother with loans & interest? Why bother keeping track of reserves, or account balances?

And interest collected doesn't reduce the money supply. Banks don't destroy the dollars they collect in interest, they either use it to pay salaries, or the shareholders, or they loan it out to earn more interest. In all of those cases, the money goes right back into circulation, and doesn't affect the money supply.

mgittlesays...

@NetRunner

I never said banks create money from nothing. They are allowed to grant someone money based on their promise to pay it back.

You're making it sound like I'm saying banks can just literally add money to their balance sheets. That is not what I'm saying.

I never said interest collected reduces the money supply. Collecting principle does. When you finish paying back a debt, the bank zeroes out the debt associated with that loan, which removes the money from the system. The interest is left over and that is what increases the money supply.

Banks bother with loans because the promise someone makes when they sign on the dotted line is the only thing of actual value in the entire system: The lender's trust and the borrower's promise. You must have that promise in order to create the money. You don't just add numbers to your balance sheet because you feel like it unless you're trying to commit fraud.

There's a difference between central bank money and commercial bank money. It's the fact that money lent out by one bank can be deposited at another bank, and that bank can make loans based on that deposit, which has not been repaid to the original bank yet. It's called re-lending. So, while each bank is not literally creating money on their balance sheets, the total aggregate interest repaid to the system is constantly increasing the money supply because that interest never existed when the process began.

I haven't been explaining it very well. Look, it's not the individual bank that's creating the $900 from $100 in deposits, it's the system overall...when you add up all the loans created by the initial $100 in Fed deposits. The ratio of publicly held money vs. Fed deposit reserves is what's important.

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

specifically:
http://en.wikipedia.org/wiki/File:Fractional_reserve_lending_varyingrates_100base.jpg

The graph shows it well. The $900 number is an approximation of the actual number, which can be obtained from the geometric series.

You can also read this document produced by the Chicago Fed branch:
http://en.wikisource.org/wiki/Modern_Money_Mechanics/Bank_Deposits%E2%80%94How_They_Expand_or_Contract

Specifically, the part where it says "...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 $9,000..."

NetRunnersays...

@mgittle okay, it sounds like we were mostly misunderstanding each other then. I pretty much agree with everything you said in the last post.

The only thing I'd point out is that the quote you cite from Modern Money Mechanics is right, but you're leaving out what happens after that in the process:

The lending banks, however, do not expect to retain the deposits they create through their loan operations. Borrowers write checks that probably will be deposited in other banks. As these checks move through the collection process, the Federal Reserve Banks debit the reserve accounts of the paying banks (Stage 1 banks) and credit those of the receiving banks.

Whether Stage 1 banks actually do lose the deposits to other banks or whether any or all of the borrowers' checks are redeposited in these same banks makes no difference in the expansion process. If the lending banks expect to lose these deposits - and an equal amount of reserves - as the borrowers' checks are paid, they will not lend more than their excess reserves.

Which is what I was getting at. A single bank that gets a $10,000 deposit, can't turn around and make $100,000 in loans itself. It loans out $9,000, and when that principal gets deposited in another bank, it can loan out $8,100, and so on and so forth.

With enough loan/deposit iterations, it can end up being as much as $100,000 in additional money in circulation, but like you said repaying the principal destroys that money again.

I'd also point out that all of the above would create money even if your currency is on a full gold standard.

But I guess before we go down that road, I probably should just ask you to elaborate a bit on your thoughts about the relationship between growth and fiat currency.

Like, what do you mean by "growth"? Increase in GDP? If GDP falls, how does that threaten the existence of fiat currency?

By my reading of economics, a shrinking economy is called a "recession", and that's exactly when modern economics says we should take advantage of the fact that we have fiat currency and use it to increase the money supply to spur growth.

bmacs27says...

Okay, explain how this magical fixed money system works? What would be used to fix the money supply? How could we ensure that people don't decide to keep their money in banks, where the banks can issue "bank notes" which people then use as surrogates for your fixed money supply? When we had a specie backed currency, these problems still existed.

Also, yes, the derivative securities market is the largest driver of inflation out there at the moment. Many estimates put the value of all these unregulated securities (that's right, poof, I have money, securities) at around $600 Trillion dollars. Makes our debt seem kinda trite doesn't it?

>> ^davidraine:

First, to my original point, a fixed money supply does not allow for fractional reserve banking -- By definition, fractional reserve banking varies the supply of money. Second, I don't remember massive inflation caused by the sale of unregulated securities, though I do remember a massive speculative bubble bursting and an economic crash.
>> ^bmacs27:

Fractional reserve banking has nothing to do with the medium of exchange. Banks have engaged in fractional reserve banking since long before the abolition of the gold standard. A better argument is that the securitization of debt (deregulation of finance) has caused massive inflation by encouraging the underwriting of bad debt by allowing the risk to be sold off.

First, I'm not proposing anything -- I was just pointing out that inflation and speculative bubbles could be largely mitigated making the supply of money fixed. Second, a fixed money supply does not presuppose (or require) price fixing, so you can still use various property as a value store.
>> ^bmacs27:
Further, the video doesn't seem to explain that in our current system I can use my wages to purchase gold at market, and can thus use it as a store of value (if I actually believed it to be fairly valued against e.g. wages or real estate). In the government price fixing system you are proposing that wouldn't be possible, and the value of my gold would be subject to systemic risk (bad policy) just like currency is today.
>> ^davidraine:
I don't think they're calling for anything -- Simply explaining. Also, the point is that everything they point out is not true for any medium of exchange. The hallmark of fiat currency that makes it true is banks' ability to conjure money out of nowhere, which starts the inflationary and speculative balls rolling. With a fixed money supply, this can't happen.


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