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Roger Breedlove
climber
Cleveland Heights, Ohio
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John, your description of the difference of how to think about he the source of money borrowed or money in a cookie jar seems apt. I can think of some complications. Let's say that I have a CD locked up in a 2 year deposit and I need some cash now. My bank agrees to loan me the money I need for my trip to the Nose 50th reunion in exchange for first rights to that CD. Now I have a loan backed by money that I have already earned. As a practical matter asset backed lending always ‘shows’ net positive assets balance. Of course this is the issue that the Fed and the Treasury are trying to figure now—the mortgage backed securities supporting the banks balance sheets are no longer believed since the default rate on the underlying homes is higher and anticipated.
Anyway just an example to show why I think that it is really important to deal with the actual issues at hand—too much leverage relative to assets—rather than definitions.
I cannot see any connection to the gold standard for valuing money and the leverage issues with loaning out money. Banks have been loaning out more than they owed to depositors long before we went off the gold standard.
I also think that there is no straight forward connection between inflation and reserve requirements. If borrowed money is invested well and is repaid, there is no reason to think that it will cause inflation or not cause inflation. If the investments are bad, it can go either way. In the dot com boom, many investments were made with borrowed money and went bust, but with the excess supply of hardware and cable, the prices have stayed low. For sure the amount of investment gets tangled up with inflation and future price expectations, but I don’t think it is clear cut, especially in a global economy.
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Roger Breedlove
climber
Cleveland Heights, Ohio
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Karl, didn't you repeat an earlier post? Are you old enough to repeat yourself or are you just fooling with me?
Anyway, I don't think that your five points are incorrect. But I think that it is more important to answer the question "so what?"
I don't think there is anything wrong with any of the conditions that you outline in your five statements. What is wrong is to create more debt than the future can repay or to create assets to support loans that cannot be easily understood, which is just another way of saying the same thing.
By the way, given the statements made by just about everyone on the reasons for and short and long term solutions to the current credit crisis, I absolutely agree that it is worth hashing these things out. It is hard enough when you have a solid understanding of how finance works.
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John Moosie
climber
Beautiful California
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" If borrowed money is invested well and is repaid, there is no reason to think that it will cause inflation or not cause inflation."
Roger, the inflation is created by having more money in circulation then goods, thus prices go up. The federal reserve by law can buy federal securities with money it does not have. This is a creation of extra money. This extra money then goes into the system which increases the money supply thus creating inflation. Then the federal reserve tightens money supply thus making a boom and bust cycle.
This video explains it fairly well.
http://video.google.com/videoplay?docid=-466210540567002553
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John Moosie
climber
Beautiful California
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The so what is that we are making a group of people extremely wealthy just for printing money and managing some loans. They have virtually no risk because the government guarantees the loans, plus they have little of their own money involved because by law they can create whatever money they need. We call this the federal reserve.
This creates inflation which is a form of taxation. A hidden tax, but never the less a tax that the little guy pays without realizing what he has done.
The video explains it better then I can.
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Karl Baba
Trad climber
Yosemite, Ca
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Topic Author's Reply - Oct 2, 2008 - 04:45pm PT
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Roger writes
"What is wrong is to create more debt than the future can repay or to create assets to support loans that cannot be easily understood, which is just another way of saying the same thing."
The words are tricky above because, as the links have shown, our system is based on debt. The federal debt can never be repaid without a huge pile of debt existing in the private sectore. If all debts were repaid everywhere, all the money would disappear completely (hard to imagine but true)
Lois
"As much as I respect you as a person, you ARE given to having very negative and panicked views of everything."
Sad that we've never met Lois, You should have come to the facelift. I've free soloed many 1000 foot faces. I'm not a panic-kind of guy, and most people think I'm the happiest person they know, and they are right.
Fatty
to Paraphrase Bob Marley...No Job, No Cry
Sitting in some reserved seat sound great but unless I get to just collect money for nothing like that FEMA director, I'm not game, but thanks
Peace
Karl
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Karl Baba
Trad climber
Yosemite, Ca
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Topic Author's Reply - Oct 2, 2008 - 05:03pm PT
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I'll take those benjis Fatty but I might need a bailout later...
;-)
Karl
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yossarian
climber
WA
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On banks "lending money they don’t have":
Banks are created and run by ordinary people. They aren’t charities, but exist in order to make a profit for their owners. If banks were required to keep all deposits on hand, they couldn’t exist in their current form.
US policymakers have concluded that it is in the country’s best interest to guarantee deposits (not the banks themselves). The benefits to society of having reasonable assurance in one’s financial institution outweighs the cost of having to provide such guarantees.
In a completely laissez-faire system, banks would have zero reserve requirements.
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yossarian
climber
WA
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“The so what is that we are making a group of people extremely wealthy just for printing money and managing some loans. They have virtually no risk because the government guarantees the loans, plus they have little of their own money involved because by law they can create whatever money they need. We call this the federal reserve.”
John,
Member banks receive a relatively low 6% return on shares in the Fed, the rest (over 98%) of the profits are returned to the US Treasury. There are better ways for corporations to earn a profit then buying shares in the Federal Reserve.
As for profits derived “just from managing loans”, banking is fairly competitive and profits don’t seem out of line compared to other industries.
Furthermore, how do you conclude banks operate in a “virtually no risk” environment?
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Karl Baba
Trad climber
Yosemite, Ca
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Topic Author's Reply - Oct 2, 2008 - 06:34pm PT
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"In a completely laissez-faire system, banks would have zero reserve requirements."
From
http://en.wikipedia.org/wiki/Reserve_requirement
"Western central banks rarely alter the reserve requirements because it would cause immediate liquidity problems for banks with low excess reserves; they prefer to use open market operations to implement their monetary policy. The People's Bank of China does use changes in reserve requirements as an inflation-fighting tool,[3] and raised the reserve requirement nine times in 2007. As of 2006 the required reserve ratio in the United States was 10% on transaction deposits (component of money supply "M1"), and zero on time deposits and all other deposits."
Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81. As the process continues, the banking system can expand the change in excess reserves of $90 into a maximum of $900 of money ($90+81+$72.90+...=$900). In contrast, with a 20% reserve requirement, the banking system would be able to expand the initial $100 deposit into a maximum of $500400 ($80+$64+$51.20+...=$400). Thus, higher reserve requirements should result in reduced money creation and, in turn, in reduced economic activity."
Since the reserve is Zero on time deposits and other deposits, I imagine they can create a lot more money with those deposits. I think this illustration also shows that banks indeed loan money they don't have. This doesn't mean we're saying they have $100 but loan $90 out. They have $100 and loan $900! as in the example above. Easy to see how that leverage can get you caught short in hard times, particularly given what we see below.
and from
http://acheson.wordpress.com/2008/02/02/loopholes-swallow-bank-reserve-requirements/
"..But these days it seems that’s an old-fashioned passe attitude. In actuality, banks are able to avoid the reserve requirements to an amazing extent. That way they can devote much more of your deposit accounts to suprime lending!
Curious exactly how its done? The FDIC (which is funded by the banks) published a study explaining it. Among other techniques, banks are using ”sweeping” rules to decrease the amount of cash reserves they must actually hold. One bank “successfully” used sweeps to “reduce its required reserves from $788,000 in August 2000 to $48,000 in August 2001, a period when deposits at the institution rose by $36 million...”
But that certainly isn't enough, The mortgage mess didn't happen until cheap gimmicky mortgages got sold to folks who couldn't afford them and then repackaged them into even riskier securities.
Complicated but figuring out if there's any intergrity in the rescue process is even harder. It's "trust me" but the fact is, the guys organizing the bailout are all multi-millionaires from this very process that they are supposed to regulate, and may choose to value their peers over common people.
Peace
karl
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immanti
climber
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Good thread Karl.
The monetary system is at the root of the current "crisis" and many people saw it coming. Peter Schiff for one. Unfortunately, none of those people are currently involved in trying to fix the problem. Ron Paul has, imo, a good understanding of the issues as well. He has been giving the Fed a hard time for quite a while.
There are many practical problems that come from gov't enforced fiat, but the most dangerous effect may be the insidious way in which it eliminates personal freedoms.
I would recommend that anyone who wishes to understand these issues read a few books, including:
"The Creature from Jekyll Island" by G. Edward Griffin
"Capitalism and Freedom" by Milton Friedman
"The Road to Serfdom" by F.A. Hayek
"Capitalism: The Unknown Ideal" by Ayn Rand
and anything by Ludwig Von Mises.
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TradIsGood
Chalkless climber
the Gunks end of the country
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:-)
Now that you have had fun with this concept, try to wrap your wits around the role that foreign central banks and commercial banks can play.
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Karl Baba
Trad climber
Yosemite, Ca
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Topic Author's Reply - Oct 2, 2008 - 08:45pm PT
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From the wiki on it
"The US debt in the hands of foreign governments is 25% of the total[33], virtually double the 1988 figure of 13%.[34] Despite the declining willingness of foreign investors to continue investing in US-dollar–denominated instruments as the US Dollar has fallen in 2007,[35] the U.S. Treasury statistics indicate that, at the end of 2006, foreigners held 44% of federal debt held by the public.[36] About 66% of that 44% was held by the central banks of other countries, in particular the central banks of Japan and China. In total, lenders from Japan and China held 47% of the foreign-owned debt.[37] This exposure to potential financial or political risk should foreign banks stop buying Treasury securities or start selling them heavily was addressed in a recent report issued by the Bank of International Settlements which stated, "'Foreign investors in U.S. dollar assets have seen big losses measured in dollars, and still bigger ones measured in their own currency. While unlikely, indeed highly improbable for public sector investors, a sudden rush for the exits cannot be ruled out completely." [38]
In 2006, the central banks of Italy, Russia, Sweden, and the United Arab Emirates announced they would reduce their dollar holdings slightly, with Sweden moving from a 90% dollar-based foreign reserve to 85%. [39] On May 20, 2007, Kuwait discontinued pegging its currency exclusively to the dollar, preferring to use the dollar in a basket of currencies.[40] Syria made a similar announcement on June 4, 2007"
The dollar is in trouble and another 700 billion won't help it. I can' understand why foreign countries invest in our debt which pays peanuts. Why get a %4 bill when the dollar devalues 30-40% over that same period. Must be a political game.
We have a fiat money system but some folks say that because oil is almost always been required to be purchased in dollars that the dollar was basically supported by that need. This is changing and it's anybody's guess what effect that will have on us, particularly as peak oil approaches.
Trying this topic of housing/central banks/oil and the dollar together is this article that I posted two years ago. The locals here called me a conspiracy theorist for posting it but it contained some wisdom that has proved itself since that time.
http://tinyurl.com/hjn5a
May 4, 2006
"....The Federal Reserve has engineered many similar coups, the most impressive being the huge stock market bubble of the late 1990s. Greenspan kept the cheap money flowing into the Wall Street casino (and refused to even increase marginal rates on stock purchases) while PE’s skyrocketed and the bubble expanded to Hindenberg proportions.
Following the explosion, which left tens of thousands of Americans stripped of their retirement and savings, Greenspan breezily noted that it is not the task of the Fed to stop bubbles.
Really? The European Central Bank (ECB) takes an entirely different tack, intervening whenever it is clearly in the public interest. Greenspan’s recalcitrance has nothing to do with principle; he was simply acting on behalf of constituents in the investment community.
Currently, the Fed has created the largest equity bubble of all time; the $9 trillion housing bubble, slapped together over the last 3 years by lowering rates to an unbelievable 1.5% (at one point) and facilitated through shabby lending practices. As rates continue to rise to satisfy America’s need for $2 billion cash inflows from foreign lenders every day, the carnage from the housing-bomb is bound to be extensive and agonizing. .."
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John Moosie
climber
Beautiful California
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"Member banks receive a relatively low 6% return on shares in the Fed, the rest (over 98%) of the profits are returned to the US Treasury. There are better ways for corporations to earn a profit then buying shares in the Federal Reserve"
Yos...You are going to have to back that up because that isn't my info.
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JEleazarian
Trad climber
Fresno CA
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I promise this is my last (perhaps exasperated) post on this subject.
Before most of you were born, there was the cartoon precursor of The Simpsons -- Rocky & Bullwinkle [No, not our Bullwinkle]. One of their characters was an empty-headed hero named Dudley Do-Right. In the words of Dudley "But it's in the newspaper, so it must be true."
Just because it's in Wikipedia, or any other web site, does not make it true. The fractional reserve banking system has existed at least since antiquity (see, e.g., Matt. 25:27 -- that passsage would be incomprehensible to the ancients who wrote and read it unless the bank loaned out some of its funds. Otherwise, how could it pay interest? As soon as it loans out any funds, it has only fractional reserves).
If you're sufficiently open-minded, you might want to read Milton Friedman's Monetary History of the United States. The data there demonstrate that the Fed has no problem controlling the money supply, despite the dire-sounding allegations on this thread.
I've been accused of not offering evidence to support my position. The American and world economies since the 1930's support my position. Yes, an occasional financial institution fails, and certainly investment banks (as opposed to commercial, FDIC-insured banks) have made some poor investment decisions. As Roger says, so what? As long as there is no panic, the system performs well, and much better than barter, gold or any other option anyone can suggest.
John
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Karl Baba
Trad climber
Yosemite, Ca
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Topic Author's Reply - Oct 2, 2008 - 09:01pm PT
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Hi John
I'm not sure what your position is because you have just stated there is wrong information in this thread but refuted nothing nor provided another view so what is your point? Things that are unsustainable aren't a problem until the critical point is reached. We have no problem basing our society on burning oil but the party will be over someday (maybe soon) Will we be prepared?
You write
"..Yes, an occasional financial institution fails, and certainly investment banks (as opposed to commercial, FDIC-insured banks) have made some poor investment decisions. As Roger says, so what? As long as there is no panic, the system performs well, and much better than barter, gold or any other option anyone can suggest. "
I won't bore you with how many institutions have failed in the past couple months but it is a LONG list of the BIGGEST financial institutions in history. We have to look at the specifics of how that happened (since, it was ENTIRELY predictable as evidenced by my link above)
But, like I said, the real point of this thread is to educate, not so much judge, how money is created in our monetary system. You said banks don't create money. I say they do and provided innumerable links. Just show me one that says they don't. I think we haven't agreed on the degree of leverage in fractional reserve banking either. If banks were just loaning out 90% of real assets-deposits (not just duplicate iou money) then no bank failures would be likely.
Peace
karl
Got to go have a beer. The debate is starting!
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happiegrrrl
Trad climber
New York, NY
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"The American and world economies since the 1930's support my position."
The American and world economy of the last few weeks, and in the upcoming weeks, months and years seems to be...oh....just slightly different.....than the one we have been believing in since the Great Depression, I think.
"Yes, an occasional financial institution fails, and certainly investment banks (as opposed to commercial, FDIC-insured banks..."
I have the feeling that by this time next year(if not much sooner) many people will be in for the economic shock of their lifetimes when they find out their FDIC-insured deposits aren't protected after all.
"It's in the newspaper; it must be true" someone says. One could make the similar statement of "Our government says so; it must be true."
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TradIsGood
Chalkless climber
the Gunks end of the country
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John, Friedman's book stopped in 1960!
Just a little bit has changed in the last 48 years. For example, the Fed screwed up horribly trying to control money supply in the 80's. Jacked rates into the stratosphere. All it did was secure the future of the euro dollar market.
But you are right, of course! Any lending virtually has to be "fractional". Woohoo. Even if one could perfectly pair off the maturity of every asset against every liability, it is not possible to do the same with credit - which fact is now finally clear to far more than it was two years ago. (That is why 0% reserves is insane.)
http://en.wikipedia.org/wiki/Impossible_trinity
Hey Karl, while you're working this deal... Maybe you could tell us whether interest rate and credit default swaps create money. The CDS market collapsed from about 62 Trillion notional amount this summer to mid 50's trillion. Its first reduction ever (I think).
Open interest on the WTI (oil) contracts is at half of summer levels. Is money created or destroyed when that market goes up or down?
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bachar
Gym climber
Mammoth Lakes, CA
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" Gold has replaced every fiat currency for the past 3000 years. "
 from http://www.kwaves.com/fiat.htm
Are we nearing the end of our current fiat cycle?
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WBraun
climber
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"This person or entity you referenced does not go around in the middle of the night like the tooth fairy and put checks under people's pillows."
Yes this entity really does do that, but not under a pillow.
If you only knew .......
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