A question for Tippit or other gold-standard proponents

[Nathyn]

I just want to demonstrate something about money creation and destruction.

So, here's a question:

Before the Fed existed, banks engaged in fractional reserve banking, not because they were forced to, but because they chose to. Even without a Federal Reserve, banks will engage in fractional reserve banking because it benefits everyone: It benefits the bank by letting them make more profit, the savers that make deposits by getting higher interest from more profitable banks, and the borrowers by getting lower interest rates from more profitable banks with more funds to lend.

So, let's say that one bank's reserve ratio is 10%.

You withdraw $10 from the bank and put it under your mattress. What does that do to the money supply? Is any money created or destroyed and, if so, how much?

 

[Dabljuh]

Also, don't forget to mention that in a gold-based currency environment, fractional reserve banking is basically the only way to increase the money supply. The fractional reserve works like a multiplier on M0.

 

[Tippit]

I just want to demonstrate something about money creation and destruction.

So, here's a question:

Before the Fed existed, banks engaged in fractional reserve banking, not because they were forced to, but because they chose to. Even without a Federal Reserve, banks will engage in fractional reserve banking because it benefits everyone: It benefits the bank by letting them make more profit, the savers that make deposits by getting higher interest from more profitable banks, and the borrowers by getting lower interest rates from more profitable banks with more funds to lend.

So, let's say that one bank's reserve ratio is 10%.

You withdraw $10 from the bank and put it under your mattress. What does that do to the money supply? Is any money created or destroyed and, if so, how much?

I'm not a gold standard proponent, but thanks for completely misrepresenting my position. Why would banks have to be forced to promise savers their money on demand while being able to lend it out at the same time? It's a great opportunity for the banks to profit at the cost of macroeconomic stability. Fractional reserve banking is inherently inflationary, it's the sole cause of bank runs, and it's the primary cause of recessions and depressions. All of the benefits you named are illusory, or immoral. Since under FRB banks lend depositor's money that is promised to them on demand - a logical contradiction - they are engaging in de facto money creation, something which ordinary private businesses and citizens are not allowed to do. So immediately we see a source of revenue which is exclusive to banks and bankers, and it is the primary reason why the global economy is two-tiered, consisting of elite bankers who control the banking cartel (yes Virgina, just like OPEC there is a far more profitable banking cartel) and everyone else. Depositors get paid to park their money in banks as opposed to having to pay storage fees otherwise, but this benefit is illusory in the sense that the FRB system itself is inflationary, and increases systemic risk - both offsetting factors. "More funds to lend" sounds great for borrowers, but what does this really mean? In fact this is the problem. The expansionary phase of the Kondratieff boom-bust cycle (otherwise known as the "business cycle") is driven by fiat money and fractional reserve banking. It results in banks making loans that ordinary creditors would never risk with their own paid-in capital. The effects of this are increased systemic risk, malinvestment, and speculation. It was responsible for the "prosperity" of the roaring twenties and the bull stock market, as well as the bull real estate market of the 90s and the CDO scams which are starting to unravel now.

To answer your last question, if the reserve requirement is 10% and I withdraw $10, that will result in the destruction of approximately $100. The simple money multiplier is the reciprocal of the RR, 1/.10, or 10. $10x10 is $100. I say approximately because there are mitigating factors that make up the difference between the simple money multiplier and the real money multiplier. So yes, leverage works in reverse too, yet another example of the increased systemic risk.

 

[Dabljuh]

Just a couple corrections.

It's a great opportunity for the banks to profit at the cost of macroeconomic stability.

Fractional reserve banking increases macroeconomic stability.

Example: At the end of the month, more money is required than in the middle of the month, due to everyone getting his wage and all dues being paid and what not. To accomplish, you either have to double the money supply (so everyone and the banks has always twice the money he needs during the month) or you use fractional reserve banking, turning banks into a micro- and macroeconomic buffer.

Fractional reserve banking is inherently inflationary,

No it's not. It acts as a multiplier on M0. But that multiplier is pretty much fixed, so it doesn't create inflation/deflation unless you change the ratio.

it's the sole cause of bank runs,

It's the sole cause of banks in the first place. There's no point in banks if not for fractional reserve banking, allowing them to provide liquidity and interest rate at the same time.

and it's the primary cause of recessions and depressions.

No serious economist thinks that fractional reserve banking causes recessions or depressions.

... something which ordinary private businesses and citizens are not allowed to do.

Correct. Everyone should be able to take in money as a business. But only something that satisfies the banking codes should be able to call itself a bank.

So immediately we see a source of revenue which is exclusive to banks and bankers, and it is the primary reason why the global economy is two-tiered, consisting of elite bankers who control the banking cartel (yes Virgina, just like OPEC there is a far more profitable banking cartel) and everyone else.

Yes, banks are too powerful. But the solution to that is not to eliminate fractional reserve banking, the solution is to allow reduction of the interest rate down to 0%.

To respond to your remaining blahblah. The recession in the 1930ies weren't caused by fractional reserve banking, but by a general capital interest rate that is below the liquidity fee of money. Unless you learn what the **** a liquidity fee and a liquidity trap is, don't come back.

 

[Nathyn]

Well, he answered the question right. I brought it up to demonstrate the fact that cash != money. That's one assumption made by a lot of people that believing in this pseudoeconomic trash. They think that banks are "evil" because they force them to give them all their money -- when in reality, if your bank is in a checking account, you haven't lost anything. Money hasn't been destroyed.

And they think that money is "conjured," because they don't understand how money is created. Explaining how money is destroyed is a better way to show that fractional reserve isn't such a shady process.

Why will banks engage in fractional reserve? Because most people put their money in banks because they don't intend to spend all of it at once, so at least some fraction will remain there, unused. Banks can use this to loan out to others and use the profit from the loan's interest to pay interest to savers. Under a full reserve system, people would have to pay the bank a high monthly fee to cover the costs of keeping their money and allow them to profit.

Nobody is exploited by fractional reserve and banks are extorting money out of you. They provide a useful service for free and not only that, they PAY YOU for it.

Here's a model of how fractional reserve banks work:

 

[Dabljuh]

To be more sciency, macroeconomists actually know different types of money.

Cash, M0 (Non-standard) is basically the amount of hard cash in circulation. "In circulation" isn't actually true, since really, the vast majority of that is in 1000$ bills and only changes hands in a blue moon and is kept on banks as a reserve.

M1 is the giral money that is "created" by the banks, as a multiplier of M0. It's not cash, it's just numbers on a bank account, that works just as much as money. (This usually also includes M0)

M2 Is basically the M1, including savings accounts.

M3 is money that is created for long-term investments.

So what happens if you withdraw 10$ from your bank's savings account is, that M2 is reduced by 10$. I wouldn't expect the banks to underrun their fractional reserve because of 10$, but if they would, they'd ask for liquidity from another bank, or even the fed, rather than to start dissolving bank accounts (which really would mean that 100$ M1/M2 are being destroyed). The banking code may provide more details on what's done there. So in reality, you wouldn't destroy 100$ of M2.

Now if you put your 10$ cash under the mattress and never use it, funnily enough, you remove 10$ from M0. Technically speaking you lower the overall turnover rate, but the result is the same.

That's also why gold is such a bad currency. It keeps getting removed from circulation, so M0 gets smaller and smaller -> Deflation.

with fiat money, if the fed decides there's a threat of deflation, they're gonna try to increase the money supply by lowering the interest rate.