Debt is the Currency

[underscored]

So in the UK the Bank of England has confirmed that we have a debt based currency; 97% of £'s are created by private banks mostly via mortgages.

This to me reads like the capture of capitalism by private banks as they are now the adjudicators of Value in society. No wonder so many are debt surfs and that land prices are so high.

Source: http://www.bankofengland.co.uk/publicat ... b14q1.aspx

[cmonkey]

Yes, all major currencies are debt-based (I believe). The majors are.

This is a good resource for anyone wanting to understand our money system. I recommend watching it multiple times over the course of a month or so to let it sink in.

https://www.youtube.com/watch?v=LyJj5La8tWA

[underscored]

That video is a little out dated according the model described by the BoE. It seems we have moved on from fractional reserve banking. The loans create the reserves! So limitless reserve banking - it explains the endless asset inflation we have suffered these last 40 years.

http://www.bankofengland.co.uk/publicat ... 14q102.pdf

" •This article explains how the majority of money in the modern economy is created by commercial banks making loans.
• Money creation in practice differs from some popular misconceptions — banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits."

"In the modern economy, most money takes the form of bank deposits. But how those bank deposits are created is often misunderstood: the principal way is through commercial banks making loans. Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.
The reality of how money is created today differs from the description found in some economics textbooks:
• Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits.
• In normal times, the central bank does not fix the amount of money in circulation, nor is central bank money ‘multiplied up’ into more loans and deposits."

[cmonkey]

The money coming from the Federal Reserve is limitless, yes, as they can create money when they are buying assets from large commercial banks.

The commercial banks can only lend out a certain amount, however, you could effectively call it unlimited now that they have all sorts of financial instruments at their disposal (such as derivatives, MBSs, etc...) that they can now sell to the Fed. Before the Fed was buying assets, it was limited by fractional means. Now the sky is the limit.

"In the modern economy, most money takes the form of bank deposits. But how those bank deposits are created is often misunderstood: the principal way is through commercial banks making loans. Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.
The reality of how money is created today differs from the description found in some economics textbooks:
• Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits.
• In normal times, the central bank does not fix the amount of money in circulation, nor is central bank money ‘multiplied up’ into more loans and deposits."

From what I understand, that is the very definition of fractional reserve banking. Banks take in deposits (say 1000), they can then lend out 90% (or whatever) of that, and now there is technically 1900 in circulation. The additional 900 can then be deposited and loaned against, repeated again and again.

Bank lending is creating deposits which creates bank lending which creates.... BOOM.

[sterlingarcher]

From what I understand, that is the very definition of fractional reserve banking. Banks take in deposits (say 1000), they can then lend out 90% (or whatever) of that, and now there is technically 1900 in circulation. The additional 900 can then be deposited and loaned against, repeated again and again.

Bank lending is creating deposits which creates bank lending which creates.... BOOM.

Except it's not 90% OF that, its 10 TIMES that.

So if Bob deposits 10, the bank can lend out 100 to Jones, meaning the bank just created 90 out of thin air.

[DSKla]

Is it really that much? I remember reading (admittedly in an older book) that banks can inflate a deposit up to about 6 times with fractional reserve banking. So if I deposited $100, through repeated loans they could turn it into about $600 in circulation. Maybe it's worse now.

[henrik]

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

[jacob]

From what I understand, that is the very definition of fractional reserve banking. Banks take in deposits (say 1000), they can then lend out 90% (or whatever) of that, and now there is technically 1900 in circulation. The additional 900 can then be deposited and loaned against, repeated again and again.

This is how it works, so if this cycle is maxed out it's 1000+900+810+729...

Or in math: 1000*sum(0.9+0.9^2+0.9^3+...) = 1000*(1/(1-0.9) = $10000.

The first equality is left as an exercise for math freshmen to prove.

Hence, everybody is correct. On each deposit, the bank can lend out 90%, but it can do this (in principle) an infinite number of times (insofar that money gets deposited back into the banking system) and the sum total of that cascade is 10x the initial deposit.

Note that reserve requirements, as mentioned above, only extends to checking accounts these days. Commercial loans such as CDs have, as far as I know, no reserve requirements. Neither do savings accounts. In principle the bank can then lend out an infinite amount on any money in these! However, before they get that far there are things like capital requirements to put a limit on the amount of lending that is allowed.

[underscored]

Thanks for taking the time to discuss this with me.

@ Jacob

I think that the position outlined by the BoE is critically different to the Fractional Reserve model being described here. The maths above suggests that the total stock of money is limited on the supply side. Fixed amount of base money being scaled up by lending.

Every loan made by a bank - via double entry book keeping - is deposited in another bank account, becoming "reserve" for that bank.

Again from the paper:

"So far this section has considered the case of an individual bank making additional loans by offering competitive interest rates — both on its loans and deposits. But if all banks simultaneously decide to try to do more lending, money growth may not be limited in quite the same way. Although an individual bank may lose deposits to other banks, it would itself be likely to gain some deposits as a result of the other banks making loans."

This to me suggests that money supply is constrained on the demand side! So long as people are demanding ever more debt, money supply will continue to expand. This surely would produce a feedback loop, as more debt is printed, prices rise so people demand more debt. This continues until the total stock of debt and required interest payments exceeds the ability of the economy to service it. Obviously what the debt is used for is important, if the debt is used to expand the capacity of the economy then it may increase the ability of the economy to service debt, speculative lending however is just going to crush the economy.

To me this is crucial, I see this not as symptomatic of our current dysfunctions - but causal!

Debtonomics - the lens through which I am starting to view the current world...

[cmonkey]

It would expand, but not infinitely. There are only so many deposits to loan against. The only way that money gets injected into the money system is through the Federal Reserve buying assets in return for "created" money. They are the only gateway for new base money.

Within the monetary system (banks, businesses, individuals all exchanging deposits and loans) there is a spectrum of "total money in circulation" ranging from deposits/cash only (the lowest amount) to all deposits loaned against (the highest amount).

So in our example, Person A may have $1000 in cash under his mattress, and he is the entire economy. Total money in circulation is now $1000. If he deposits that money in a bank, its still only $1000 in circulation. However, if the bank lends out 90% of that to person B, the amount of money in circulation moves to the top of the spectrum - $1900. It could also be any number in between here, depending on loan demand. So the spectrum is anywhere from $1000 to $1900, which is finite. Add in 300 million Persons and thousands of banks and the model stays the same. There is no way to increase the money supply infinitely.

The well known, but well ignored truth about that monetary spectrum though is that only the lowest number on the spectrum is actually "real money". The loaned money (the 90%) only exists during the duration of the loan, at which point the loan is paid off, the money doesn't exist anymore.

Enter the Federal Reserve. Say the bank has some assets it wants/needs to sell. The Federal Reserve buys those assets and transfers another $1000 to the banks balance sheets. They now have a total of $2000 in assets available to loan against. Where did that $1000 come from? Not the actual economy, but was simply created.

So long as people are demanding ever more debt, money supply will continue to expand. This surely would produce a feedback loop, as more debt is printed, prices rise so people demand more debt. This continues until the total stock of debt and required interest payments exceeds the ability of the economy to service it.

In my mind, what you describe here is not really something that could happen at the individual consumer level because we don't have direct access to the monetary injection point (the Fed), but is in fact happening right now at the macro level. Our government is not able operate without increasing levels of debt and so Congress has the Treasury sell some bonds to the Federal Reserve which services them with increasing (ultimately infinite) amounts of debt. That's why our national liabilities (not just debt) are increasing exponentially right now. I'm not sure about the UK, but that's how it works here. I know the UK's monetary base has been increasing faster than ours so I'm guessing it works the same.

Also, the money that the Fed is creating right now is not really trickling down into the lower reaches of the economy (our checking accounts), but rather is just flying around the balance sheets of corporations and governments, most of it being used outside the USA. Most of that is used in the petro markets. That's why we haven't seen massive inflation/hyperinflation at this point. If it did make it down to the lower economy, you would see the situation you describe, but it would happen on a pretty slow timeline I think.