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The exponentiality of credit growth

phattonez

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Hayek said:
We may start as before by examining the procedure of a single bank. At this bank a certain amount of cash is newly deposited: a sum, let us say, equal to 5 percent of its previous total deposits. If the policy of the bank was to keep a reserve of 10 percent against deposits, that ratio has now been increased, by the new deposit, to 14.3 percent, and the bank is therefore in a position, in accordance with its policy, to grant new credit. If we assume further that it re-lends 90 percent of the newly deposited money and that the whole of this is immediately utilized by the borrower (in order, let us say, to increase his purchases of raw materials) then the ratio of cash to deposits has again sunk to 10 percent. In so far as the bank does not change its policy its individual lending capacity is exhausted, in these circumstances, before it has even re-lent the whole of the amount newly deposited.

The effect of the sums newly deposited at one bank on the lending capacity of the whole banking system is, however, not exhausted by this transaction. If the borrower does not use the credit in a way that leads quickly to the market for consumers' goods, such as wage payments, but devotes it instead to the purchase of raw materials or half-finished products, then it is to be assumed that payment will be made by check and that the seller will hand over the sum received to his own bank for encashment, the amount being credited to his own account. The next consequence must be that the clearing-house position of this bank improves by exactly the amount transferred, and it therefore obtains an equivalent amount of cash from the bank that originally granted the credit.

For the second bank, therefore, the sum originating in the granting of credit and paid into its accounts (representing, as we remember, 90 percent of the original deposit) is just as much an original deposit, based on cash payments, as it was to the bank we originally considered. It will, therefore, be regarded as a basis for additional lending and used in just the same way as any other new deposit. If the second bank also keeps 10 percent of its deposits as cash reserves, it too will be in a position to lend 90 percent of the new deposit, and the same process will be continued as long as the amounts are merely transferred from bank to bank and are not taken out in cash. As every bank re-lends 90 percent of the amount paid into it and thus causes an equivalent increase in deposits for some other bank, the original deposit will give rise to credit representing 0.9+0.92+0.93+0.94… times the original amount. As the sum of this converging infinite series is 9, the banks will be enabled, in an extreme case, to create, against an amount of cash flowing in from an outside source, credit equal to nine times that amount. This becomes clear when we consider that the process can only stop when the last part of this cash is required for the 10 percent reserve of the deposits.

For simplicity's sake we have made use of an assumption that is undoubtedly incorrect, but which affects our conclusion only in so far as it reduces the actual amount of new credit the banks can create with a reserve ratio of 10 percent. Its omission leaves our fundamental conclusion intact: i.e., that they can grant credit to an amount several times greater than the sum originally deposited. In fact some part of the credit at least, if not on the first then on subsequent occasions, will always be withdrawn in cash and not deposited with other banks. For example, if 70 percent is always re-deposited instead of the full 90 percent, this amount being re-lent by every bank and the remainder being used in cash transactions, then the increase in deposits will give rise to additional credit equal to only 0.7+0.72+0.73… times (i.e., two and one-third times) the original. So long as any part of the credit granted is not withdrawn in cash but re-deposited with the banks, the latter will be able to create additional credit, of a larger or smaller amount, as a consequence of every increase in their cash holdings.[88] The lifetime of this pyramid of credit is limited to that of the first credit granted, save in the case (which can be assumed as long as there are no withdrawals from deposits) where it is immediately replaced by a fresh credit. If, however, deposits unexpectedly diminish at any part of the banking system, the process will be reversed, and the original diminution of deposits will occasion a contraction of credit correspondingly exceeding the amount withdrawn.[89]

In this connection we must note for further emphasis later the fact that the proportion in which the credit granted is transferred to other accounts — and not paid out in cash — must be regarded as subject to very wide fluctuations as between different individuals at a given moment, as well as between various periods of time for the economic system as a whole. We return later to the significance of this fact.

What has been said above should be sufficient to show that the possibility of creating credit over and above the sums deposited — which, under Continental banking conditions, is not open to any individual bank — is, however, open to the whole banking system of the country to a considerable extent. The fact that a single bank cannot do what is automatically done by the banking system as a whole also explains another circumstance, which might otherwise easily be cited as a proof of the impossibility of additional credit creation. If every bank could re-lend several times the amount deposited, there would be no reason against its offering a much higher rate of interest on deposits than it actually does, or, in particular, under the existing discount rates of the central banks, against its procuring cash in unlimited quantities by way of rediscount; for it would only have to charge its customers a small part of the rate of interest charged by the banks in order to make the business pay. This apparent contradiction between theory and practice is cleared up as soon as one realizes that an increase of deposits by a single bank only offers possibilities for credit creation to the banking system as a whole. But the importance of this circumstance transcends the mere clearing up of this difficulty.
From Monetary Theory and the Trade Cycle

If you've ever thought about why a crash can be so bad. Banks can be very inflationary even without a central bank if fractional reserve banking is sponsored.
 

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I think there are a lot of flaws in the practicality of this logic. The largest flaw is assuming that "new" money will ever be deposited. Almost all money is already deposited, so where does the "new" money come from? Is it the result of a loan? And if it is, then has it not already been counted in a previous lending/depositing/relending cycle? And when deposits are made in the bank they most certainly rarely sit there, they are usually spent quite rapidly (not allowing much time to be lent). A car buyer may borrow the money to purchase a car (the borrowed money has already been accounted for in previous cycle) but the car dealer does not just let that money sit in the bank, he uses it to pay his bills, and the reciepients of his bill money use their deposits to pay their bills. And regardless of all this, a bank can simply not lend more than is deposited with it.

Banks themselves are not inflationary although I would agree that the high velocity of money that banks can help to facilitate can be inflationary. Of course it takes a high velocity of money to have a good economy also. And the lending cycle does not even have to involve banks, there is nothing special about banks, and increase in the velocity of money can be directly created between venders and purchasers (like my raw material vendor gives me 30 day terms so that I can afford to purchase raw materials and I give my customers 30 day terms so that he can afford inventory to sell).

The only way any of this matters is if the government printed up some new money and deposited it in banks. That would be the only way that "new" money could magically appear in banks to create the deposit/lent/re-deposited/re-lent effect. Our gov tried that almost two years ago (TARP) and our economy only got worse.
 

phattonez

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Companies aren't going to spend all of the money that have gotten in a loan right away. They might need to keep it to pay wages until the investment pays off. So say they keep 50%, and the reserve ratio from the bank that loaned the money is 30%. Say the loan was for $70. The depositor has his original $100. The company gets $70 (multiple claims now on the same $70), but now $35 goes into a bank. That bank can then use 30% of that $35 to back a loan. The cycle keeps going, but you can see how money supply can grow because of this process.
 

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Companies aren't going to spend all of the money that have gotten in a loan right away. They might need to keep it to pay wages until the investment pays off. So say they keep 50%, and the reserve ratio from the bank that loaned the money is 30%. Say the loan was for $70. The depositor has his original $100. The company gets $70 (multiple claims now on the same $70), but now $35 goes into a bank. That bank can then use 30% of that $35 to back a loan. The cycle keeps going, but you can see how money supply can grow because of this process.
Maybe. Every time I have ever borrowed money for personal or for business use I have immediately spent every penny. Most of the time I never even deposited the bank check (it went straight to the other party).

That leads me to my next point about the flaws in the theory that banks somehow create money: If the proceeds of the loan are not spent and are deposited, even if the funds are loaned out by the bank again, no additional money has entered our economy (because it is in the bank and unspent).

So lets say there is you and me and someone else and the bank. If we are all broke except for me, and I deposit $100 into the bank, and if the bank then lends you $90, then there is only $90 circulating (because the $100 I have in the bank is not circulating). If you purchase something from the other guy, and if he deposits his $90, then the bank may could lend another $81, but since I have $100 that is deposited and not circulating, and since you are now broke because you spent your money, and because the guy who deposited your money now has no money (because he deposited it), then the only money that is circulating is the $81 that the bank lent out. Yes, the original $100 that was in circulation is now down to $81. You can argue that several transactions totaling more than $100 took place, but those transactions could have taken place without the aid of the bank (and without the requirment for a reserve, the full $100 would still be in circulation). Fractional reserve banking tends to reduce the circulating money supply because of the "reserve" part of the concept.
 

phattonez

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That leads me to my next point about the flaws in the theory that banks somehow create money: If the proceeds of the loan are not spent and are deposited, even if the funds are loaned out by the bank again, no additional money has entered our economy (because it is in the bank and unspent).
But it has. The second you have multiple claims to the same dollar then additional money has entered the economy.
 

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But it has. The second you have multiple claims to the same dollar then additional money has entered the economy.
But if it is sitting in the bank, is it really in our economy? If I make a million bucks and then bury it in the back yard, is it in our economy?

If I have one dollar and loan it to you, have we really created any more money? I think that just one dollar still exists. Now what if you loaned that dollar back to me, how many dollars would be in existance? Just one. What if we loaned that dollar back and forth a million times, would either of us have a million dollars? No, I would still only have one dollar and you would have none.
 
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oldreliable67

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But if it is sitting in the bank, is it really in our economy? If I make a million bucks and then bury it in the back yard, is it in our economy?

If I have one dollar and loan it to you, have we really created any more money? I think that just one dollar still exists. Now what if you loaned that dollar back to me, how many dollars would be in existance? Just one. What if we loaned that dollar back and forth a million times, would either of us have a million dollars? No, I would still only have one dollar and you would have none.
Neither your back yard nor the two of you alone constitute or avail yourselves of a fractional reserve banking system. It is the fractional reserve system, by standing between parties to transactions and imposing it's fractional reserve requirements, that facilitates expansion/contraction of the money supply, not the individual holder of claims to money.
 
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phattonez

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But if it is sitting in the bank, is it really in our economy? If I make a million bucks and then bury it in the back yard, is it in our economy?

If I have one dollar and loan it to you, have we really created any more money? I think that just one dollar still exists. Now what if you loaned that dollar back to me, how many dollars would be in existance? Just one. What if we loaned that dollar back and forth a million times, would either of us have a million dollars? No, I would still only have one dollar and you would have none.
But say I bury that money in the backyard. Then you write a piece of paper to a guy guaranteeing him that money in the backyard. Both that guy and I will act in accordance with the thought that we own that money in the backyard. We cannot both concurrently own it, and once that is realized you have a problem. Until then, you have effectively increased the money supply.
 

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But say I bury that money in the backyard. Then you write a piece of paper to a guy guaranteeing him that money in the backyard.
If "I" bury a portion of my money in the back yard, and "you" write a piece of paper to a third party guaranteeing the third party my money that "I" buried, that is not increasing the money supply, that is fraud. Of course, it isn't necessary to bury money in the backyard. Simply promising someone else that I will pay them a sum certain without my being a party to the contract is fraud.

A simple IOU from you to someone else does not increase the money supply. A simple IOU from you to someone else that that someone else re-discounts at a deposit taking institution that is subject to the fractional reserve banking regime, will increase the money supply (absent any offsetting by the central bank of the reserves created).
 
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phattonez

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If "I" bury a portion of my money in the back yard, and "you" write a piece of paper to a third party guaranteeing the third party my money that "I" buried, that is not increasing the money supply, that is fraud.
Well that's why I said the money supply has effectively increased. It's not as if more bills are in circulation, but it's the same effect as if you did put more bills into circulation. And yes, it definitely is fraud, and this is in no way different than what banks do.

Of course, it isn't necessary to bury money in the backyard. Simply promising someone else that I will pay them a sum certain without my being a party to the contract is fraud.
And it also in effect increases the money supply.

A simple IOU from you to someone else does not increase the money supply.
Agreed, because in this instance you won't have multiple claims to the same dollar.

A simple IOU from you to someone else that that someone else re-discounts at a deposit taking institution that is subject to the fractional reserve banking regime, will increase the money supply (absent any offsetting by the central bank of the reserves created).
Exactly.
 

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Well that's why I said the money supply has effectively increased. It's not as if more bills are in circulation, but it's the same effect as if you did put more bills into circulation. And yes, it definitely is fraud, and this is in no way different than what banks do.



.






Exactly.
This is neither fraud nor an increase in the money supply. This sounds very similar to the trillions of dollars of imputed value of derivitives. In the AIG example, they guarenteed that cetain bonds would retain their value. Buffett has a huge deriviative play of where the stock market will be years out.
 

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I think there are a lot of flaws in the practicality of this logic. The largest flaw is assuming that "new" money will ever be deposited. Almost all money is already deposited, so where does the "new" money come from? Is it the result of a loan? And if it is, then has it not already been counted in a previous lending/depositing/relending cycle? And when deposits are made in the bank they most certainly rarely sit there, they are usually spent quite rapidly (not allowing much time to be lent). A car buyer may borrow the money to purchase a car (the borrowed money has already been accounted for in previous cycle) but the car dealer does not just let that money sit in the bank, he uses it to pay his bills, and the reciepients of his bill money use their deposits to pay their bills. And regardless of all this, a bank can simply not lend more than is deposited with it.

Banks themselves are not inflationary although I would agree that the high velocity of money that banks can help to facilitate can be inflationary. Of course it takes a high velocity of money to have a good economy also. And the lending cycle does not even have to involve banks, there is nothing special about banks, and increase in the velocity of money can be directly created between venders and purchasers (like my raw material vendor gives me 30 day terms so that I can afford to purchase raw materials and I give my customers 30 day terms so that he can afford inventory to sell).

The only way any of this matters is if the government printed up some new money and deposited it in banks. That would be the only way that "new" money could magically appear in banks to create the deposit/lent/re-deposited/re-lent effect. Our gov tried that almost two years ago (TARP) and our economy only got worse.
in your example the raw material vendor acts as a bank, because he is extending credit. tarp money was meant to bolster banks equity positions, make them stronger. as far as lending, all sources of funding aren't created equal. in fact, banks often purchase funds to lend.
 

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Well that's why I said the money supply has effectively increased. It's not as if more bills are in circulation, but it's the same effect as if you did put more bills into circulation.
No. You have merely exchanged a white piece of paper that can't be used to purchase goods or services for a green piece of paper than can. The sum total of purchasing power in circulation has not changed. You can buy beer with the pieces of paper you received from the person who now holds your IOU. The person who holds your IOU cannot do anything with it except hope to exchange with someone else or with you.
 

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imagep said:
The largest flaw is assuming that "new" money will ever be deposited.
Loan proceeds are almost always in the form of a credit to a demand deposit account. Yes, sometimes they can be in the form of a cashier's check (or other bank obligation for the benefit of the borrower), and yes, sometimes the credit to a demand deposit account is immediately withdrawn. Those tend to be exceptions. Moreover, even when the proceeds of a loan are immediately withdrawn, they are typically and almost always deposited into another demand deposit account in short order.

imagep said:
where does the "new" money come from? ... a bank can simply not lend more than is deposited with it.
liblady said:
banks often purchase funds to lend.
Ok, Money & Banking 101:

First, realize that the largest component of the money supply is in the form of demand deposits, i.e., some form of checkable deposit subject to central bank (i.e., FeD, BoJ, etc.) reserve requirements. Physical money or currency is by far the smallest component of money.

"New" money is created via the fractional reserve banking system. By this, we refer to the retention in the form of reserves of only a fraction of the deposits gathered by of lending and deposit-taking institutions, and the lending of the portion of those deposits which are not held as reserves. Easy so far, right?

But now that portion of the initial deposit is deposited in another demand deposit account (it can be with the same or a different institution). Again, required reserves are retained, but the portion not required to held as reserves is lent out.

And the process repeats itself, until eventually the expansion limit is reached. This limit is typically thought to be m= 1/R where m=money supply and R = reserve requirement.

There are many, many links to this available at your favorite search engine. Wiki has a particularly (IMO) easy-to-understand presentation, here.

This whole fractional reserve system gets many observers quite worked up. It is, after all, a 'fiat' money system, in that there is no gold or other 'hard' asset securing the claims of depositors (i..e, tying the value of the currency to some hard asset). You can also find a zillion links to this topic at your favorite search engine!
 
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But say I bury that money in the backyard. Then you write a piece of paper to a guy guaranteeing him that money in the backyard. Both that guy and I will act in accordance with the thought that we own that money in the backyard. We cannot both concurrently own it, and once that is realized you have a problem. Until then, you have effectively increased the money supply.
With my bookkeeping, I have a balance sheet. I am required to submit my balance sheet with my corporate taxes plus my bank requires annual financials as terms to a loan agreement. If I were to borrow money I would have to show on my balance sheet the money that I borrowed and the offseting debt - otherwise I my financials would be fraudulent. Thus for any loan (increased money supply) there is an equal and offseting debt (anti-money or negative money). The last time I checked X-X=0. No direct increase in money supply or wealth.

I understand that you guys are thinking that every time money circulates (or is loaned) that it is added to the economy, but it really is'nt because there is an equal and offseting amount of debt created. Debt is indicated as negative money like "-$100" or "$(100)". Any debt created HAS to be subtracted from the money supply because it represents money that is going to be removed from circulation at some point. If I have $100 of your money, although I may can spend that $100 YOU can't, so although I may add $100 of money to circulation, the process of you no longer holding your $100 subtracts $100 from circulation.

Once again, if the bank has $100 and I borrow that $100 and purchase a $100 widget there still exists only $100 regardless of who has the $100 because I now owe the bank $100 and that debt offsets the $100 that the widget seller may deposit. Thus the bank still only has $100, I am in debt to the bank for a $100, and the widget seller now has a claim to $100. So add up how much money exists: $100 (held by the bank) + $100 (owed to the bank by me) - $100 (that the bank owes the widget seller) = $100 (which is how much our economy started out with). No new money created.

What you guys are doing is claming that every time money circulates it gets added to the total money in circulation. Yes, money does circulate over and over again, but certainly doesn't get added every time that it circulates.

So lets say that there were no banks, and instead of the bank having $100, I have $100. I then exchange my $100 for a $100 widget. Maybe the guy who purchased the widget decides that he wants to buy it bank from me and I agree to selling him back the widget for the same price he paid. At that point I then have my origional $100 back and he has no money. Two $100 transactions occured, but no additional money was created. We cant say that I had $100 and since I now have another $100 that I now have $200. I don't have $200 - I still only have $100.
 

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There are many, many links to this available at your favorite search engine. Wiki has a particularly (IMO) easy-to-understand presentation, here.
What I am trying to explain is that their are huge logic faults in the concept that banks create money. I have studied the Wiki article before, take a look at the chart at the bottom. The very bottom line of that chart indicates that the bank owes it's depositors $457.05 and that it lent out $357.05 leaving only the origional $100. Now how did that create any money? The $100 figure is the one that represents actual assets, the other two numbers cancel each other out. The $357 that was lent out does not represent "created" money, it simply represents the amount of money that circulated. The flaw is the assumption that every time a dollar circulates that it magically becomes a "new" dollar. It's not, it is the same dollar circulating like it is supposed to. Claiming that every time money circulates creates "new" money is like claiming that if I sell my used car that a new car is created - it's not. Sure, the reason I am selling my old car may be because I am going to buy a new car, but I could likely have bought a new car without selling my old car. The sale of the old car itself does not represent the creation of a new car. It's still the same old car, just like reused money is just the same old money. Ownership was transfered, nothing new was created.

When the banks do their balance sheets, every dollar that is deposited with them is subtracted from every dollar that they have on hand and is owed to them. A bank that has $100 of it's own money plus a Gadzillion dollars in deposits and a Gadzillion dollars loaned out still only has "equity" of $100.

The "fractional reserve banking system" if anything restricts our money supply because of the "fractional reserve" part. That means that banks cant lend every penny that is deposited with them - thus the amount of money that is circulating is actually reduced. The bank has to store part of every dollar deposited with them. Take that Wiki chart and replace the "individual bank" heading with a heading that reads "individual consumer", then change "amount deposited" with "amount in wallet", change "amount lent" to "amount spent" and strike out that "reserve" collumn. You will see that money "multiplies" much faster WITHOUT a "fractional reserve" banking system. The banking system exists to facilitate financial transactions and to make borrowing easier, not to increase our money supply. The fractional reserve system was put in place to reduce the likelyhood of runs on the bank - not to expand our money supply.

The concept that the "fractional reserve banking system" somehow increases our money supply is a myth perpetuated by those who apparently don't understand basic accounting and by people who think that moving money from one pile to another pile somehow created more money (counting it again every time they move it from one pile to another).

I suspect that someone came up with the "creating money" theory to demonstrate how money circulates and someone else misinterpreted that to think that the circulation of money expands our money supply and then someone took that misinterpretation and applied it to a bank lending cycle, then every college professor started teaching it because, after all, it is in the text book so it must be correct. Now every banker and economist thinks that it is correct because it is what they learned in college.
 
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phattonez

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No. You have merely exchanged a white piece of paper that can't be used to purchase goods or services for a green piece of paper than can. The sum total of purchasing power in circulation has not changed. You can buy beer with the pieces of paper you received from the person who now holds your IOU. The person who holds your IOU cannot do anything with it except hope to exchange with someone else or with you.
Except often those white pieces of paper are seen to be as good as money.
 

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I understand that you guys are thinking that every time money circulates (or is loaned) that it is added to the economy, but it really is'nt because there is an equal and offseting amount of debt created.
That's not what I've been saying. What I've been saying is that multiple claims to the same dollar increases the effective amount of money in circulation.
 

phattonez

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This is neither fraud nor an increase in the money supply. This sounds very similar to the trillions of dollars of imputed value of derivitives. In the AIG example, they guarenteed that cetain bonds would retain their value. Buffett has a huge deriviative play of where the stock market will be years out.
If I have $10 in my vault and I write a $10 loan to someone, I can't possibly give both people the money that they see as rightfully theirs. Hence it is fraud.
 

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imagep said:
The flaw is the assumption that every time a dollar circulates that it magically becomes a "new" dollar. It's not, it is the same dollar circulating like it is supposed to.
phattonez said:
If I have $10 in my vault and I write a $10 loan to someone, I can't possibly give both people the money that they see as rightfully theirs. Hence it is fraud.
You are both conflating demand deposits with currency in circulation. "Money," remember, consists of both. Go back to your T-accounts and separate currency in circulation from demand deposits and see what happens. Remember, you can create claims on money which are an asset to one party and an asset to the counterparty and never involve physical currency.
 

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washunut said:
This is neither fraud nor an increase in the money supply. This sounds very similar to the trillions of dollars of imputed value of derivitives. In the AIG example, they guarenteed that cetain bonds would retain their value. Buffett has a huge deriviative play of where the stock market will be years out.
The key difference is that derivatives derive their value from the change in value of something else, some underlying asset, and are not a claim on the underlying asset itself. In the example posited, the claim was on the asset itself, not a change in the value of the asset. Thus, the value of the derivative, which is a contractual obligation, changes value coincident with, but not necessarily equal to, the change in value of the underlying asset. In the fulfillment of the derivative's contractual obligation, the underlying asset very rarely changes hands.

You are correct: it is not an increase in the money supply.
 

imagep

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You are both conflating demand deposits with currency in circulation. "Money," remember, consists of both. Go back to your T-accounts and separate currency in circulation from demand deposits and see what happens. Remember, you can create claims on money which are an asset to one party and an asset to the counterparty and never involve physical currency.
How can you create claims on money that are assets to more than one party? Sounds like fraud to me.
 

phattonez

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How can you create claims on money that are assets to more than one party? Sounds like fraud to me.
It is, and it creates monetary inflation even though as oldreliable continually points out there are no extra bills in circulation. People, however, act with the idea that those notes are worth something.
 

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imagep said:
The concept that the "fractional reserve banking system" somehow increases our money supply is a myth perpetuated by those who apparently don't understand basic accounting and by people who think that moving money from one pile to another pile somehow created more money (counting it again every time they move it from one pile to another).
Okay, once more into the breach...

You're above comment is suggestive of a concept limited only to physical money, i.e., moving something from "one pile to another." Note, though, that a bank creates a demand deposit on its books with a loan. No physical currency has shifted from one pile to another, merely a bookkeeping entry in an electronic ledger. On your books, the demand deposit is an asset to you; the corresponding note evidencing the loan is a liability to you, satisfying your double-entry bookeepping requirements. On the bank's books, just the opposite. In the banking system as a whole, the bank has just increased the money supply by the amount of that loan minus the reserve requirement. (Reserves are not part of the money supply.)

The recipient of a loan will presumably use it for transactions. When that occurs, the bank receiving the demand deposit is now able to lend the amount of that deposit, less the reserve requirement. Even if the deposit is in the form of cash, the asset and liability created by the deposit are transformed on the bank's books to a demand deposit. The bank now has excess reserves with which it can create a new demand deposit, thereby adding to the stock of money.

To reiterate, nowhere in this process is it necessary nor even desirable from a practical perspective, to shift from demand deposits to currency. There is no shifting from "one pile to another" either figuratively or literally.

Does this help?
 
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liblady

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Okay, once more into the breach...

You're above comment is suggestive of a concept limited only to physical money, i.e., moving something from "one pile to another." Note, though, that a bank creates a demand deposit on its books with a loan. No physical currency has shifted from one pile to another, merely a bookkeeping entry in an electronic ledger. On your books, the demand deposit is an asset to you; the corresponding note evidencing the loan is a liability to you, satisfying your double-entry bookeepping requirements. On the bank's books, just the opposite. In the banking system as a whole, the bank has just increased the money supply by the amount of that loan minus the reserve requirement. (Reserves are not part of the money supply.)

The recipient of a loan will presumably use it for transactions. When that occurs, the bank receiving the demand deposit is now able to lend the amount of that deposit, less the reserve requirement. Even if the deposit is in the form of cash, the asset and liability created by the deposit are transformed on the bank's books to a demand deposit. The bank now has excess reserves with which it can create a new demand deposit, thereby adding to the stock of money.

To reiterate, nowhere in this process is it necessary nor even desirable from a practical perspective, to shift from demand deposits to currency. There is no shifting from "one pile to another" either figuratively or literally.

Does this help?

i don't understand.
 
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