My mind is getting blown as I'm watching these videos of yours. This is answering fundamental questions that I've had in the back of my mind for years. Thank you!
0:58 Hierarchy of Money. 1:50 Simple Mortgage Loan. 2:59 Banks make money on interest, not deposits. 3:47 Loans are approved independent of reserve positions. 5:16 Bank loan risk. 6:36 Loanable Funds Theory. 7:39 Loanable Funds Transaction. 8:47 Why Loanable Funds is incomplete. 9:31 Savings is not equal to investment. 10:52 A better flow of funds. 11:55 Endogenous Money Conclusions. 12:35 Is it Counterfeiting?
Thanks for the timestamps! If you put these timestamps in the video description, CZcams will automatically create chapters in your video at the timestamps :)
Hello Wayne again,can you expand more on risk involved on creating deposit as you mentioned in video.Where can from wells fargo get funding if someone decide to move that deposit to another bank.
Hi Wayne, great videos, I studied economics in school and I wish that these concepts had been explored there. Quick question: With the Fed deciding to buy corporate bonds recently (first buying ETFs then promising it will purchase bonds directly), would endogenous money suggest that the Fed can increase aggregate demand by turning bond assets into deposits (liquidity) for investment funds, while increasing aggregate demand in the process? So if I have this right, when the Fed buys the bond from the Investment Fund, total deposits increase by 500 to 5500, thereby inadvertently stimulating demand (while also, in the real world, increasing liquidity and keeping bond yields lower so as to reduce bond default potential?). In a way, if I am not wrong, banks aren't the only ones creating money, but now corporations can (indirectly) too in a crisis. Thanks for the informative and clear videos.
Hi Thomas, Yes! In that case, the company is acting very much like a bank. If The Fed buys a corporate bond, it would be a net expansion of deposits (and reserves). The Fed would get a bond asset, while expanding bank reserves. The company's bank would get the reserve asset, while expanding their deposit liabilities to the company. And the company would get a deposit asset, while expanding their bond liabilities. On aggregate demand, it really depends how the Company spends the new deposits. If they use it to rollover existing debt, it would have little affect on demand, but if they used it to pay wages, or purchase capital equipment, it would boost demand. Thanks for watching! -Wayne
Hi Wayne, first of all thank you so much for your video series. It has greatly enhanced my understanding of our monetary system :) I have a question that may be slightly naive but I’m sure it would help me (and lots of other people presumably) understand the system even better. What’s the difference between … A) our current system with a x% fractional reserve requirement B) a system in which banks act as true intermediaries where lending out money that they don’t have is illegal. So a 100% fractional reserve requirement. Monetary base = whole money supply. There would be no M2, M3 etc. There would only be MB. I'm assuming that the central bank would increase MB whenever it is not enough to satisfy the demand for loans. So MB in system B would be way bigger than it is in system A So I guess essentially my question is: what’s a better way of creating liquidity (is that the right word?) - give banks the freedom to lend out money that they don’t have VS just increase MB? My intuition is that the current system A is way better but I can’t pinpoint why exactly. I would love to understand exactly why. I think the main advantage of system A is that money supply is directly determined by actual demand for loans (= win-win deals). Whereas in system B the central bank would always be trying to guess how they need to change MB to get it right. There must be more reasons. I'm wondering if the two systems have different effects on inflation? Also, maybe system B is dangerous because the central bank would have too much power?
Hi Simon, Those are tough questions! I'm not sure if there is a clear answer, but I can give you my opinion. You've already touched on a lot of the key points. A) The current system doesn't use fractional reserves anymore. Fractional reserves are an artifact of the gold standard, when providing liquidity meant coming up with physical gold. In a fiat system, there is no limit to the amount of dollars that The Fed can provide on demand, so there is no need to have any physical reserves. The Bank of England has had zero RRs for decades, and The Fed reduced RRs to zero this year! www.federalreserve.gov/newsevents/pressreleases/monetary20200315b.htm B) I think it is very tough to contain endogenous money, because it is based on private agreements, rather than a quantity of base money. If everyone accepted everyone else’s credit, there would be no need for any base money at all. In this vein, modern banking became a wrapper for something that developed naturally in the marketplace. Hence, why it is so hard to contain credit-based systems. A wrote a blog about Full Reserve Banking a number of years ago, you might enjoy it: drive.google.com/file/d/0BzBgxNrSWMA9aktVYm5EUzhNSE0/view?usp=sharing You touch on the key advantages of credit based systems. Money is based on demand for money, so transactions and investment can occur with very little friction. At its best, a credit system allocates resources towards the most productive means, based on risk evaluation. Another excellent point you bring up is about inflation. Credit based system will always return to zero over the long-run. Meaning, every new dollar created by a bank holds a promise to be destroyed. If everyone stopped creating new loans, than the money supply would eventually return to zero. This intrinsically contains inflation, because money is being destroyed by banks as fast as it is created. This is also what causes the ‘hangover’ effect when a spending binge (boom) is followed by a painful deleveraging (bust). Another downside is a lot of room for corruption. Clever investors borrow to invest…they create money to purchase financial assets rather than create money to build a new factory or provide a new service. This behavior is what leads to equity booms and busts, and should probably be outlawed. So why is system A, better than system B? Because system B has never existed, even under the gold standard, and it questionable if it would be possible or preferable. Is there a better system? Yes. There are lots of ways to improve the current system, but most of them are regulatory. We can require banks hold more capital, to make them more resistant to default pressures. We need to be telling banks what they *can* do, rather than why they can’t do. If we could restrict bank lending to GDP generating activities, it would fix a lot of the problems. Thanks for the excellent questions! Hope this helps, its a huge topic. -Wayne
Hey Wayne, Wow that was quick. Thank you! _“If everyone accepted everyone else’s credit, there would be no need for any base money at all.“_ --> Fascinating thought! My initial reaction was: “But there needs to be some base money to use as our unit of account.” But then I thought it actually doesn’t matter whether our unit of account exists on a base level below or it is just an “imaginary” unit of measurement that we use to describe the purchasing power of a certain quantity of credit in a standardised way. After all, that’s what we do in physics and other fields too. What’s hard to grasp here and what makes this unique is that the purchasing power changes over time, but slow enough for the unit of account to still make sense. Do you agree or am I missing something? _“Another downside is a lot of room for corruption. Clever investors borrow to invest…they create money to purchase financial assets rather than create money to build a new factory or provide a new service. This behavior is what leads to equity booms and busts, and should probably be outlawed.”_ --> Do you have any idea how governments could approach that problem? Where do you draw the line? Are there any concrete policy suggestions out there? Where can I find your blog posts? I want to read them all :) Seriously, I would love to read everything you have ever written. Also, I am super interested in macroeconomics and public economics. Do you have any recommendations for teaching material? Any great teachers on youtube that I should check out? Who were your favourite teachers? -Simon
So when banks earn interest on borrowing out of thin air, they eventually "earn" reserves or governement money, right? Which money do they invest in financial sector? Reserves? And if they invest their reserves why would that represent the problem like a lot of them argue?
This is a lecture from economist Richard Werner about banking and money creation: "I will tell you key points about banks. In case you thought banks lend money, they take deposits and lend money. You are wrong . Banking was developed, modern banking was developed, in the United Kingdom in the 17th century and the legal facts are very clear but not very well known. Banks do not take deposits and banks do not lend money. That's a fact. How is that possible. How is that possible. Well, legally they do not take deposits. They borrow from the public, because your money at the bank is not on deposit. Its not held in custody, it's not a bailment. What is it legally? You have lent money to the bank. So the expression in banking are designed to mislead what's really happening. Who is the owner of this money? It is the banks, you are just a general creditor. Which is very different from the impression given when we use the term deposit. What about lending surely banks lend money? No they don’t. No bank has ever lent any money. How is that possible? What does a bank do? Banks purchase securities and they don’t pay up. That's what they do. How is that? Well if you go to the bank and you borrow money you sign a loan contract. Very crucial. Your signature creates the money supply. Because the bank legally will consider the loan contract a promissory note. And that is what is considered legally, is a promissory note. Just like the bank of England Note, central bank money, paper money, is a promissory note from the central bank. And the bank purchases this contract. That is what they do, they purchase the loan contract. Now they owe you money. You say I dont care about the mechanics, give me the money. The banker will say we will put it in your account. You will find it in your bank account. Well what is a bank account? It is not a deposit. Its a record of the bank's debt to the public. It is a record of the bank's debt to the new borrower, and they show you the record of how much money they owe you. That is it, they don’t pay up. And this is how the money supply is created. So lets go in sequence: Step one: You go to the bank and you sign the loan contract, say a thousand pounds. This will be recorded in the bank balance sheet as an increase in bank assets. The bank, will then, record its debt to the borrower. But it will do some accountant trick. It should really say this is an accounts payable item. Something that the bank has to pay but it has not yet paid. But it wont record as an accounts payable. If you talk to an bank's accountant they are horrified “No you cannot use an expression like accounts payable in a bank” And do you know why? Because they recorded it as customer deposit. They show it on the bank's liability side as a customer deposit. But nobody has deposited it, the customer has not deposited for sure. The customer is borrowing it. The bank has not deposited either. It is added to the money supply, and this is how 97% of the money supply is created out of nothing on the basis of a signature and of course on the credit of the borrower. That is money creation. So no money is transferred from any where else to the borrowers account."
okay I'm still struggling to really get it.Yes...when the bank of America creates a liability out of nothing,I can then go spend it a 7/11.great, that's endogenous money creation.But but banks eventually secure financing for that liability through capital bond issuance/money markets/Retaining customers bank deposits.So in effect there is no new net aggregate demand,someone's withheld consumption finances my conumption.quid pro quo.
+intajake *_"banks eventually secure financing for that liability"_* Banks will only secure funding for net outflows to other banks (whatever it owes CHIPS at the end of the day), this is a small fraction of total accounts payable. In many cases, funding is acquired so that there are zero outflows, zero government money exchanging hands. Assuming zero inflows from other banks, the lending bank would fund the new deposits using The Federal Funds market, which is not a standard money market, it is exclusively for banks. In this market, they do not borrow private savings deposits, they borrow Bank Reserves. Meaning, when a bank borrows in the Fed Fund market, it is not debiting a private saving account, no _private_ purchasing power has been reduced to fund the new deposits. Wasn't purchasing power removed by the Bank lending the Reserves to fund the new deposits? No, reserves do not circulate outside the interbank & treasuries markets - private citizens or companies do not use bank reserves. So, moving bank reserves from one bank to another changes absolutely nothing for the private sector. The other sources of funding you mention, equity, and retaining deposits. One, equity funding will only be used by banks if they reach their regulatory thresholds. Although today, there is a tendency for banks to open subsidiaries rather than attract new equity. But yes, if a bank is forced by regulators to increase equity, then you can say the new deposits are funded by savings. On retaining deposits, they are the cheapest source of funding for banks, so they have an interest to retain as many as possible. However, theoretically (ignoring regulation), a bank can lend and operate retaining zero deposits by acquiring the funding wholesale in the Fed Funds Market. This of course decreases the profitability of the bank. *_"no new net aggregate demand"_* When an individual saver lends their deposits to a borrower no new deposits are created. When a commercial bank lends their deposits, it is increasing the total quantity of demand deposits in the economy - it is increasing purchasing power, without decreasing the purchasing power of a saver. Borrowing money from existing deposits: Saver(-deposits)→Borrower(+/-deposits)→Seller(+deposits) = Net Zero Borrowing money from commercial banks: Borrower(+/-deposits)→Seller(+deposits) = Net Positive The opposite is also true, when a borrower pays off debt to an investment fund or individual saver, then bank deposits are not destroyed. When a borrower pays off principle to a commercial bank, total deposits decline. The growth of demand deposit money can significantly outpace the growth of government money. One way to look at this is that banks are increasing the quantity of inside money, by increasing the velocity of outside money. I prefer to look at government money, and bank deposits, as two entirely different financial assets. Government is the _issuer_ of US Dollars, and if they printed up a c-note and spent it at 7/11 no one would argue this wasn't an increase in nominal demand, without a decrease in nominal savings - it is new money. Banks are the _issuers_ of Bank Deposits, and if the printed up a $100 worth of deposits, and the borrower spent then at 7/11 this is _also_ an increase in nominal demand, without a decrease in nominal savings - it is new money. There _are_ some important distinctions between inside and outside money, but for all practical purposes interbank clearing, and interbank lending have made government reserves mostly irrelevant operationally - they only become significant during crisis times. Market entities are _users_ of both government money, and private bank money, but government money is only a small fraction. The creators of our _"money"_ are private banks - I would argue that this is mostly positive and endogenous money is one reason why capitalism is so dynamic (and unstable). Does that help? =/
+intajake Here is a more detailed response - I turned your points into an article post! ;) *BANK FUNDING & AGGREGATE DEMAND* Got a great comment on my _How Banks Create Money_ video (tinyurl.com/pp84c9m). Here is the post: *_"Okay, I'm still struggling to really get it. Yes, when Bank of America creates a liability out of nothing, I can then go spend it a 7/11...great, that's endogenous money creation. But banks eventually secure financing for that liability through capital bond issuance/money markets/Retaining customers bank deposits. So, in effect there is no new net aggregate demand, someone's withheld consumption finances my conumption. quid pro quo"_* These are really good questions, not your typical conspiracy mumbo-jumbo. The author is asking about the timing of bank funding. What is the difference between a bank acquiring funding immediately before or immediately after the issuance of new deposits? Banks create deposits from thin air, but they are responsible for those deposits, they must _" eventually secure financing for that liability through capital bond issuance/money markets/Retaining customers bank deposits."_. The answer is yes...and no. If the depositor holding the new deposits spends them with a vendor who banks with another bank, at that moment, the issuing bank must find funding - it must settle in its assets. But this isn't quite the whole story because banks don't _immediately_ settle the transactions. Instead, banks transfer the deposits into an accounts payable, effectively converting one liability (deposits) into another liability (debt to CHIPS). Throughout the day, banks accumulate both payables to CHIPS, and receivables from CHIPS. At the time of settlement, the receivables and payables cancel each other out, and the bank is only responsible for the net. Once the issuing bank determines how much they owe CHIPS, their net settlement position, they will look for funding - this is the moment the commenter is asking about, but it doesn't play out how one might think. At the moment of clearing, the bank's entire goal is to *_not_* have to settle their liability to CHIPS with assets (reserves). There are a couple of ways a bank can make sure they have zero outflows at the end of the day. The cheapest way is to attract a lot of depositors - this will guarantee a lot of receivables coming from CHIPS. In this function, retaining deposits acts as a source of funding for banks. If you can retain enough depositors, you will be sitting on a net positive position at the end of each day, and get to earn interest lending your surplus to deficit banks. If a bank doesn't have enough depositors and finds itself in a deficit position it will borrow the difference in the Federal Funds Market. The whole point of this market is to _zero out_ the CHIPS system, so that banks don't owe each other anything during clearing. Banks holding positive balances with CHIPS lend their surplus reserves to banks holding negative balances with CHIPS. At the moment of interbank clearing, few (if any) reserves are actually transferred. Other significant characteristics of the Fed Funds Market: lending here is not counted in regulatory requirements, and the availability of funding here is limitless, since The Fed will always supply the reserves need to defend its target interbank rate. Meaning, it is bank lending that drives the quantity of reserves, not the quantity of reserves driving lending (other than the price). The last source of funding the commenter mentions is equity funding, issuing new shares and attracting investors. The commenter mentions _capital bonds_, which is an attempt by banks to sidestep regulations. Capital Bonds allow them to attract _"equity"_ without having to dilute ownership privileges. The problem is, the bank is counting these bonds as _equity_, but the investors are counting them as bank _liabilities_. The shady behavior came from banks scrambling to meet new capital controls, but I don't believe these sorts of shenanigans will continue much longer - Banks hate it, and would much rather push their risk into external balance sheets. In any case, equity funding is a last resort for banks - it is only used when banks are forced by regulatory thresholds and it is certainly not _needed_ for banks to expand deposit liabilities. Now that we got that out of the way, let's explore the commenter's more interesting question. If banks must find funding for the new deposits, doesn't this mean _"there is no new net aggregate demand,someone's withheld consumption finances my consumption"_. The commenter proposes that all bank lending is funded from private savings, if not before, than some time after the deposits are created. No, The Federal Funds market is not a standard money market (which exchanges bank deposits), it is exclusively for banks. In this market, banks are not borrowing private savings deposits, they are borrowing Bank Reserves which do not circulate outside the banking sector. When a bank borrows in the Fed Funds market, it is not debiting a private saving account, no private entity is giving up existing deposits, no purchasing power has been reduced to fund the new deposits. When an individual saver lends their deposits to a borrower in a money market, no new deposits are created. When a commercial bank lends their deposits, it is increasing the total quantity of demand deposits in the economy - it is increasing purchasing power, without decreasing the purchasing power of a saver. The opposite is also true, when a borrower pays off debt to an investment fund or individual saver, then bank deposits are not destroyed. When a borrower pays off principle to a commercial bank, total deposits decline. When banks create deposits, they are increasing aggregate demand without a saver. When bank deposits are destroyed, it decreasing aggregate demand, without crediting a saver. There is more happening than a simple transfer from savers to borrowers. It is possible to have accelerating private savings, and private investment, and still experience a decline in aggregate demand, if the pace of deleveraging is faster than the pace of private savings/investment. Let's take a step back from the nuts and bolts - sometimes a conceptual approach is better. The growth of demand deposits can significantly outpace the growth of government money. One way to look at this is that banks are increasing the quantity of inside money, by increasing the velocity of outside money. This is not entirely inaccurate, but I believe it is better to look at government money, and bank deposits, as two entirely different financial assets. Government is the _issuer_ of US Dollars. If they "printed" up a c-note and spent it at 7/11 no one would argue this wasn't an increase in nominal demand, without a decrease in nominal savings - it is new money. Banks are the _issuers_ of Bank Deposits, and if they "printed" up a $100 worth of deposits, and the borrower spent them at 7/11 this is also an increase in nominal demand, without a decrease in nominal savings - it is new money. Market entities are the _users_ of both US Dollars, and Bank Deposits, but US Dollars are only a small fraction of the total money supply. There are some important distinctions between inside and outside money, but for all practical purposes interbank clearing, interbank lending, and government guarantees have made bank reserves mostly irrelevant in day-to-day banking operations - they are only significant to set the base rate on lending, and during crisis times of course. The creators of our most widely used form of "money" are private banks. In my opinion, this is mostly positive and endogenous money is one reason why capitalism is so dynamic (and unstable). But it does mean that banks play a role in creating new nominal demand in the economy. Total borrowing, at any given moment in time, consists of both transferring savings to borrowers _and_ banks creating new purchasing power independent of savers.
+intajake annnnnd...here is an excellent lecture on the differences between endogenous money theory and loanable funds theory. Enjoy! =) czcams.com/video/ICKD83sZ-qg/video.html
@@TheBalancedAmerican But why were than central banks injecting so much reserves into the banking system.Actually bailing out private investors who were holding bonds(if they hold them) or pension funds.
@@TheBalancedAmerican i don't understand still but those deposits that show in our account are matched by reserves only.If i deposited money in my bank account then transfer that money to someone else account then bank will send reserves also to that someone else banks! Same with loans if loan is given loan taker will send it to different banks and bank will send reserves to different bank.The same reserves revolving matching deposits.Only case deposit is new if it remains in same bank.Wayne so this is somewhat confusing.
so wayne i read your gold standard article.So you saying bank is modern world intermediary...so they give us deposit as asset and and take home as collateral...i don't understand why we have to give our home as collateral to bank if they just giving us debt aka deposit....why we can't do this our own because people don't trust each other money or just fiat is accepted everywhere i suppose that is why...i just don't understand why bank take our asset as collateral if they just giving us deposit aka debt lol...banking looks like very profitable business....my question is just that if bank is just giving as debt instrument to exchange between us why they take collateral from us for whose safety??
I’ve always found this a rather favorable deal for the bank as well. The argument would be, the bank is responsible for the deposits because it must ultimately fund the deposits with currency. Although considering bank funding is virtually guaranteed by the system, it seems unfair the bank would be able to acquire the property at default with such little risk. At its best, modern banking is a really prudent way to bind money creation to the productive effort of the borrower. At its worst, modern finance can be parasitic and exploitative.
@@TheBalancedAmerican Wayne i really wanna say thanks to you for these videos and even comments under it you have answered (i read them all) it has enchanced my knowledge of monetary and fiscal system greatly.Thanks again!I will say credit creation is dangerous too. Especially from the perspective of derivative trading these days 0DTE options are very popular and if you see twitter many earning good money from 0DTE too from chart trading but then these so called forex trading platform provides already 500x leverage too.Like this credit creation is mostly not going too productive purposes but leverage trading things...so much leveraged is system.
@@TheBalancedAmerican Wayne since you said bank funding is virtually guaranteed by system i wonder what are all ways through which bank funding is virtually guaranteed by system? 1) interbank market ( i.e. money market as much i know) 2) discount window 3) in crisis by federal reserve ( so when in crisis federal reserve give temporary liquidity to system or banks) is it free or banks have to pay it back to fed?
@@shubhamsingla9340 Yes! The fed will not lend to an insolvent bank, unless it would be catastrophic to the system. I speak briefly about how banks go down in the Federal Funds Market video. In 2007, Fed allowed Lehman Brothers and Bear Sterns to fail before it start lending to insolvent banks. During that crisis, the Fed ended up buying many of the bad assets on the books of insolvent banks. I believe those bad assets are still on the Fed's balance sheet! (see Maiden Lane Transactions). So what is happening with SVB? Although it is still early, it looks like they are getting the double-whammy...collapsing asset values, and a run on their deposits. Best guess, SVB was over-exposed to bonds issued by Tech companies, which have been going bust left and right lately. Word got out that they had a bunch of non-performing assets, and so investors started moving their uninsured deposits to other banks. How does SVG respond to everyone moving their deposits? It needs to convert one payable ('deposits') to another ('fed funds loan')...only this time, other banks wouldn't lend to them! Their assets are non-performing. Can't sell their assets, can't get a loan, and all the bank's capital is chewed up, its over for them!
My mind is getting blown as I'm watching these videos of yours. This is answering fundamental questions that I've had in the back of my mind for years. Thank you!
0:58 Hierarchy of Money.
1:50 Simple Mortgage Loan.
2:59 Banks make money on interest, not deposits.
3:47 Loans are approved independent of reserve positions.
5:16 Bank loan risk.
6:36 Loanable Funds Theory.
7:39 Loanable Funds Transaction.
8:47 Why Loanable Funds is incomplete.
9:31 Savings is not equal to investment.
10:52 A better flow of funds.
11:55 Endogenous Money Conclusions.
12:35 Is it Counterfeiting?
Thanks for the timestamps! If you put these timestamps in the video description, CZcams will automatically create chapters in your video at the timestamps :)
Thank you so much, you have very clear mental models and it's a pleasure to learn from you.
Great Video, very good explanation! Are you an economist or an accountant? Wayne, are familiar with the work of Richard Werner?
Hello Wayne again,can you expand more on risk involved on creating deposit as you mentioned in video.Where can from wells fargo get funding if someone decide to move that deposit to another bank.
Hi Wayne, great videos, I studied economics in school and I wish that these concepts had been explored there. Quick question:
With the Fed deciding to buy corporate bonds recently (first buying ETFs then promising it will purchase bonds directly), would endogenous money suggest that the Fed can increase aggregate demand by turning bond assets into deposits (liquidity) for investment funds, while increasing aggregate demand in the process? So if I have this right, when the Fed buys the bond from the Investment Fund, total deposits increase by 500 to 5500, thereby inadvertently stimulating demand (while also, in the real world, increasing liquidity and keeping bond yields lower so as to reduce bond default potential?). In a way, if I am not wrong, banks aren't the only ones creating money, but now corporations can (indirectly) too in a crisis.
Thanks for the informative and clear videos.
Hi Thomas,
Yes! In that case, the company is acting very much like a bank. If The Fed buys a corporate bond, it would be a net expansion of deposits (and reserves). The Fed would get a bond asset, while expanding bank reserves. The company's bank would get the reserve asset, while expanding their deposit liabilities to the company. And the company would get a deposit asset, while expanding their bond liabilities.
On aggregate demand, it really depends how the Company spends the new deposits. If they use it to rollover existing debt, it would have little affect on demand, but if they used it to pay wages, or purchase capital equipment, it would boost demand.
Thanks for watching!
-Wayne
Hello Wayne! Can you pls create a video on Inter Bank Foreign Exchange market?
Here ya go! =D
czcams.com/video/ghHnZADyRQw/video.html
Hi Wayne, first of all thank you so much for your video series. It has greatly enhanced my understanding of our monetary system :)
I have a question that may be slightly naive but I’m sure it would help me (and lots of other people presumably) understand the system even better.
What’s the difference between …
A) our current system with a x% fractional reserve requirement
B) a system in which banks act as true intermediaries where lending out money that they don’t have is illegal. So a 100% fractional reserve requirement. Monetary base = whole money supply. There would be no M2, M3 etc. There would only be MB. I'm assuming that the central bank would increase MB whenever it is not enough to satisfy the demand for loans. So MB in system B would be way bigger than it is in system A
So I guess essentially my question is: what’s a better way of creating liquidity (is that the right word?) - give banks the freedom to lend out money that they don’t have VS just increase MB?
My intuition is that the current system A is way better but I can’t pinpoint why exactly. I would love to understand exactly why. I think the main advantage of system A is that money supply is directly determined by actual demand for loans (= win-win deals). Whereas in system B the central bank would always be trying to guess how they need to change MB to get it right.
There must be more reasons. I'm wondering if the two systems have different effects on inflation? Also, maybe system B is dangerous because the central bank would have too much power?
Hi Simon,
Those are tough questions! I'm not sure if there is a clear answer, but I can give you my opinion. You've already touched on a lot of the key points.
A) The current system doesn't use fractional reserves anymore. Fractional reserves are an artifact of the gold standard, when providing liquidity meant coming up with physical gold. In a fiat system, there is no limit to the amount of dollars that The Fed can provide on demand, so there is no need to have any physical reserves. The Bank of England has had zero RRs for decades, and The Fed reduced RRs to zero this year! www.federalreserve.gov/newsevents/pressreleases/monetary20200315b.htm
B) I think it is very tough to contain endogenous money, because it is based on private agreements, rather than a quantity of base money. If everyone accepted everyone else’s credit, there would be no need for any base money at all. In this vein, modern banking became a wrapper for something that developed naturally in the marketplace. Hence, why it is so hard to contain credit-based systems. A wrote a blog about Full Reserve Banking a number of years ago, you might enjoy it:
drive.google.com/file/d/0BzBgxNrSWMA9aktVYm5EUzhNSE0/view?usp=sharing
You touch on the key advantages of credit based systems. Money is based on demand for money, so transactions and investment can occur with very little friction. At its best, a credit system allocates resources towards the most productive means, based on risk evaluation.
Another excellent point you bring up is about inflation. Credit based system will always return to zero over the long-run. Meaning, every new dollar created by a bank holds a promise to be destroyed. If everyone stopped creating new loans, than the money supply would eventually return to zero. This intrinsically contains inflation, because money is being destroyed by banks as fast as it is created. This is also what causes the ‘hangover’ effect when a spending binge (boom) is followed by a painful deleveraging (bust).
Another downside is a lot of room for corruption. Clever investors borrow to invest…they create money to purchase financial assets rather than create money to build a new factory or provide a new service. This behavior is what leads to equity booms and busts, and should probably be outlawed.
So why is system A, better than system B? Because system B has never existed, even under the gold standard, and it questionable if it would be possible or preferable.
Is there a better system? Yes. There are lots of ways to improve the current system, but most of them are regulatory. We can require banks hold more capital, to make them more resistant to default pressures. We need to be telling banks what they *can* do, rather than why they can’t do. If we could restrict bank lending to GDP generating activities, it would fix a lot of the problems.
Thanks for the excellent questions! Hope this helps, its a huge topic.
-Wayne
Hey Wayne,
Wow that was quick. Thank you!
_“If everyone accepted everyone else’s credit, there would be no need for any base money at all.“_
--> Fascinating thought! My initial reaction was: “But there needs to be some base money to use as our unit of account.” But then I thought it actually doesn’t matter whether our unit of account exists on a base level below or it is just an “imaginary” unit of measurement that we use to describe the purchasing power of a certain quantity of credit in a standardised way. After all, that’s what we do in physics and other fields too. What’s hard to grasp here and what makes this unique is that the purchasing power changes over time, but slow enough for the unit of account to still make sense. Do you agree or am I missing something?
_“Another downside is a lot of room for corruption. Clever investors borrow to invest…they create money to purchase financial assets rather than create money to build a new factory or provide a new service. This behavior is what leads to equity booms and busts, and should probably be outlawed.”_
--> Do you have any idea how governments could approach that problem? Where do you draw the line? Are there any concrete policy suggestions out there?
Where can I find your blog posts? I want to read them all :) Seriously, I would love to read everything you have ever written.
Also, I am super interested in macroeconomics and public economics. Do you have any recommendations for teaching material? Any great teachers on youtube that I should check out?
Who were your favourite teachers?
-Simon
So when banks earn interest on borrowing out of thin air, they eventually "earn" reserves or governement money, right?
Which money do they invest in financial sector? Reserves? And if they invest their reserves why would that represent the problem like a lot of them argue?
This is a lecture from economist Richard Werner about banking and money creation:
"I will tell you key points about banks. In case you thought banks lend money, they take deposits and lend money. You are wrong . Banking was developed, modern banking was developed, in the United Kingdom in the 17th century and the legal facts are very clear but not very well known. Banks do not take deposits and banks do not lend money. That's a fact.
How is that possible. How is that possible. Well, legally they do not take deposits. They borrow from the public, because your money at the bank is not on deposit. Its not held in custody, it's not a bailment.
What is it legally? You have lent money to the bank. So the expression in banking are designed to mislead what's really happening. Who is the owner of this money? It is the banks, you are just a general creditor. Which is very different from the impression given when we use the term deposit.
What about lending surely banks lend money? No they don’t. No bank has ever lent any money. How is that possible? What does a bank do?
Banks purchase securities and they don’t pay up. That's what they do. How is that? Well if you go to the bank and you borrow money you sign a loan contract. Very crucial. Your signature creates the money supply.
Because the bank legally will consider the loan contract a promissory note. And that is what is considered legally, is a promissory note. Just like the bank of England Note, central bank money, paper money, is a promissory note from the central bank. And the bank purchases this contract. That is what they do, they purchase the loan contract.
Now they owe you money. You say I dont care about the mechanics, give me the money. The banker will say we will put it in your account. You will find it in your bank account. Well what is a bank account? It is not a deposit. Its a record of the bank's debt to the public. It is a record of the bank's debt to the new borrower, and they show you the record of how much money they owe you. That is it, they don’t pay up. And this is how the money supply is created.
So lets go in sequence:
Step one: You go to the bank and you sign the loan contract, say a thousand pounds. This will be recorded in the bank balance sheet as an increase in bank assets. The bank, will then, record its debt to the borrower. But it will do some accountant trick. It should really say this is an accounts payable item. Something that the bank has to pay but it has not yet paid. But it wont record as an accounts payable.
If you talk to an bank's accountant they are horrified “No you cannot use an expression like accounts payable in a bank” And do you know why? Because they recorded it as customer deposit. They show it on the bank's liability side as a customer deposit. But nobody has deposited it, the customer has not deposited for sure. The customer is borrowing it. The bank has not deposited either. It is added to the money supply, and this is how 97% of the money supply is created out of nothing on the basis of a signature and of course on the credit of the borrower. That is money creation. So no money is transferred from any where else to the borrowers account."
Nice excerpt! Thanks for sharing. =)
Wayne isn't it funny if all banks create deposit at same pace in any sector let's say agriculture they don't need reserves at all!!!
okay I'm still struggling to really get it.Yes...when the bank of America creates a liability out of nothing,I can then go spend it a 7/11.great, that's endogenous money creation.But but banks eventually secure financing for that liability through capital bond issuance/money markets/Retaining customers bank deposits.So in effect there is no new net aggregate demand,someone's withheld consumption finances my conumption.quid pro quo.
+intajake
*_"banks eventually secure financing for that liability"_*
Banks will only secure funding for net outflows to other banks (whatever it owes CHIPS at the end of the day), this is a small fraction of total accounts payable. In many cases, funding is acquired so that there are zero outflows, zero government money exchanging hands.
Assuming zero inflows from other banks, the lending bank would fund the new deposits using The Federal Funds market, which is not a standard money market, it is exclusively for banks. In this market, they do not borrow private savings deposits, they borrow Bank Reserves. Meaning, when a bank borrows in the Fed Fund market, it is not debiting a private saving account, no _private_ purchasing power has been reduced to fund the new deposits.
Wasn't purchasing power removed by the Bank lending the Reserves to fund the new deposits? No, reserves do not circulate outside the interbank & treasuries markets - private citizens or companies do not use bank reserves. So, moving bank reserves from one bank to another changes absolutely nothing for the private sector.
The other sources of funding you mention, equity, and retaining deposits. One, equity funding will only be used by banks if they reach their regulatory thresholds. Although today, there is a tendency for banks to open subsidiaries rather than attract new equity. But yes, if a bank is forced by regulators to increase equity, then you can say the new deposits are funded by savings.
On retaining deposits, they are the cheapest source of funding for banks, so they have an interest to retain as many as possible. However, theoretically (ignoring regulation), a bank can lend and operate retaining zero deposits by acquiring the funding wholesale in the Fed Funds Market. This of course decreases the profitability of the bank.
*_"no new net aggregate demand"_*
When an individual saver lends their deposits to a borrower no new deposits are created. When a commercial bank lends their deposits, it is increasing the total quantity of demand deposits in the economy - it is increasing purchasing power, without decreasing the purchasing power of a saver.
Borrowing money from existing deposits: Saver(-deposits)→Borrower(+/-deposits)→Seller(+deposits) = Net Zero
Borrowing money from commercial banks: Borrower(+/-deposits)→Seller(+deposits) = Net Positive
The opposite is also true, when a borrower pays off debt to an investment fund or individual saver, then bank deposits are not destroyed. When a borrower pays off principle to a commercial bank, total deposits decline.
The growth of demand deposit money can significantly outpace the growth of government money. One way to look at this is that banks are increasing the quantity of inside money, by increasing the velocity of outside money. I prefer to look at government money, and bank deposits, as two entirely different financial assets.
Government is the _issuer_ of US Dollars, and if they printed up a c-note and spent it at 7/11 no one would argue this wasn't an increase in nominal demand, without a decrease in nominal savings - it is new money.
Banks are the _issuers_ of Bank Deposits, and if the printed up a $100 worth of deposits, and the borrower spent then at 7/11 this is _also_ an increase in nominal demand, without a decrease in nominal savings - it is new money.
There _are_ some important distinctions between inside and outside money, but for all practical purposes interbank clearing, and interbank lending have made government reserves mostly irrelevant operationally - they only become significant during crisis times.
Market entities are _users_ of both government money, and private bank money, but government money is only a small fraction. The creators of our _"money"_ are private banks - I would argue that this is mostly positive and endogenous money is one reason why capitalism is so dynamic (and unstable).
Does that help? =/
+intajake
Here is a more detailed response - I turned your points into an article post! ;)
*BANK FUNDING & AGGREGATE DEMAND*
Got a great comment on my _How Banks Create Money_ video (tinyurl.com/pp84c9m). Here is the post:
*_"Okay, I'm still struggling to really get it. Yes, when Bank of America creates a liability out of nothing, I can then go spend it a 7/11...great, that's endogenous money creation. But banks eventually secure financing for that liability through capital bond issuance/money markets/Retaining customers bank deposits. So, in effect there is no new net aggregate demand, someone's withheld consumption finances my conumption. quid pro quo"_*
These are really good questions, not your typical conspiracy mumbo-jumbo. The author is asking about the timing of bank funding. What is the difference between a bank acquiring funding immediately before or immediately after the issuance of new deposits? Banks create deposits from thin air, but they are responsible for those deposits, they must _" eventually secure financing for that liability through capital bond issuance/money markets/Retaining customers bank deposits."_. The answer is yes...and no.
If the depositor holding the new deposits spends them with a vendor who banks with another bank, at that moment, the issuing bank must find funding - it must settle in its assets. But this isn't quite the whole story because banks don't _immediately_ settle the transactions. Instead, banks transfer the deposits into an accounts payable, effectively converting one liability (deposits) into another liability (debt to CHIPS). Throughout the day, banks accumulate both payables to CHIPS, and receivables from CHIPS. At the time of settlement, the receivables and payables cancel each other out, and the bank is only responsible for the net.
Once the issuing bank determines how much they owe CHIPS, their net settlement position, they will look for funding - this is the moment the commenter is asking about, but it doesn't play out how one might think. At the moment of clearing, the bank's entire goal is to *_not_* have to settle their liability to CHIPS with assets (reserves).
There are a couple of ways a bank can make sure they have zero outflows at the end of the day. The cheapest way is to attract a lot of depositors - this will guarantee a lot of receivables coming from CHIPS. In this function, retaining deposits acts as a source of funding for banks. If you can retain enough depositors, you will be sitting on a net positive position at the end of each day, and get to earn interest lending your surplus to deficit banks.
If a bank doesn't have enough depositors and finds itself in a deficit position it will borrow the difference in the Federal Funds Market. The whole point of this market is to _zero out_ the CHIPS system, so that banks don't owe each other anything during clearing. Banks holding positive balances with CHIPS lend their surplus reserves to banks holding negative balances with CHIPS. At the moment of interbank clearing, few (if any) reserves are actually transferred.
Other significant characteristics of the Fed Funds Market: lending here is not counted in regulatory requirements, and the availability of funding here is limitless, since The Fed will always supply the reserves need to defend its target interbank rate. Meaning, it is bank lending that drives the quantity of reserves, not the quantity of reserves driving lending (other than the price).
The last source of funding the commenter mentions is equity funding, issuing new shares and attracting investors. The commenter mentions _capital bonds_, which is an attempt by banks to sidestep regulations. Capital Bonds allow them to attract _"equity"_ without having to dilute ownership privileges. The problem is, the bank is counting these bonds as _equity_, but the investors are counting them as bank _liabilities_. The shady behavior came from banks scrambling to meet new capital controls, but I don't believe these sorts of shenanigans will continue much longer - Banks hate it, and would much rather push their risk into external balance sheets. In any case, equity funding is a last resort for banks - it is only used when banks are forced by regulatory thresholds and it is certainly not _needed_ for banks to expand deposit liabilities.
Now that we got that out of the way, let's explore the commenter's more interesting question. If banks must find funding for the new deposits, doesn't this mean _"there is no new net aggregate demand,someone's withheld consumption finances my consumption"_.
The commenter proposes that all bank lending is funded from private savings, if not before, than some time after the deposits are created. No, The Federal Funds market is not a standard money market (which exchanges bank deposits), it is exclusively for banks. In this market, banks are not borrowing private savings deposits, they are borrowing Bank Reserves which do not circulate outside the banking sector. When a bank borrows in the Fed Funds market, it is not debiting a private saving account, no private entity is giving up existing deposits, no purchasing power has been reduced to fund the new deposits.
When an individual saver lends their deposits to a borrower in a money market, no new deposits are created. When a commercial bank lends their deposits, it is increasing the total quantity of demand deposits in the economy - it is increasing purchasing power, without decreasing the purchasing power of a saver.
The opposite is also true, when a borrower pays off debt to an investment fund or individual saver, then bank deposits are not destroyed. When a borrower pays off principle to a commercial bank, total deposits decline.
When banks create deposits, they are increasing aggregate demand without a saver. When bank deposits are destroyed, it decreasing aggregate demand, without crediting a saver. There is more happening than a simple transfer from savers to borrowers. It is possible to have accelerating private savings, and private investment, and still experience a decline in aggregate demand, if the pace of deleveraging is faster than the pace of private savings/investment.
Let's take a step back from the nuts and bolts - sometimes a conceptual approach is better.
The growth of demand deposits can significantly outpace the growth of government money. One way to look at this is that banks are increasing the quantity of inside money, by increasing the velocity of outside money. This is not entirely inaccurate, but I believe it is better to look at government money, and bank deposits, as two entirely different financial assets.
Government is the _issuer_ of US Dollars. If they "printed" up a c-note and spent it at 7/11 no one would argue this wasn't an increase in nominal demand, without a decrease in nominal savings - it is new money.
Banks are the _issuers_ of Bank Deposits, and if they "printed" up a $100 worth of deposits, and the borrower spent them at 7/11 this is also an increase in nominal demand, without a decrease in nominal savings - it is new money.
Market entities are the _users_ of both US Dollars, and Bank Deposits, but US Dollars are only a small fraction of the total money supply.
There are some important distinctions between inside and outside money, but for all practical purposes interbank clearing, interbank lending, and government guarantees have made bank reserves mostly irrelevant in day-to-day banking operations - they are only significant to set the base rate on lending, and during crisis times of course.
The creators of our most widely used form of "money" are private banks. In my opinion, this is mostly positive and endogenous money is one reason why capitalism is so dynamic (and unstable). But it does mean that banks play a role in creating new nominal demand in the economy. Total borrowing, at any given moment in time, consists of both transferring savings to borrowers _and_ banks creating new purchasing power independent of savers.
+intajake
annnnnd...here is an excellent lecture on the differences between endogenous money theory and loanable funds theory. Enjoy! =)
czcams.com/video/ICKD83sZ-qg/video.html
@@TheBalancedAmerican But why were than central banks injecting so much reserves into the banking system.Actually bailing out private investors who were holding bonds(if they hold them) or pension funds.
@@TheBalancedAmerican i don't understand still but those deposits that show in our account are matched by reserves only.If i deposited money in my bank account then transfer that money to someone else account then bank will send reserves also to that someone else banks! Same with loans if loan is given loan taker will send it to different banks and bank will send reserves to different bank.The same reserves revolving matching deposits.Only case deposit is new if it remains in same bank.Wayne so this is somewhat confusing.
so wayne i read your gold standard article.So you saying bank is modern world intermediary...so they give us deposit as asset and and take home as collateral...i don't understand why we have to give our home as collateral to bank if they just giving us debt aka deposit....why we can't do this our own because people don't trust each other money or just fiat is accepted everywhere i suppose that is why...i just don't understand why bank take our asset as collateral if they just giving us deposit aka debt lol...banking looks like very profitable business....my question is just that if bank is just giving as debt instrument to exchange between us why they take collateral from us for whose safety??
I’ve always found this a rather favorable deal for the bank as well. The argument would be, the bank is responsible for the deposits because it must ultimately fund the deposits with currency. Although considering bank funding is virtually guaranteed by the system, it seems unfair the bank would be able to acquire the property at default with such little risk.
At its best, modern banking is a really prudent way to bind money creation to the productive effort of the borrower.
At its worst, modern finance can be parasitic and exploitative.
@@TheBalancedAmerican Wayne i really wanna say thanks to you for these videos and even comments under it you have answered (i read them all) it has enchanced my knowledge of monetary and fiscal system greatly.Thanks again!I will say credit creation is dangerous too. Especially from the perspective of derivative trading these days 0DTE options are very popular and if you see twitter many earning good money from 0DTE too from chart trading but then these so called forex trading platform provides already 500x leverage too.Like this credit creation is mostly not going too productive purposes but leverage trading things...so much leveraged is system.
@@TheBalancedAmerican Wayne since you said bank funding is virtually guaranteed by system i wonder what are all ways through which bank funding is virtually guaranteed by system?
1) interbank market ( i.e. money market as much i know)
2) discount window
3) in crisis by federal reserve ( so when in crisis federal reserve give temporary liquidity to system or banks) is it free or banks have to pay it back to fed?
@@TheBalancedAmerican here goes silicon valley bank wayne...banks can actually fail...and fed won't save them.
@@shubhamsingla9340 Yes! The fed will not lend to an insolvent bank, unless it would be catastrophic to the system. I speak briefly about how banks go down in the Federal Funds Market video. In 2007, Fed allowed Lehman Brothers and Bear Sterns to fail before it start lending to insolvent banks. During that crisis, the Fed ended up buying many of the bad assets on the books of insolvent banks. I believe those bad assets are still on the Fed's balance sheet! (see Maiden Lane Transactions).
So what is happening with SVB? Although it is still early, it looks like they are getting the double-whammy...collapsing asset values, and a run on their deposits. Best guess, SVB was over-exposed to bonds issued by Tech companies, which have been going bust left and right lately. Word got out that they had a bunch of non-performing assets, and so investors started moving their uninsured deposits to other banks.
How does SVG respond to everyone moving their deposits? It needs to convert one payable ('deposits') to another ('fed funds loan')...only this time, other banks wouldn't lend to them! Their assets are non-performing. Can't sell their assets, can't get a loan, and all the bank's capital is chewed up, its over for them!