Elements of Monetary Science

Satya_anveshi · Post by **Satya_anveshi** » 03 Dec 2011 20:18

Neshant ji, gauanglet has been thrown by Pranav ji and you have excellent opportunity to drill some economic common sense into junta. I am sure there are others noobs like me who are "all ears" to get more gyan

Pranav ji,

Even as you patiently wait for Neshant to come back, I get that having too high reserve requirement (by that I mean even anywhere >5%) overall creates a ton of money just sitting idle out of productive economy. Having too low creates more money in the system which by itself does not mean increase in the money supply.

But once this is settled, can you comment on assumptions around deposit rates? Given that $ is currency of choice and it spreads far and wide pretty quickly (relative to other currencies), does the money get deposit at "reasonable" rates? The lower the deposit rate the lower the money in the system.

What are the effects of this money that is getting out of the "local" system?

Pranav · Post by **Pranav** » 03 Dec 2011 23:35

Satya_anveshi wrote:Neshant ji, gauanglet has been thrown by Pranav ji and you have excellent opportunity to drill some economic common sense into junta. I am sure there are others noobs like me who are "all ears" to get more gyan

Pranav ji,

Even as you patiently wait for Neshant to come back, I get that having too high reserve requirement (by that I mean even anywhere >5%) overall creates a ton of money just sitting idle out of productive economy. Having too low creates more money in the system which by itself does not mean increase in the money supply.

But once this is settled, can you comment on assumptions around deposit rates? Given that $ is currency of choice and it spreads far and wide pretty quickly (relative to other currencies), does the money get deposit at "reasonable" rates? The lower the deposit rate the lower the money in the system.

What are the effects of this money that is getting out of the "local" system?

Yes, if you increase the cash reserve ratio (CRR), that will reduce liquidity. So you do occasionally read news items like "RBI increases CRR to curb inflation".

As regards interest rates, they are market determined. I will give my take on interest rates a little later. Will first wrap up discussion of Fractional Reserve, by Monday or Tuesday.

Satya_anveshi · Post by **Satya_anveshi** » 03 Dec 2011 23:50

But once this is settled, can you comment on assumptions around deposit rates? Given that $ is currency of choice and it spreads far and wide pretty quickly (relative to other currencies), does the money get deposit at "reasonable" rates? The lower the deposit rate the lower the money in the system.

My apologies....By "deposit rates" I didn't mean interest rates. I mean the ratio of money that eventually gets back as deposits (may be we can call it plow back ratio). Clearly, not all money comes back as deposit but some does. Whether it is all that comes back, 90%, or 70% depends on other factors. For USD this could be of particular siginificance.

Pranav · Post by **Pranav** » 04 Dec 2011 06:48

Satya_anveshi wrote:
But once this is settled, can you comment on assumptions around deposit rates? Given that $ is currency of choice and it spreads far and wide pretty quickly (relative to other currencies), does the money get deposit at "reasonable" rates? The lower the deposit rate the lower the money in the system.
My apologies....By "deposit rates" I didn't mean interest rates. I mean the ratio of money that eventually gets back as deposits (may be we can call it plow back ratio). Clearly, not all money comes back as deposit but some does. Whether it is all that comes back, 90%, or 70% depends on other factors. For USD this could be of particular siginificance.

If there is interest (which is a factor we haven't brought into the picture yet), it doesn't make sense to keep the money under a mattress - so the "plow back" rate will be quite high.

With a CRR of 10% and a 100% plow back rate, the loan volume will be 900% of the initial deposit. If the plow back rate is less, then the loan volume will also be less.

hariks · Post by **hariks** » 04 Dec 2011 12:14

What this says is 1 = N + 1 - N (where (N + 1) is deposit/reserve cash and (-N) is loans) and N can be arbitrarily high.
But when N is greater than the real money in the system (1 in this case) the system is not sustainable. Suppose a depositor wants to withdraw 2 gold coins (which has has deposited in two installments earlier) - the bank is insolvent. I don't have any economics background, but this sounds similar to a ponzi scheme.

shyam · Post by **shyam** » 04 Dec 2011 14:31

That is why they use paper instead of gold.

They can print two papers and thereby insolvency can be avoided. None of the bankers want a banking system that uses gold, even though technology is available for that.

Pranav · Post by **Pranav** » 04 Dec 2011 23:39

hariks wrote:What this says is 1 = N + 1 - N (where (N + 1) is deposit/reserve cash and (-N) is loans) and N can be arbitrarily high.
But when N is greater than the real money in the system (1 in this case) the system is not sustainable. Suppose a depositor wants to withdraw 2 gold coins (which has has deposited in two installments earlier) - the bank is insolvent. I don't have any economics background, but this sounds similar to a ponzi scheme.

Money deposited is lent out (apart from what is set aside as reserve). So yes, there can be a problem if so many depositors want to withdraw, that the reserves prove insufficient. Under normal circumstances, the probability of this happening is negligibly small.

And even if it does happen, the bank can borrow cash from the RBI (which can print money for the purpose, if necessary). When when the panic subsides, and the bank has gotten back the money lent out, it can return the money to the RBI, which can then withdraw it from circulation. So the money printed to tide over the panic doesn't have to result in any permanent expansion in the money supply.

So no, it's not a Ponzi scheme.

Neshant · Post by **Neshant** » 05 Dec 2011 07:27

Pranav wrote:Under normal circumstances, the probability of this happening is negligibly small.

Its not negligibly small, its routine. Its the reason all fiat currencies inevitably collapse. The more the leverage grows, the more likely it is to collapse due to a proportionatly small withdrawl which cannot be met.

Leverage is essentially gambling with someone else's savings often times without his permission. That is just wrong.

But just for the sake of argument, if we try to imagine a non-leveraged fiat money system that's half way honest (i.e. mimics gold), this should ideally be the scenario :

What should be happening in a bank run under the fiat system is the bank should increase the dividend paid to savers for NOT participating in the bank run. Not only will that provide strong incentive not to participate in the run, it will also attract other savers willing to take the risk (of losing their capital) for the reward. Instead what happens is savers get ripped off with money being counterfeited at their expense to pay off those making withdrawls.

A bank "deposit" is a misnomer. It should be called a "loan to a bank" because that is what most people are doing when they deposit their money in a bank. A loan implies risk of not getting your money back. This should be CLEARLY spelt out to any person making a deposit. There should be no FDIC which passes on the risks to other people who never signed up for the risk to begin with.

Its really for the free market to work out what terms should exist between lender (saver) and borrower (bank). For example, a bank might state that a minimum 3 months waiting period is required before your withdrawl request is processed. You'd agree to this before you ever made a deposit of course.

The evil of central banking, inflating and intrinsically worthless money is to penalise a person who does not want to participate in the useless middleman industry game of paper shuffling. Inflation destroys the fruits of his labor and tries to force the person to loan money to a fee-collecting bank and assume needless risk where the reward at best is keeping the value of what he has earned. All kinds of bizaare theories are used to explain why destroying a person's savings is good for him.

Pranav · Post by **Pranav** » 05 Dec 2011 08:59

Neshant wrote:
Pranav wrote:Under normal circumstances, the probability of this happening is negligibly small.
Its not negligibly small, its routine. Its the reason all fiat currencies inevitably collapse.

Let's not mix up issues ... first we need to recognize that a bank operating by the fractional reserve system does not "print money", "out of thin air", as many folks mistakenly allege. In due course we will discuss backing of currency.

Leverage is essentially gambling with someone else's savings often times without his permission. That is just wrong.

Depositors are well aware that they can earn interest only if their money is put to work! And of course there is a risk. In the US, for example, banks are required to follow norms and pay premiums for FDIC insurance, which will cover deposits only up to $200,000.

Those who don't want to earn interest are perfectly free to sign up for Islamic Sharia compliant banking.

Neshant · Post by **Neshant** » 05 Dec 2011 10:15

Let's not mix up issues ... first we need to recognize that a bank operating by the fractional reserve system does not "print money", "out of thin air", as many folks mistakenly allege.

It does print money out of thin air. When you spend or lend out something you have not earned, in essence you have counterfeited it (i.e. stolen its value from someone who has earned it). Why is this concept so hard to grasp??????

Depositors are well aware that they can earn interest only if their money is put to work! And of course there is a risk.

But you said there is no interest on deposit of the gold coin. Yet there is risk. So why would anyone be depositing a gold coin with a bank only to be enrolled in a ponzi scheme and incur huge risks.

Under the paper standard, the "interest" is nothing more than money that has been confiscated from savers through theft by the printing press. Where is the risk if everybody believes they will be made whole by the FDIC which is to say sending the bill to some other sucker/taxpayer for your own investment ineptitude.

Also what is this notion of "put it to work"? Being forced to loan money to a bunch of guys gambling with my savings under the duress of inflating (devaluing / counterfeiting / destroying) the fruits of my labor strikes me as fraud. It exists only to perpetuate the useless fee collecting middleman industry not for the benefit of society.

You need to get away from the criminal mindset of counterfeiting money. Erase all that junk from your mind. The power of money needs to reside with the people who have worked hard to EARN it, not the people who are counterfeiting it nor the people who are gaming the system to milk others of it.

Neshant · Post by **Neshant** » 05 Dec 2011 10:52

My favourite video, i post it often. Please check it out :

What you may find amazing is this video was made well before 2008. Yet note how accurately it describes events. Quite frankly it was an eye opener to me.

Pranav · Post by **Pranav** » 05 Dec 2011 12:19

Neshant wrote:
Let's not mix up issues ... first we need to recognize that a bank operating by the fractional reserve system does not "print money", "out of thin air", as many folks mistakenly allege.
It does print money out of thin air. When you spend or lend out something you have not earned, in essence you have counterfeited it (i.e. stolen its value from someone who has earned it). Why is this concept so hard to grasp??????

The bank is lending with the consent of the depositor. Anyway, the point is that the number of gold coins has not increased. As you admitted, the money supply remains unchanged. How could there have been any counterfeiting if the money supply remains exactly what it was?

Depositors are well aware that they can earn interest only if their money is put to work! And of course there is a risk.

But you said there is no interest on deposit of the gold coin. Yet there is risk.

So why would anyone be depositing a gold coin with a bank only to be enrolled in a ponzi scheme and incur huge risks.

OK, I have not introduced interest as yet. Let's also assume that all borrowers are scrupulously reliable. Once we overcome, in this simplified scenario, misconceptions like banks "printing money out of thin air", we can bring interest, risk, and fiat currency into the picture.

Under the paper standard, the "interest" is nothing more than money that has been confiscated from savers through theft by the printing press. Where is the risk if everybody believes they will be made whole by the FDIC which is to say sending the bill to some other sucker/taxpayer for your own investment ineptitude.

Also what is this notion of "put it to work"? Being forced to loan money to a bunch of guys gambling with my savings under the duress of inflating (devaluing / counterfeiting / destroying) the fruits of my labor strikes me as fraud. It exists only to perpetuate the useless fee collecting middleman industry not for the benefit of society.

You need to get away from the criminal mindset of counterfeiting money. Erase all that junk from your mind. The power of money needs to reside with the people who have worked hard to EARN it, not the people who are counterfeiting it nor the people who are gaming the system to milk others of it.

There are a large number of misconceptions in all that, but let us not divert ourselves.

Pranav · Post by **Pranav** » 05 Dec 2011 12:24

Neshant wrote:My favourite video, i post it often. Please check it out :

What you may find amazing is this video was made well before 2008. Yet note how accurately it describes events. Quite frankly it was an eye opener to me.

I am aware of the Jekyll Island book by this guy. He does tell some interesting history, but his understanding of monetary science and his policy prescriptions are deeply flawed.

Neshant · Post by **Neshant** » 05 Dec 2011 14:58

Pranav wrote:The bank is lending with the consent of the depositor.

No it isn't. The depositor fully expects to get his money back at all times. If whatever venture the bank has invested in goes bust (never mind the fact that its leveraged 9 to 1 !), where is the money to pay the depositor coming from?

You make so many assumptions to the point where the whole scenario becomes unbelievable.

The whole scenario feels more like the element of monetary fraud rather than monetary science. If anything just thinking about it makes me fearful of how dangerously close the western world is to fiat collapse and destroying savers.

Pranav · Post by **Pranav** » 05 Dec 2011 17:09

Neshant wrote:
Pranav wrote:The bank is lending with the consent of the depositor.
The depositor fully expects to get his money back at all times. If whatever venture the bank has invested in goes bust (never mind the fact that its leveraged 9 to 1 !), where is the money to pay the depositor coming from?

Banks are supposed to make judgments about credit-worthiness, and secure collateral. The depositor knows that if the bank management is incompetent, he is protected only up to a limit ($200K in the US).

If that is not good enough, he is quite free to sign up for Islamic Sharia compliant banking, or keep his gold coins under his mattress.

But whether the depositor is getting a raw deal is besides the immediate point - which is the simple fact that the money supply has not increased at all.

You make so many assumptions to the point where the whole scenario becomes unbelievable.

We simplify the model to get rid of non-essential clutter. Decreases the opportunity to muddy the water. Standard practice in scientific analysis.

Neshant · Post by **Neshant** » 06 Dec 2011 07:55

Pranav wrote: Banks are supposed to make judgments about credit-worthiness, and secure collateral. The depositor knows that if the bank management is incompetent, he is protected only up to a limit ($200K in the US).

Protected how? WHERE is the money coming from to make good the losses (taxpayer??) ? The fruits of WHO'S labor should be confiscated to cater to these banking pretenders who claim to make judgements about credit-worthiness when they incur a loss? These charlatans have gambled and lost trillions in recent times proving they know zero. They have no special insight into anything and are just rolling dice.

There is no magic money that appears out of nowhere. When you spend or lend out something you have not earned, in essence you have counterfeited it (i.e. stolen its value from someone who has earned it). When you gamble with leverage, someone else who has not agreed to be enrolled in a ponzi scheme is forced to assume the loss when it goes under. Its just that simple.

But whether the depositor is getting a raw deal is besides the immediate point - which is the simple fact that the money supply has not increased at all.

Where is the interest deposit coming from? Where is the money to pay for losses coming from when losses are 9X deposits?

We simplify the model to get rid of non-essential clutter. Decreases the opportunity to muddy the water. Standard practice in scientific analysis.

This is not a model, its a load of nonsense. There is no magic pot of money. If there were, we'd all be setting up banks, counterfeiting money and getting rich.

I'll tell you what the scenario above parallels. It parallels house flipping back in 2006/7. People with no/little income were leveraging 1/2 million dollar mortgages and when things went boom, the productive people in society are put on the hook for decades on end paying off their foolish debts. The model of house flipping has gone up in smoke and with it your scenario!

As mentinend this is not monetary science, its monetary fraud.

Pranav · Post by **Pranav** » 06 Dec 2011 08:35

Neshant wrote:Where is the interest deposit coming from? Where is the money to pay for losses coming from when losses are 9X deposits?

We can very easily bring interest and losses into the picture, but first things first. Let us recognize that the bank, lending out a fraction of its deposits, does not increase the money supply at all.

hariks · Post by **hariks** » 06 Dec 2011 12:49

Pranav wrote: So yes, there can be a problem if so many depositors want to withdraw, that the reserves prove insufficient. Under normal circumstances, the probability of this happening is negligibly small.

And even if it does happen, the bank can borrow cash from the RBI (which can print money for the purpose, if necessary). When when the panic subsides, and the bank has gotten back the money lent out, it can return the money to the RBI, which can then withdraw it from circulation. So the money printed to tide over the panic doesn't have to result in any permanent expansion in the money supply.

So no, it's not a Ponzi scheme.

What if the rich uncle (RBI) does not exist? If we assume that the scenario is played out in olden times with no central bank and a loan shark essentially performs as a bank. The transactions are carried out in real gold coins and nobody accepts paper (printed money).
Now the 9:1 leverage will be too risky for the loan shark, and he has to limit amount of outstanding loans to the amount of money he has put in + a fraction of the depositors money (not more than the whole capital in the system, like the 9:1 scenario).
The depositors understand that they are taking a risk, and they may not get all the money back if loans go bad, and interest is the reward for the risk. Not many will be willing to gamble with all their money, so the fraction lent out will be more on the conservative side.
With this restriction on the amount of outstanding loans the system can sustain. Do not give further loans till some existing loans are repaid. Otherwise it can collapse easily and bailouts (RBI helping hand) will be needed.

Pranav · Post by **Pranav** » 06 Dec 2011 19:46

hariks wrote:
Pranav wrote: So yes, there can be a problem if so many depositors want to withdraw, that the reserves prove insufficient. Under normal circumstances, the probability of this happening is negligibly small.

And even if it does happen, the bank can borrow cash from the RBI (which can print money for the purpose, if necessary). When when the panic subsides, and the bank has gotten back the money lent out, it can return the money to the RBI, which can then withdraw it from circulation. So the money printed to tide over the panic doesn't have to result in any permanent expansion in the money supply.

So no, it's not a Ponzi scheme.
What if the rich uncle (RBI) does not exist? If we assume that the scenario is played out in olden times with no central bank and a loan shark essentially performs as a bank. The transactions are carried out in real gold coins and nobody accepts paper (printed money).
Now the 9:1 leverage will be too risky for the loan shark, and he has to limit amount of outstanding loans to the amount of money he has put in + a fraction of the depositors money (not more than the whole capital in the system, like the 9:1 scenario).
The depositors understand that they are taking a risk, and they may not get all the money back if loans go bad, and interest is the reward for the risk. Not many will be willing to gamble with all their money, so the fraction lent out will be more on the conservative side.
With this restriction on the amount of outstanding loans the system can sustain. Do not give further loans till some existing loans are repaid. Otherwise it can collapse easily and bailouts (RBI helping hand) will be needed.

Yes, in the situation you depict (no RBI), the banker would probably need to be more conservative.

Pranav · Post by **Pranav** » 06 Dec 2011 19:50

One clarification as regards leverage in the situation we have set up: It is not that the bank is loaning out 9 times the amount it has received in deposits. In fact, total loans are always less than total deposits. Leverage, if defined as the ratio of loans to deposits, is 0.9x, not 9x.

However, both total loans and total deposits could be many times the number of physical gold coins in the system. The same coins are being reused.

paramu · Post by **paramu** » 07 Dec 2011 07:02

In fractional reserve banking, does asset/commodity/labor prices go up?

If yes, isn't that same as increase in money supply?
If not, what happens to the money that is lent out and what is its role in the society.

Suppose, people are allowed to exchange the receipts for gold deposits (which is later became currency) to exchange commodities. Does that increase money supply? or cause inflation? Now people can trade using gold they have and receipts for gold they deposited.

Pranav · Post by **Pranav** » 07 Dec 2011 08:10

paramu wrote:In fractional reserve banking, does asset/commodity/labor prices go up?

If yes, isn't that same as increase in money supply?
If not, what happens to the money that is lent out and what is its role in the society.

Suppose, people are allowed to exchange the receipts for gold deposits (which is later became currency) to exchange commodities. Does that increase money supply? or cause inflation? Now people can trade using gold they have and receipts for gold they deposited.

Without fractional reserve, a lot of the gold coins would remain sitting in vaults and under mattresses. So, with a smaller amount of currency circulating, wages and prices would tend to be lower. With fractional reserve, the equilibrium will be at a higher level. Which is not a bad thing, everything is relative.

Fractional reserve allows the surpluses created in one section of the economy to be efficiently redeployed to other sections where value creation is maximum. For example, suppose the nation is short of cement. You keep your savings in a bank. You don't know anything about manufacturing cement, but someone who does can borrow from the bank and set up a plant. If he expects a high return, he can give a high interest to the bank, which in turn can give you a high interest on your savings.

As regards banks issuing gold backed paper notes - it is a bad system. Bankers are liable to print more notes than there is gold in their vaults. The modern system does not permit banks to run printing presses, only the RBI can do that.

paramu · Post by **paramu** » 08 Dec 2011 03:55

Pranav wrote:Without fractional reserve, a lot of the gold coins would remain sitting in vaults and under mattresses. So, with a smaller amount of currency circulating, wages and prices would tend to be lower. With fractional reserve, the equilibrium will be at a higher level. Which is not a bad thing, everything is relative.

Let's keep aside whether prices going up is good or bad. So you agree that FRB causes prices to go up, which is similar to causing inflation. How is that different from creating additional money supply? Another thing that FRB causes is increase in debt. Is that a good thing?

Fractional reserve allows the surpluses created in one section of the economy to be efficiently redeployed to other sections where value creation is maximum. For example, suppose the nation is short of cement. You keep your savings in a bank.

Again let us keep aside whether it is <> efficient or <> maximum. Without any additional money printing, all FRB does is to shift the equilibrium point. What happens after that? It is again going to be in the same state as one without any FRB.

Now you come to the same state as before, albeit at a different equilibrium point, but you have more debt and associated risk. Is that a good thing? What exactly is the gain you have now with FRB?

To let the FRB party going, it needs inflation, that is more money printing and the additional FRB leverage.

Neshant · Post by **Neshant** » 08 Dec 2011 08:10

We can very easily bring interest and losses into the picture, but first things first. Let us recognize that the bank, lending out a fraction of its deposits, does not increase the money supply at all.

Counterfeiting DOES increase the money supply. It dilutes the value of money that others have legitimately earned.

You cannot lend out (aka gamble with) something you don't have unless you are taking it from someone else through force or fraud. In this case the latter.

Pranav · Post by **Pranav** » 08 Dec 2011 08:23

paramu wrote:So you agree that FRB causes prices to go up, which is similar to causing inflation.

I would say that the equilibrium for wages and prices is at a higher point.

How is that different from creating additional money supply?

Depends on the definition. Some definitions count only the deposits without counting the balancing loans. I prefer the monetary base ("M0"), which, in our case, is the number of gold coins in circulation.

Another thing that FRB causes is increase in debt. Is that a good thing?

It makes loans available for those who want them.

Without any additional money printing, all FRB does is to shift the equilibrium point. What happens after that? It is again going to be in the same state as one without any FRB.

Now you come to the same state as before, albeit at a different equilibrium point, but you have more debt and associated risk. Is that a good thing? What exactly is the gain you have now with FRB?

The good thing is facilitating the redeployment of surpluses generated in one sector to other sectors where value creation is higher. You can't expect every saver to do their own research about the business prospects of various companies that need funds.

To let the FRB party going, it needs inflation, that is more money printing and the additional FRB leverage.

No, FRB does not need inflation, we will come to that shortly.

For now we remark that if you keep the money supply static in a growing economy, you will enter into a deflationary spiral, which will bring the economy to a grinding halt (as happened for example in 1929 in the US).

Pranav · Post by **Pranav** » 08 Dec 2011 08:25

Neshant wrote:
We can very easily bring interest and losses into the picture, but first things first. Let us recognize that the bank, lending out a fraction of its deposits, does not increase the money supply at all.
Counterfeiting DOES increase the money supply.

Go back to the Tom, Dick and Harry scenario. As you admitted, Dick, by borrowing 8 gold coins from Tom, and lending 5 of them to Harry, has not increased the money supply. Dick may be a very evil person, but he has not increased the money supply.

Neshant · Post by **Neshant** » 08 Dec 2011 10:55

Go back to the Tom, Dick and Harry scenario. As you admitted, Dick, by borrowing 8 gold coins from Tom, and lending 5 of them to Harry, has not increased the money supply. Dick may be a very evil person, but he has not increased the money supply.

You said 9X leverage. The moment that happens, money is being counterfeited and the money supply is being increased - through fradulent means.

Also why should some clueless guy dressed in a tie at a bank be counterfeiting my money and offloading the loss on me. I can do it myself ! He doesn't have any more insight than I do. I can hit print button on my printer & lend it out too. Why stop at 9X. Why not 90X. Or 9000X. Surely if creating money out of thin air works for the banker, it should work for everyone.

Only question is who's eating the loss when things go south.

Pranav · Post by **Pranav** » 08 Dec 2011 11:06

Neshant wrote:
Go back to the Tom, Dick and Harry scenario. As you admitted, Dick, by borrowing 8 gold coins from Tom, and lending 5 of them to Harry, has not increased the money supply. Dick may be a very evil person, but he has not increased the money supply.
You said 9X leverage. The moment that happens, money is being counterfeited and the money supply is being increased - through fradulent means.

Also why should some clueless guy dressed in a tie at a bank be counterfeiting my money and offloading the loss on me. I can do it myself ! He doesn't have any more insight than I do. I can hit print button on my printer & lend it out too. Why stop at 9X. Why not 90X. Or 9000X. Surely if creating money out of thin air works for the banker, it should work for everyone.

Only question is who's eating the loss when things go south.

0.9X, not 9X. Perhaps you missed this post - http://forums.bharat-rakshak.com/viewto ... 5#p1207095 . The bank is doing exactly what Dick did, multiple times.

ArmenT · Post by **ArmenT** » 08 Dec 2011 13:08

Interesting thing though is that most of the currency transfers these days are via electronic means rather than exchanging gold or notes. So there's no need for a bank to actually print extra notes. Public merely assumes that the bank is sticking to the FRB rules (i.e. not lending out more money than it has on the books.)

Now say the bank is a multinational shady type and really has $1000 on deposit. Say, Joe American applies to this bank for $5000. Now if the bank was following FRB rules and could not loan more than 90% of deposits, it could not possibly cover this loan application because it can only loan our $900 max. However, shady bank grants this loan and for the federal auditors benefit, claims that Sheik Bin Cheatin' had just deposited $20,000 worth of gold bars the previous day in their middle-eastern branch, therefore they can easily loan out $5000. So, they grant a loan at 5% interest rate and transfer $5000 to Joe American's bank account electronically. Federal official has no way to check if Sheik Bin Cheatin' even exists or not, as he's outside their jurisdiction. However, Joe American eventually has to pay back $5000 + $250 if he wants to fully repay his loan.

Wonder if such a thing is actually possible? Well, replace the name of the bank with an actual Paki-run bank called BCCI (Bank of Credit and Commerce International) and you sort of have their story in a nutshell. It was set up in such a way that no single country had overall regulatory supervision and the head offices were in two countries with notoriously lax banking laws. At one point, BCCI was lending to one family alone, more than 3x their capital. When asked where their rapid growth came from, they claimed it came from large deposits by oil-rich Arab families and Arab states who owned stock in the bank.

shyam · Post by **shyam** » 08 Dec 2011 13:44

Pranav wrote:0.9X, not 9X. Perhaps you missed this post - http://forums.bharat-rakshak.com/viewto ... 5#p1207095 . The bank is doing exactly what Dick did, multiple times.

0.9x is the lending ratio. 9x is the leverage, if the bank effectively lends out 9 times the original deposit it had.

shyam · Post by **shyam** » 08 Dec 2011 13:48

ArmenT: check this article.
Money has been privatised by stealth

Pranav · Post by **Pranav** » 08 Dec 2011 15:03

ArmenT wrote: Now say the bank is a multinational shady type and really has $1000 on deposit. Say, Joe American applies to this bank for $5000. Now if the bank was following FRB rules and could not loan more than 90% of deposits, it could not possibly cover this loan application because it can only loan our $900 max. However, shady bank grants this loan and for the federal auditors benefit, claims that Sheik Bin Cheatin' had just deposited $20,000 worth of gold bars the previous day in their middle-eastern branch, therefore they can easily loan out $5000. So, they grant a loan at 5% interest rate and transfer $5000 to Joe American's bank account electronically. Federal official has no way to check if Sheik Bin Cheatin' even exists or not, as he's outside their jurisdiction. However, Joe American eventually has to pay back $5000 + $250 if he wants to fully repay his loan.

Wonder if such a thing is actually possible? Well, replace the name of the bank with an actual Paki-run bank called BCCI (Bank of Credit and Commerce International) and you sort of have their story in a nutshell. It was set up in such a way that no single country had overall regulatory supervision and the head offices were in two countries with notoriously lax banking laws. At one point, BCCI was lending to one family alone, more than 3x their capital. When asked where their rapid growth came from, they claimed it came from large deposits by oil-rich Arab families and Arab states who owned stock in the bank.

Interesting story

Can deposits in kind (i.e. gold bars) be counted as reserves? AFAIK the banks' reserve accounts are maintained with the Fed and are denominated in USD.

Pranav · Post by **Pranav** » 08 Dec 2011 15:05

shyam wrote:
Pranav wrote:0.9X, not 9X. Perhaps you missed this post - http://forums.bharat-rakshak.com/viewto ... 5#p1207095 . The bank is doing exactly what Dick did, multiple times.
0.9x is the lending ratio. 9x is the leverage, if the bank effectively lends out 9 times the original deposit it had.

(total loans)/(total deposits) is what we should look at.

A good deal of confusion arises in discussions among people who use different definitions of leverage. The term is used differently in investments and corporate finance, and has multiple definitions in each field.

http://en.wikipedia.org/wiki/Leverage_%28finance%29

Pranav · Post by **Pranav** » 08 Dec 2011 18:24

ArmenT wrote: Now say the bank is a multinational shady type and really has $1000 on deposit. Say, Joe American applies to this bank for $5000. Now if the bank was following FRB rules and could not loan more than 90% of deposits, it could not possibly cover this loan application because it can only loan our $900 max. However, shady bank grants this loan and for the federal auditors benefit, claims that Sheik Bin Cheatin' had just deposited $20,000 worth of gold bars the previous day in their middle-eastern branch, therefore they can easily loan out $5000. So, they grant a loan at 5% interest rate and transfer $5000 to Joe American's bank account electronically. Federal official has no way to check if Sheik Bin Cheatin' even exists or not, as he's outside their jurisdiction. However, Joe American eventually has to pay back $5000 + $250 if he wants to fully repay his loan.

Hmm ... suppose Joe has an account with BofA. The money is not credited to Joe's account until BofA's reserve account (with the Fed) is credited $5000 from the reserve account of the bank on which the check is drawn.

So it's not clear how the scam works ... maybe BofA was also a part of the scam?

Pranav · Post by **Pranav** » 08 Dec 2011 18:31

shyam wrote:ArmenT: check this article.
Money has been privatised by stealth

From the article -

Here's how it works. When you ask the bank for the money to buy a one-bedroom box in London, the money that appears in your account isn't borrowed from some prudent grandmother's life savings. In fact, the bank simply types those numbers into your account, creating brand new money that you can now spend.

This is highly misleading. The assumption seems to be that the borrower has his account with the lending bank (say Bank A). When the borrower writes a check to the seller of the house, and the seller deposits it in his bank (say Bank B ), then the amount is deducted from Bank A's reserve account (with the Central Bank) and transferred to Bank B's reserve account.

So how much Bank A can lend is constrained by how much it has in its reserve account with the Central Bank. And the money in Bank A's reserve account does come ultimately from the proverbial prudent grandmother.

shyam · Post by **shyam** » 08 Dec 2011 21:53

Pranav wrote:
shyam wrote:0.9x is the lending ratio. 9x is the leverage, if the bank effectively lends out 9 times the original deposit it had.
(total loans)/(total deposits) is what we should look at.

The actual cash that bank has is the initial amount. It is only the book value that goes with lending and deposits. The denominator for leverage is the actual cash in the bank.

Pranav · Post by **Pranav** » 08 Dec 2011 22:43

shyam wrote:
Pranav wrote: (total loans)/(total deposits) is what we should look at.
The actual cash that bank has is the initial amount. It is only the book value that goes with lending and deposits. The denominator for leverage is the actual cash in the bank.

The point is that irrespective of the definition of leverage being used (and there are several of those), the bank is just repeatedly doing what Dick did when he borrowed 8 coins from Tom and lent 5 of them to Harry. Since Dick did not increase the money supply, neither does the bank.

Neshant · Post by **Neshant** » 09 Dec 2011 02:48

The point is that irrespective of the definition of leverage being used (and there are several of those), the bank is just repeatedly doing what Dick did when he borrowed 8 coins from Tom and lent 5 of them to Harry. Since Dick did not increase the money supply, neither does the bank.

It IS increasing the money supply. Lending out more than the base money is counterfeiting. No amount of shell games or fancy terminology can disguise that fact.

Counterfeiting money is fraud. It steals from the productive economy. Its no different than if I were to start printing $900 up on my printer.

I too can open up 3 banks, deposit and lend out my own money in each of my banks and hit the Print button at the end of the day. Its plain old counterfeiting and the paper shuffling merely meant to baffel the ignorant.

Satya_anveshi · Post by **Satya_anveshi** » 09 Dec 2011 06:25

Pranav saab,

as a special case of FRB, consider CRR of 0%; interest rate=0%;

Does the money supply increase?
more importantly, does it matter whether money supply increased or decreased?
What happens to the perceived value of "currency"?

Pranav · Post by **Pranav** » 09 Dec 2011 07:23

Neshant wrote:
The point is that irrespective of the definition of leverage being used (and there are several of those), the bank is just repeatedly doing what Dick did when he borrowed 8 coins from Tom and lent 5 of them to Harry. Since Dick did not increase the money supply, neither does the bank.
It IS increasing the money supply. Lending out more than the base money is counterfeiting. No amount of shell games or fancy terminology can disguise that fact.

If Dick did not increase the money supply by borrowing 8 coins and lending 5, he will not increase the money supply if he does the same thing n times. n times zero is zero.