[phaemon]

No, read the pdf I linked. Yours is the first misconception they address.

In summary, though, if we imagine that the bank is required to hold 10% reserve: I go to the bank and get a loan for $900. This is credited to my account. There is no requirement for this money to actually exist. The same day, you go and deposit $100 in actual dollar bills. Your account is credited with $100.

The bank's liabilities are now $100 (in your account) plus $900 (in my account) for a total of $1000. The banks reserve is $100 (real dollar bills you gave them). This is 10% reserve so the bank is legally OK. $900 has been created.

That's how it works. More detail in the PDF I linked.

[makomk]

Quite. Now suppose you take that $900 you've been loaned and spend a mere $90 of it buying goods from a supplier that uses a different bank. Suddenly your bank cannot meet its reserve requirements. However, if the supplier used the same bank everything would be fine. The amount banks can lend is constrained not by how much deposits they currently have, but whether it could cause a net outflow of deposits to other banks in the future.

Amongst other things, this means that how profligate a bank can be in lending money depends heavily on how much all the other banks are lending. So long as all the other banks are lending just as much out and their savings terms are competitive, the outflow of loaned funds will be balanced by an inflow of other banks' loaned funds. What happens in practice is that there's a glut of easy credit during booms which dries up during busts, making the boom-bust cycle worse. You can find some discussion of this here: http://www.bankofengland.co.uk/research/documents/workingpap...

[poof131]

Thanks for the pdf and this comment. The source seems reputable and it definitely changed my understanding of how money is created. I thought banks could only lend the money they took in through deposits or borrowing and had no idea they had the authority to actually create money directly.

[RobertoG]

It's a very common misconception.

It's interesting to realize that you can create money in the same way that a bank. Just give your friend a promise that you will pay him in the future and he could use it as money with third parties. Most people wouldn't accept it, but that is a different issue.

If somebody is in the mood to destroy more preconceptions about economy I recommend Warren Mosler 'Seven deadly innocent frauds of economic policy', it can be a good introduction to Modern Monetary Theory:

http://moslereconomics.com/wp-content/powerpoints/7DIF.pdf

[blue1]

> Deadly Innocent Fraud #1: The federal government must raise funds through taxation or borrowing in order to spend. In other words, government spending is limited by its ability to tax or borrow.

Unfortunately, in the (deadly?) Eurozone this is indeed how it works.

[RobertoG]

Yes, but most people, including me, didn't realized at the time what was going on.

And most don't realize yet.

[spdionis]

But if they can borrow from the European Central Bank what's the problem?

[blue1]

Statute of the ECB, Article 21.1:

«In accordance with Article 123 of the Treaty on the Functioning of the European Union, overdrafts or any other type of credit facility with the ECB or with the national central banks in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the ECB or national central banks of debt instruments.»

[nabla9]

Anyone who reads Modern Monetary Theory should keep in mind that its somewhat fringe (not outside fringe like Austrian school, but very criticized and not widely accepted).

[RobertoG]

What you mean is that it's not mainstream. That's true.

Despite that, I can't recommend it enough. It's just after starting to read it that what was going on in the economy of the world made any sense to me.

Also, mainstream economy is just totally wrong in many of its descriptive aspects, but they continue teaching falsehoods anyway. An example at hand is how the fractional banking and the creation of new 'money' by banks works in, virtually, all the modern economies.

This is the reason that the linked PDF by someone a few posts above is so important. They say what Modern Monetary Theory have been saying all the time but the source is the Bank of England.

I think it deserve to be linked again: http://www.bankofengland.co.uk/publications/Documents/quarte...

As Henry Ford said: "It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning."

[vezzy-fnord]

The problem with MMT is that it extrapolates far too much from accounting identities and treats both the financial system and the state as a closed vacuum divorced from all issues of public choice and expectations. This is what leads to Mosler's "Seven Deadly Innocent Frauds" and his policy proposals. That they're frauds is technically correct from a national accounting POV, but taking them literally as the MMTers do can be disastrous. In fact, it's not taking them literally that separates MMTers and other people. It's not that mainstream economists aren't aware of the logical implications of ex nihilo fiat money creation.

Also, MMT is nothing new or groundbreaking, contrary to their claims. There have been chartalist and endogenous money creation theories for ages, and most mainstream economists are quite aware of them, contrary to the assertions of many MMTers. What separates MMT from the rest is its fusion with more dubious Post-Keynesian theories.

[RobertoG]

I have to read yet a good criticism of MMT that have not been addressed by the MMT proponents. Maybe you can address me to one.

MMT people don't claim it to be any new or groundbreaking, on the the contrary, they claim is just common sense and chartalism. What they claim is that chartalism is true, especially in modern economies. This is a very difficult thing to dispute if you analyze how money works nowadays.

In my experience, the real problem with MMT, is that the implications of what an economy is or how it really works are politically indigestible for a lot of people and inconvenient for a few.

[frankchn]

Under your scenario, if a bank can lend out $900 for every $100 it collects in deposits, then won't we see runaway monetary growth? Consider the following scenario:

1) Alice deposits $100 in Bank X

2) Bob takes out $900 loan from Bank X and deposits it in Bank Y

3) Charlie takes out $8,100 loan from Bank Y and deposits it in Bank X

4) Eve takes out $72,900 loan from Bank X and deposits it in Bank Y

5) ... the cycle continues ...

Also, I would assume that the interest rates that my bank pays for my deposits would be a lot higher if it could lend out 9x as much as it holds in deposits.

The model where a bank lends out 90% of its total deposits still makes more sense to me and will result in $900 of total money created per $100 initially deposited.

1) Alice deposits $100 in Bank X

2) Bob takes out $90 loan from Bank X and deposits it in Bank Y

3) Charlie takes out $81 loan from Bank Y and deposits it in Bank X

4) Eve takes out $72.90 loan from Bank X and deposits it in Bank Y

5) ... the cycle continues ...

and if you sum the geometric series, which in this case is finite, you get $900 of total additional money created for the initial $100 Alice put in.

[RobertoG]

"2) Bob takes out $900 loan from Bank X and deposits it in Bank Y"

If Bob takes cash from Bank X and deposits in Bank Y, Bank X has less cash, that movement is reflected in their balance and in their reserves.

If Bob makes and electronic transfer from Bank X to Bank Y, at the end of the day, Bank X and Y have to clear their balance with each other. As some people have moved money in the opposite direction, from Bank Y to Bank X, the balance could be compensated.

If for some reason, people only retire money from a bank without never making deposits, you have a bank run and it's an indicator of mistrust in that bank.

[dogma1138]

Transfer of money from one bank to another is on it's own (in the simplest of terms) a loan.