[lagrange77]

> Banks loan out a multiple of their deposits. In other words, banks create money when they make loans. Amazing, isn't it?

I've heard about that, and it's really amazing.

If i understand it correctly, the loan interest i have to pay is money that also does not exist yet, at the point of time, when i get the cash. The bank faces the risk of me not being able to generate (get from others, who potentially also take loans) that extra money, so they demand a collateral as an insurance against that risk.

> Inflation happens when the government prints money that has no collateral, and has no correspondence to added value in the economy and so it dilutes the value of the money that is already in circulation.

What instance decides, if some printed money does or does not have collateral?

[jollybean]

This is kind of a misunderstanding.

Banks retain assets for loans they make. They don't print money.

But imagine this scenario: you deposit $10 at bank A, they loan that $10 to person B, that person B puts their $10 account at Bank C, thank bank loans out that $10 to person D etc..

You can see all of a sudden, $10 turns into $100! or $1000 in assets!

So what we require banks to do is keep a part of the assets they receive. So if they get $100 in deposits, they can only lend out $90 i.e. they have to keep '10% in reserve'.

This means that banks are leveraged at 90%.

It also means that if there is a calamity, and a 'run on the bank' or it loses 10% of it's assets, the bank is wiped out.

So what all of this means is that there is 'leverage' in the system, and it means there is 10x money going into the economy than is released by the Fed. It definitely adds a lot of flexibility to the system. Banks are still responsible for evaluating risk of their loans and paying the price if they fail.

"The interest on the loan" is mostly a function of risk and the cost of that bank managing that money i.e. getting the depositors to loan you the money in the first place.

The OP's definition of 'inflation' is a bit warped.

Inflation is when there's more money than demand for stuff.

If stuff is harder to make or is more rare, prices will go up irrespective of money supply.

If you throw money in the economy for no reason inflation will happen.

But most economies are expanding a bit, and so they need more money in the supply to keep prices stable, which is why we like to have just a bit of money printing.

All money loaned out - even given out by the central banks has collateral. The Fed keeps mostly TBills (Government Debt) and real estate as collateral.

[WalterBright]

> They don't print money.

Oh, absolutely they do. That's why currency is called "banknotes". The banks printed them. Each bank printed their own banknotes. You can find their images in numismatics books.

In 1914, the government took over the function of printing banknotes. But the banks still print money. We just call them "cashier's checks", "money orders" and "travelers' checks". But more normally, they simply credit your account with created money.

> If stuff is harder to make or is more rare, prices will go up irrespective of money supply.

That isn't inflation, because extra dollars are not being created. For example, tomatoes going up in price in the store because of crop failure isn't inflation, because more money doesn't appear in your pocket to pay the premium. What happens is you wind up with fewer dollars in your pocket, meaning you buy less of other things, and with the annoying Law of Supply and Demand, the prices of those other things drop.

[jollybean]

Listen, you are really confusing yourself and others here.

That banks used to print notes in the past is not relevant in this discussion, when we talk about 'printing money' what we are referring to is how money comes into circulation. Physical bank notes are barely relevant to the equation as it makes up a tiny portion of the money supply, and of course, they are only printed by the Central Bank.

Money comes into circulation when the Central Bank 'buys' TBills off the free market. That's when the Central Bank 'creates' money.

Then, through fractional lending, a considerably larger amount of money ends up getting into the system by way of accounting.

Finally, the 'credit market' - which is really 10x bigger than even money in circulation, and which is the real thing that matters in business, develops like a bubble on top of that.

"That isn't inflation, because extra dollars are not being created."

Yes - it is 100% inflation and you are absolutely spreading false information at that point.

The 'result' could be as simple as 'less of that product is bought' - meaning, we use 'less gas' when gas prices rise - while every other aspect of the economy remains mostly the same. That is 100% inflation.

Aside from 'buying less of the product with price increase' or 'buying less of other stuff' we can also borrow, use savings, buy on credit etc. to adjust for the price inflation - so it's not going to necessarily work out to be some kind of net price levelling in the economy.

Increasing prices = inflation [1]. That's it. It's not necessarily related to money supply.

And finally - as the economy expands, more money needs to be introduced into the system just to keep prices even. This is an example of where there is more money supply and it does not change prices.

[1] https://en.wikipedia.org/wiki/Inflation

[WalterBright]

> What instance decides, if some printed money does or does not have collateral?

A great question. No actual decision is made, it's just that there are more dollars floating chasing the same value, so the price in dollars gets bid up.

[jollybean]

This is misleading.

There is a 'decision' made and there is always collateral - at the bank, and even at the Fed.

The 'decision' that might be made, is what kind of assets to accept on the Feds balance sheet.

At a private bank, they can do whatever they want with respect to what kind of assets they accept as collateral, within regulatory requirements. They have capital ratios to uphold, but if they take stupid risks, well they are going to go out of business.

The OP is implying that money is printed out of thin air and that is not what is happening.

Your retort that 'money money, in a system of all other things being equal, will raise prices' - but the implication of 'all other things being equal' is never a reality. Economies are usually growing, in which case, they need more money to keep prices from going down actually, and, there can be external shocks, which we see every decade or so.

[landemva]

This is misleading.

The Federal Reserve assumprion of bank's underperforming loans was done in 2008 with funds created out of thin air. The value of the underperforming loans was significantly less than face value, which is why banks could not sell them on the market. The Fed gave full value with magic money it created.