How Banks invent money

http://thefinanser.co.uk/.a/6a01053620481c970b0120a562cd98970c-pi

always hatin on finance

We need to reform the system to save the system!

Bankers are fun targets too.

http://www.youtube.com/watch?v=WSDT_qcfp1Y&feature=related

What's your point, RS? The gold standard that doesn't work, never has, never will?

"What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers' transaction accounts."

You draw the wrong conclusion - if you have one - RS. Accounting is double-entry. When you credit an account you need to have an offsetting debit. Ergo, the money comes from somewhere - deposits.

It is not a direct, one-to-one correspondence. The distribution of the bank's assets against its liabilities is on the balance sheet.

I don't have a point, other than an interesting view of Credit Creation has been pointed out that challenges some of the basic ideas behind the current solution to the banking crisis.

Sunday, September 20, 2009
2 Nobel Economists Confirm that Credit is NOT Created Out of Excess Reserves

We've all been taught that banks first build up deposits, and then loan extend credit and loan out their excess reserves.

But critics of the current banking system claim that this is not true, and that the order is actually reversed.

Sounds crazy, right?

Certainly.

But take a look at the following quotes:

“[Banks] do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers' transaction accounts."
- 1960s Chicago Federal Reserve Bank booklet entitled “Modern Money Mechanics”

"The modern banking system manufactures money out of nothing. The process is perhaps the most astounding piece of sleight of hand that was ever invented. Banking was conceived in inequity and born in sin . . . . Bankers own the earth. Take it away from them but leave them the power to create money, and, with a flick of a pen, they will create enough money to buy it back again. . . . Take this great power away from them and all great fortunes like mine will disappear, for then this would be a better and happier world to live in. . . . But, if you want to continue to be the slaves of bankers and pay the cost of your own slavery, then let bankers continue to create money and control credit."
- Sir Josiah Stamp, president of the Bank of England and the second richest man in Britain in the 1920s.

Banks create money. That is what they are for. . . . The manufacturing process to make money consists of making an entry in a book. That is all. . . . Each and every time a Bank makes a loan . . . new Bank credit is created -- brand new money.
- Graham Towers, Governor of the Bank of Canada from 1935 to 1955

[W]hen a bank makes a loan, it simply adds to the borrower's deposit account in the bank by the amount of the loan. The money is not taken from anyone else's deposit; it was not previously paid in to the bank by anyone. It's new money, created by the bank for the use of the borrower.
- Robert B. Anderson, Secretary of the Treasury under Eisenhower, in an interview reported in the August 31, 1959 issue of U.S. News and World Report

This is a bizarre concept, and you might not be convinced by these claims.

But as Steve Keen writes today, 2 Nobel-prize winning economists have shown that the assumption that reserves are created from excess deposits is not true :

The model of money creation that Obama’s economic advisers have sold him was shown to be empirically false over three decades ago.

The first economist to establish this was the American Post Keynesian economist Basil Moore, but similar results were found by two of the staunchest neoclassical economists, Nobel Prize winners Kydland and Prescott in a 1990 paper Real Facts and a Monetary Myth.

Looking at the timing of economic variables, they found that credit money was created about 4 periods before government money. However, the “money multiplier” model argues that government money is created first to bolster bank reserves, and then credit money is created afterwards by the process of banks lending out their increased reserves.

Kydland and Prescott observed at the end of their paper that:

Introducing money and credit into growth theory in a way that accounts for the cyclical behavior of monetary as well as real aggregates is an important open problem in economics.

In other words, if the conventional view that excess reserves (stemming either from customer deposits or government infusions of money) lead to increased lending were correct, then
Kydland and Prescott would have found that credit is extended by the banks (i.e. loaned out to customers) after the banks received infusions of money from the government. Instead, they found that the extension of credit preceded the receipt of government monies.

Indeed, as Mish has previously noted:

Conventional wisdom regarding the money multiplier is wrong. Australian economist Steve Keen notes that in a debt based society, expansion of credit comes first and reserves come later.

Indeed, some critics of the current banking system - like Ellen Brown - claim that the entire credit-creation system is an accounting sleight-of-hand, and that banks simply enter into loan agreements, and then count the loans as reserves on their books. In other words, they claim that banks extend money first, and then increase their reserves on their books later.

If true, this would certainly turn our entire understanding of the banking and credit-creation system on its head.

It's called the money multiplier effect, moron. One of the first concepts you learn in macroeconomics. Without it, we'd be a poor backwater economy.

Why not create a thread on how trees are evil because they create oxygen.

"2 Nobel Economists Confirm that Credit is NOT Created Out of Excess Reserves"

Here's the explanation, Rivers:

http://www.investopedia.com/terms/m/multipliereffect.asp?&viewed=1

The multiplier effect is a maximum effect - if the money is, in fact, lent out.

I think you will be hard-pressed to find anyone who agrees with Basil Moore's point other than Basil himself.

"expansion of credit comes first and reserves come later"

Of course it does: expansion of credit increases the money supply, which is what necessitates the reserves. Where there no credit, there would be no need for reserves.

Sheesh.

And assuming uncritically the economic opinions of anyone pre-Keynes (such as Graham Towers) is just plain dumb. The Towers quote is pre-Keynes, pre-Depression, made by a mercantilist imperialist peer under the gold standard. It's not worth its weight in tin.

Classical economics is dead, as is neoclassical. It breaks down under stressful conditions. Keynes does not.

One of the first concepts you learn in macroeconomics. Without it, we'd be a poor backwater economy.

Remembers one chapter in in Samuelson and a genius.

Rivers, best just to admit that your post is dumb.

Banks CAN'T create money out of reserves, b/c reserves are precisely what they CAN'T lend.

They don't create loans out of deposits DIRECTLY; they create assets out of liabilities and capital. Deposits (for banks) are liabilities; loans are assets. Some of their liabilities go into loans, some into leases, some into reserves, some into equity. Just like any other company, only backwards in terms of accounting.

Holy crap, we got ourselves a canned food and underground shelter redneck.