Dear Douglas,
Maybe I can help out here. I studied this in college and made "A"s.
Hugh Lovel
>Hi Roberto,
>
>This is [was going to be] off list because though interesting, it's
>not a sustainable ag topic, strictly speaking.
>
>Thursday, December 30, 1999, 10:03:15 AM, you wrote:
>
>RV> commercial banks create money, that is how they make so much of
>RV> it.
>
>OK, Roberto, let's go over this again. You are making a claim that I
>can neither refute nor confirm at this time. For discussion's sake,
>let's say banks *do* actually do this. But I don't feel you've
>explained the mechanism by which it's accomplished.
>
Doug,
Banks actually DO do things this way. The mechanism is called the
fractional reserve system. Let's say they are required to keep on hand a
fractional reserve of 10% of the "money" that they issue as credit. This
means that if you deposit $100 dollars of cash in the bank they can put
this cash in reserve and issue credits of $1,000 against it since 10% of
$1,000 is $100. Actually it is never quite supposed to max out like this
and it works more like they issue the credit and will put it in your
account on the books. But only a small portion of the credit is out in
liquid cash at any one time. Ever wonder why banks are so interested in
serving the customers at the windows where cash flows in or out and why
checking accounts operate at such low rates? Seeing that the flow of
currency is smoothly maintained is essential to seeing that the fractional
reserve system works. So they take in $100 and by having that exchange
going at the teller's window they can loan out the $1,000 in credit and
rely on circulation, cash flow of about $100 to come back in in payments so
that they loan a thou today but get a hundred of it back today as well.
This means that when they do the books that night it comes out they only
actually loaned a net of $900 that day because they loaned $1,000 but were
repaid $100 of it. This maintains a cushion that keeps cash disbursements
covered and their reserve untouched, unused and actually in reserve. It may
sound a little complex and confusing because it is a pretty slick juggling
act.
>I have to assume that any credit made by a bank is backed by money
Incorrect assumption. When you boil it down only a small fraction is backed
by any money and the rest is backed by debt.
>that has to reside somewhere other than the banks own books.
Some does. I realize I was a little clumsy in my description of this above,
but it's there if you puzzle through it.
>Therefore: I understand you to be saying that banks issue credits that
>*aren't* backed by money, just as governments can create money that
>isn't backed by reserves of foreign currency, gold or something
>external.
Quite right. Consider the practice of holding foreign currency in reserve.
If 20 or 30 countries are shuffling their currency around to hold it in
reserve and only one has anything substantial, isn't this rather like a
gigantic shell game?
>
>(This is a dangerous thing for a government to do, btw - it's
>inflationary and can result in the devaluation of the country's
>currency, if a lack of confidence results from it, as often occurs. To
>get away with it even occasionally, a country would have to have a
>strong, productive economy in other respects. I live in Mexico where
>this was once done on a major scale and believe me, the results
>require a heavy sacrifice in order to finally be corrected).
There's a few different things going on here. First, inflation is not based
purely on the supply of money, but also on the supply of goods. If there is
a lot of money out on loan to manufacturers and goods are plentiful and
cheap this may be deflationary even if the money markets see to it that
money supply is plentiful, deposits at banks go up while loans go down. and
fractional reserves grow. Conversely if you tighten the supply of cash
when goods are scarce and drive up the interest rates people are going to
want to borrow a lot more no matter the interest rates so they can purchase
what they need of scarce commodities. This can end up fueling inflation if
the percentage of fractional reserves shrinks, say to 5% and a $100 deposit
can then be turned into $2,000 worth of loans. Remember what the Fed did
during Jimmy Carter's re-election campaign? They had interest rates over
20% and it was a major inflationary period. Later the Fed relaxed rates
under Reagan and during his presidency the Gipper added something like 4
trillion dollars to the Federal debt, but that was deflationary.
>
>RV> I've posed this question so many times, even to economists, and
>RV> have almost always gotten the wrong answer: ASSUMING A RESERVE
>RV> REQUIREMENT OF 10%, HOW MUCH ADDITIONAL MONEY CAN THE BANKING
>RV> SYSTEM LEND, IF YOU DEPOSIT 100 DOLLARS IN YOUR BANK?
>
>Once again: You are saying that the credit system is generated by the
>banks themselves and that this is in accordance with the legal
>structure in most economically strong countries?
>
>RV> If your answer is 90, which is what I also thought a year ago, you
>RV> -- like almost everyone else -- are underestimating the power of
>RV> banks.
>
>RV> The correct answer is 900. Please read that again: from your 100
>RV> dollar deposit, the banking system can lend a maximum of 900, not 90,
>RV> dollars.
Doug,
See? It is like I said above.
>
>RV> If the reserve requirement is 1% instead of 10%, then the banking
>RV> system can lend from your 100-dollar deposit and total of $9,900. (And
>RV> not $99, which is the most common answer.)
Doug,
Strange as it seems to ever so many people, Roberto is right. It's a
fantastic shell game, and because of arrangements like our (US)Federal
Deposit Insurance Corporation (FDIC) which makes the threat of a "run" of
withdrawals nearly non-existent, it is not nearly so risky for the bank as
you might think.
>
>OK, the amount of money a bank can lend is related to the percentage
>they are required to hold in reserve. What I want to know is, *HOW*
>can they lend money they don't have? Where do they "get" it? Do they
>themselves get credit with a central bank? If this is the case, there
>are undoubted criteria that the bank has to meet in order to qualify,
>which does not exclude the possibility of that a "bankers club" exists
>(but that is true in most fields, as well as on sanet). Please be as
>explicit as possible, including the country you're referring to in any
>example you give.
>
>Banks have to deliver some kind of documentation to whoever receives a
>credit. You are saying that banks are "licensed" to issue documents
>that aren't backed by anything except the percentage of reserves then
>in effect. I know there is an element of trust involved, but am not
>ready to suppose that the world's "major" currencies are no better
>than a stock market, where expectations (and rumors) drive
>investments.
This is a lot truer than you might think. Let's think back a few years to
when the Mexican peso collapsed. NAFTA had recently gone into effect and
the Mexican economy was booming with contracts for production to be sold in
the US and Canada and lots of loans (secured by leins on the factories,
chicken houses, production facilities like mines or oil that the loans
built or opened up.) made because the producer had contracts for the
production at good rates. There was plenty of new construction and lots of
jobs. Then some of the big New York banks that had been buying pesos dumped
pesos on the currency exchanges. Suddenly there were too many pesos and
nobody wanted pesos. They went to 60% and though I wasn't paying much
attention (I'm a farmer with cows to milk and vegetables to grow) I think
ithe Mexican peso went to 40% or even briefly down under 20% of its value.
The goods still left the country going north, but the rate of exchange
meant terrible prices for anything locked in on contracts--and it was the
fact there were so many contracts out there for production that fueled the
craze for loans. What do you think happened to the factories, chicken
houses, production facilities like mines, oil, etc.? When the loans could
not be paid ownership, stock, securities of whatever kind became property
of the lenders--which in many cases were the same New York banks that
collapsed the currency. Mexico is a country that is rich in raw materials
and labor. Who controls these? Sure there's bankers' clubs, licenses,
instruments of credit, central banks and trust involved. There's also
dog-eat-dog manipulations, betrayals, rumors, expectations and deception.
Big time. Please don't be naive about this.
Prime Banks are in the position of being the biggest sharks in the water,
aren't they? They didn't get to be prime banks by passing up the slow
swimmers and the unwary. Please think about this. They do seem to lend some
degree of solidity to the fabric of world banking. But why is it this
meager degree of solidity is so filled with poverty, ignorance,
environmental degredation, and political injustice? Please think about
this. I wonder where you've been all your life that you wouldn't know this
because you obviously are educated and articulate.
Might it be that you watch the nightly new strobing at you and you've been
in a hypnotic trance when downloading information? I wonder. I don't wish
to pity you or demean you. You come across as a nice guy who is asking some
good questions and deserves to wake up.
>
>The fact that foreign currencies are generally involved in the
>reserves of a given country, and the fact that banking standards
>backed by experience are taking effect in more and more countries;
>would seem to lend some degree of solidity to the cloth of the worlds
>banking system, at least where major "Prime Banks" are concerned, even
>if the gold standard is past history and admittedly, none of this
>guarantees social justice.
>
>Please explain exactly how what you describe is done within the
>European Community and the U.S. economies (which are still setting the
>pace in finance, for now).
>
>Douglas Hinds
>
Douglas,
I'm out of time for this and have to be brief. Besides you need to start
figuring these things out for yourself. Europe and the US are where the big
sharks are lounging for the moment, particularly the US. Gas has been cheap
for a long time. The roads are good and people have been edging up into
bigger and bigger cars for a long time. There's a LOT of petroleum involved
in domestic production. The dollar has been strong, strong and credit has
been expanding for a long time. What do you suppose is likely to happen
next?
And let me throw this at you since I'm a farmer. Summer grass has been at a
premium in Texas for a couple three years. (Actually I'm in Georgia market
gardening, but from time to time I get a little information about other
places. I'd like you to think about something you can follow in most any
newspaper.) Grains have been low. Partly this is due to the fact that way
too many farmers are locked into cash grain farming and too few are
grazing, which is environmentally disasterous and exacerbates the kinds of
summer droughts we've been having. It can be environmentally constructive
to graze, but cash grain farming is notorious for being environmentally
ruinous. Cow/calf operations depend on grass while feedlots depend on
grain. Now you might think that if there isn't enough grass there won't be
that many cows and calves, but in agriculture you've got to realize there's
lots of lead time. Without grass this past summer brood cows couldn't be
fed well enough and had to be sold for hamburger which drove that price
down and it may take two years to rebuild these herds. In many cases baby
calves could hardly be given away. Texas brood herds were decimated. Feeder
beef for the feedlots were a different story. Beef prices were down in
general, you see, feedlots were feeding out the previous year's calves on
cheap grain and that sure didn't help prices either. Anything that could be
fattened for better cuts went to the feedlots, which just incidentally are
an abomination both in terms of their inhumanity and their environmental
ruinousness. Now with corn prices so low cash grain farmers are numb with
shock beef prices are rising because there's not enough feeder beef to fill
the feedlots, and this demand for new brood herds and young stock to feed
is driving calves back up. Farmers will be paying through the nose for
calves they were giving away last summer. Farmer's tend to lose when hay
and grain are poor AND paradoxically they tend to loose when these are
abundant. But sometimes and some farmers tend to win some of the time.
Droughts, floods, market cycles and lead times are cyclical and there's
options and choices and if one is a really savvy grower, in tune with the
cycles, well-informed, foresighted and a bit lucky it's a pretty exciting,
even rewarding, game. Local, regional and national trends can mean a lot in
terms of the options to cash in fairly well, but commodity manipulators
have a lot of advantages. For one thing, they are so much more liquid than
producers that it isn't funny. Consider what happens to these options when
things like NAFTA and GATT go into effect and manipulators can catch
regional producers in one part of the world at a time when prices and
production are doing well and import enough from another part of the world
to drive prices down and buy up the successful production cheap and then
whisk what they bought up cheap to another part of the world and drive
prices down and buy up production cheap, hopscotching from place to place
without end. Is it any wonder it means so much to manipulators to be able
to ship American hormone/beef to Europe or Japan who would rather keep it
out? It isn't the producers that are complaining trade barriers are unfair
so much as it is the manipulators. Make a six month study of world trade in
a basket of commodities and read between the lines who is making a killing
and who is getting screwed. It ought to be an education that will
eradicate your naivety.
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