Guest Post: More Evidence that Banks Create Credit Out of Thin Air

Washington’s Blog.

I recently provided evidence that banks create credit out of thin air.

I’ve just found two more pieces of evidence:

(1)  William C. Dudley, President and Chief Executive Officer of the Federal Reserve Bank of New York, said in a speech last July:

Based on how monetary policy has been conducted for several decades, banks have always had the ability to expand credit whenever they like. They don’t need a pile of “dry tinder” in the form of excess reserves to do so. That is because the Federal Reserve has committed itself to supply sufficient reserves to keep the fed funds rate at its target. If banks want to expand credit and that drives up the demand for reserves, the Fed automatically meets that demand in its conduct of monetary policy. In terms of the ability to expand credit rapidly, it makes no difference

(2)  On February 10th, Ben Bernanke proposed the elimination of all reserve requirements:

The Federal Reserve believes it is possible that, ultimately, its operating framework will allow the elimination of minimum reserve requirements, which impose costs and distortions on the banking system.

Of course, Bernanke’s proposal is the exact opposite of the 100% reserve system proposed by Nobel prize winning economist Milton Friedman and Laurence Kotlikoff, former Senior Economist for the President’s Council of Economic Advisers.

More importantly, if banks don’t make loans based on available reserves, but can enter into loan agreements first and then borrow any reserves needed, that means:

(1) This was never a liquidity crisis, but rather a solvency crisis, as I and many others have repeatedly tried to explain.  In other words, it was not a lack of available liquid funds which got the banks in trouble, it was the fact that they speculated and committed fraud,so that their liabilities far exceeded their assets.  If you don’t understand what I’m saying, please read this


(2) The giant banks are not needed, as the federal, state or local governments or small local banks or credit unions can create the credit instead, if the near-monopoly power the too big to fails are enjoying is taken away, and others are allowed to fill the vacuum.

Hat tip: Rob Parenteau for the Dudley quote.

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About George Washington

George Washington is the head writer at Washington’s Blog. A busy professional and former adjunct professor, George’s insatiable curiousity causes him to write on a wide variety of topics, including economics, finance, the environment and politics. For further details, ask Keith Alexander…


  1. Debt Based Currency

    Banks don’t create money, you must be insane! Said the banker, nothing to see here!

    “We are completely dependant on the commercial banks. Someone has to borrow every dollar we have in circulation, cash or credit. If the banks create ample synthetic money we are prosperous; if not, we starve. We are absolutely without a permanent money system…. It is the most important subject intelligent persons can investigate and reflect upon. It is so important that our present civilization may collapse unless it becomes widely understood and the defects remedied very soon.”

    –Robert H. Hamphill, Atlanta Federal Reserve Bank…1939

  2. Hu Flung Pu

    Does anyone need “evidence” that banks create credit out of thin air? Any banker will acknowledge this. That’s how a fractional reserve system works. If I start a bank that requires 10% equity/assets (and let’s assume my equity acts as my liquidity on the asset side of the balance sheet), and I fully lever up, my loans/investments are 10x my equity (to keep things simple). That 90% was “created out of thin air.” Furthermore, as banks add to retained earnings (yeah, hasn’t happened recently, I know, but the point’s the same) the same concept applies. I don’t think there’s anyone in economics or banking on the Planet Earth that doesn’t understand this. So, I’m not sure I understand the purpose of the post. Just as I don’t think it’s necessary for a post labeled, “Further Evidence that the Earth is Round.”

    1. George Washington Post author


      It might be obvious to the financially savvy, but most Americans assume that it is bank reserves from them and other depositors which is the starting point.

      Indeed, this concept is so counter-intuitive to the average American, that if the head of a bank let me interview him or her, the story would actually gain a lot of interest.

      Anyone game?

    2. MyLessThanPrimeBeef

      10% equity/asset ratio…

      Adding retained earnings to that equity…

      Banks make loans based on equity (per Hu) but you can borrow (even after the loan has been arranged apparently) your needed reserves so you can make loans (per Washington)? But what you borrow is not your equity.

  3. Skippy


    It’s becoming clearer to me, that economics is a cult. And its members are having an in house ideological cat fight, whilst we all suffer their learning machinations, having been stuffed in the bag with them.

    The previous post with John Daily shows just how simplistically uneven the capitalistic playing field is to date…eh. Well the priests always talk virtue whilst enjoying the offerings of the dimwitted populace…sigh.

    Skippy…was talking with some young mathematicians last week and in describing CDOs/CDS et al, they were dumbfounded by the derivative connotation (mathematically speaking) with regards to its abuse. The capture of a tool for describing the universe cocked and loaded at our heads and for what personal enrichment of a few.

    PS. thanks for your fortitude.

    1. Alexandra Hamilton

      “It’s becoming clearer to me, that economics is a cult.”
      Very good observation. I have come to the same conclusion when they suddenly claimed that recovery was based on “confidence”, and “believe”. This is the hallmark of a cult, but not of a science.

      1. Dan Duncan

        Hello Friend.

        You misuse the term “cult”. We are not a “cult”. We are a group of like-minded professionals who understand that planet Earth is on the verge of a massive cleansing as the earth’s trajectory takes it through the tail of Comet Hale-Bopp.

        BTW; Did you know that the only chance you have to survive The Pending Cleanse is to relinquish all ties to your personal “possessions” and to properly leave your “body-vessels” through celestial consecration?

        Believe me when I say this, Friend: It is NO coincidence that we just happen to be having a consecration this weekend at our secluded and peaceful commune in Ecuador.

        Join us.

        It’s our millennial Keynesian Castration to Consecration Kool-Aid Extravaganza.

        1. Skippy

          Damn now I’m rally scared, DD has a sense of humor.

          Skippy…your freaking me out Dan!!! JK.

  4. MacroStrategy Edge

    Washington –

    You just “discovered” the first piece of evidence…because I provided it to you in my response to yesterday’s fallacious blog on the money multiplier.

    As anyone will see who reads the responses to your post yesterday.

    You are better off attributing to your sources…as you request yourself on your website…dontchya think?

    I treat the 100% commodity money/100% reserve requirement system of money and banking arrangements in the March Richebacher Letter.

    There is a reason why there are few, possibly no (I have challenged people to identify them, so far no takers), historical examples of this Austrian School scheme…short of possibly the Stone Ages.

    Read it and find out why the market may have selected against 100% commodity money/100% reserve requirement systems. Murray Rothbard and crew may have left something out of his goldsmith story.

    1. George Washington Post author

      Attribution: done (let me know if you want me to link to your site).

      Question: Do you agree that this was an insolvency, not a liquidity crisis, and that the too big to fails should be broken up?

      Are you strictly Austrian in terms of consumers and businesses need to repair their balance sheets and purge the malinvestments, or do you think government should do something to increase employment? If the latter, how?

      Do you believe in public banking?

      Do you think we should abolish the Fed?

      I’m curious …

      1. MacroStrategy Edge

        Thanks for the hat tip. I do appreciate that. No need for links of any sort. Just requesting what you yourself request of others.

        Regarding your questions, see below.

        Question: Do you agree that this was an insolvency, not a liquidity crisis, and that the too big to fails should be broken up?

        The flight to highly liquid assets based on uncertainty about solvency created a self fulfilling solvency problem.

        When the repos and short term paper positioning the longer term assets in SIVS and on bank and brokerage and insurance company balance sheets could not be rolled over or renewed because investors and firms went into cash conservation mode post Lehman, each of these entities had to shrink their balance sheets, which meant forced fire sales of assets, which eventually would reveal negative net worth. So the two are not separate, but the authorities lied in my estimation: this was ultimately a solvency issue. That is why Paulson turned TARP into capital injections, and that is what I wrote they would do in the Richebacher Letter before they did it, based on the understanding that solvency not liquidity was the nub of the problem.

        I believe there needed to be an execution of existing prompt corrective action as Bill Black has argued where that was relevant to unwind those organizations covered by PCA, and some other ad hoc emergency facility for orderly liquidation of the others. At a minimum existing management needed to be taken out and bondholders should not have been coddled. But that is in my ideal world, and I am quite sure the realities, in terms of legal capacity and investor reaction etc. made it a much thornier mess to resolve than I am portraying.

        Are you strictly Austrian in terms of consumers and businesses need to repair their balance sheets and purge the malinvestments, or do you think government should do something to increase employment? If the latter, how?

        The only way the private sector can net save and pay down debt is if the foreign sector deficit spends (we run a trade surplus) or the government deficit spends. Take your pick. That’s just the tyranny of double entry bookkeeping. Otherwise, your talking “balance sheet repair” by liquidation and default, which will cascade through the system in the fashion Irving Fisher described in his 1933 piece on debt deflation. Most modern societies have a very hard time remaining intact after severe private debt deflations, although it is conceivable it can be done, but not without major risk of social disintegration, as we may be about to see in Greece and elsewhere.

        Regarding employment, Google “employer of last resort” or “job guarantee”, both of which are discussed at the billy blog and New Economic Perspectives websites. Pilot projects in Argentina, India, and elsewhere have shown good promise.

        Do you believe in public banking?

        I am searching for better banking system designs. Send me some links on this if you get a chance. In the last Richebacher Letter I explored the Austrian 100% solution, and I was not satisfied with that one. I have only briefly spent time on the AMI website, so perhaps there is a key piece you could identify there that might help me see what is involved in public banking.

        Do you think we should abolish the Fed?

        I think before you abolish the Fed you need to be very clear about what kind of monetary arrangement you propose to replace it with, and as with banking, I am currently searching for something better than what we’ve got, but not satisfied with what I am finding out there. This is not some intellectual exercise, abolishing existing arrangements. You need constructive and credible proposals, otherwise you are just going to get in over your head very quickly and lead people into some very difficult and possibly desperate situations…hey, wait a minute, that’s what have already, right?

          1. MacroStrategy Edge

            I did read it George. I don’t need the agit-prop. I already get that something is broken. I need the new blueprint, with specifics. We all need it. If there is such thing, please provide links. If there isn’t something ready yet for prime time, get to it to me when it is. But time is a waisting, so sooner is better than later. Show me the stuff that is one or two steps away from enabling legislation. Show me the historical precedents. Then I can see what you’ve really got.



        1. Ingolf

          “The only way the private sector can net save and pay down debt is if the foreign sector deficit spends (we run a trade surplus) or the government deficit spends.”

          Rob, no argument on net savings but I don’t think the same holds true for paying down debt. During the boom, for example, domestic non-financial debt in the US grew by 15% of GDP or more per year, many multiples of the trade deficit. The financial sector at the peak added another 10% or so. Presumably credit contraction is equally unconstrained by these financial sector balances.

          Or perhaps you meant something else by “pay down debt”?

          1. MacroStrategy Edge


            Ok, so we need to now take this one step further from simplification.

            Any sector can net pay down debt by:

            1. Exhausting existing cash balances paying down loans
            2. Selling assets to another sector, and using the cash proceeds to do 1)
            3. Run a financial surplus/net saving position with another sector and use the proceeds to pay down debt.

            1 & 2 are limited by the existing or current stock of cash or sellable assets on the balance sheet of the sector. They can be exhausted over time. Only 3 is sustainable over time (although even here, we must keep in mind, unless the persistent deficit spending sector can create money or sustain perpetual or serial asset price bubbles, guess what – eventually they too will run out of assets and cash to sell and will default).

            Also, I want to be very clear. We are talking about what is posslbe for sectors as a whole. We are not examining the debt that is issued and held by agents within a sector. That all nets out at the level of sector analysis: some households are net savers, some are deficit spenders, and the net savers hold claims against the net deficit spenders. These cancel out when we aggregate to the sector level, which is one reason why you do not want to stop your analysis of financial stability at this level of sector financial balances. There is another level to drill down as well.

            Hope that helps Ingolf.

    2. RueTheDay

      I’m curious as to your take on why the market selected against a 100% reserve system.

      In my view, the answer is simple. Under a 100% reserve requirement, a bank isn’t actually a bank. It cannot make loans. It is a mere warehouse for money. I don’t see the business of simply warehousing money as either 1) something that would be desirable for a person with excess funds since they’d be better off storing their money on their own rather than paying for it and 2) given 1 above it probably would be a very profitable business for the warehouse owner.

      But I’m interested in hearing your take.

      1. MacroStrategy Edge

        Rue – You’ll have to read the March Richebacher Letter for the whole deal, but you are on to it. The bank becomes a safe deposit box provider, and charges for the service, or it does not offer demand deposits but rather CDs and such that have to be held to term.

        Put that up against a fractional reserve bank, and guess who’s lunch gets eaten? The market selected against the Austrian 100% solution (if it ever existed – still not convinced it did: even the kings used to clip the coins for grains of gold), which the Austrians don’t care to admit, because in their more theological moments, the unfettered market is never wrong.

        1. RueTheDay

          And at that very moment, the Austrians/Libertarians will switch from a consequentialist argument about outcomes to a deontological argument that fractional banking represents fraud and is therefore immoral a priori.

          Critical Review ran an article a couple of years ago entitled, “The Libertarian Straddle” that covered the tendency of libertarian sorts to take a priori deontological arguments as far as they could before switching to a posteriori consequentialist arguments and so on and so forth.

          Rothbard was particularly bad in this regard.

          1. MacroStrategy Edge

            Rue – send link on this to me. I run into this all the time, but didn’t quite recognize why this style of argumentation they employ used to run me up a tree everytime I came across it (which was just about everytime, at least with the pure blooded Austrian Schoolers). Would be good to rally understand the essence of this bait and switch method they seem to have (consciously?) adopted.



        2. Ingolf

          Rob, re your comment March 18 @ 12:25 AM (the system wouldn’t let me respond directly to that comment, I don’t think too many serious advocates of 100% reserve banking believe it could ever survive competition against fractional reserve banking (at least as anything other than a very small niche market for ultra-security minded depositors) unless the lending of call deposits was in fact made illegal.

          Also, my general perception is that the “100% reserves” rule for most advocates is only meant to apply to call deposits. The problem that RueTheDay raises (that the banking business would under such a system become one of simply warehousing money) doesn’t therefore really apply. As you say, such banks could still lend against longer term deposits that have to be held to term.

          1. Ingolf

            Huh, the system did allow a direct response to your comment after all. Sorry about any confusion.

          2. MacroStrategy Edge

            Ingolf –

            I will simply say I run into some deadly serious people in the Austrian School who insist anything less than 100% reserve banking is fraud and must be stopped at once. Take my word for it. Also, look up Chicago Plan for 100% reserves in Great Depression. Irving Fisher also became attracted to this idea, and Minsky even flirted with it (Simons was one of his teachers, involved in Chicago Plan) after the S&L crisis.

            But yes, you clearly see the problems or rather limitations it presents, and why competition in free markets might select against it over time.

    3. JKH

      Hear, hear, Rob. Attribution is most warranted, particularly given your outstanding efforts to instruct properly in the area.

      I’d be circumspect about anybody quoting from that Dudley speech though. It’s a very curious mixture of unusually accurate insight and complete balderdash, as if it were cut and pasted from staff member writers of glaringly different competence.

      Here’s the excellent part. Our host blogger left out several important words in the final sentence. The entire quote is fundamentally important to a correct understanding of the monetary system:

      “In terms of imagery, this concern seems compelling—the banks sitting on piles of money that could be used to extend credit on a moment’s notice. However, this reasoning ignores a very important point. Based on how monetary policy has been conducted for several decades, banks have always had the ability to expand credit whenever they like. They don’t need a pile of “dry tinder” in the form of excess reserves to do so. That is because the Federal Reserve has committed itself to supply sufficient reserves to keep the fed funds rate at its target. If banks want to expand credit and that drives up the demand for reserves, the Fed automatically meets that demand in its conduct of monetary policy. In terms of the ability to expand credit rapidly, it makes no difference whether the banks have lots of excess reserves or not.”

      Here’s the dreadful part:

      “Is this concern well founded? The answer is that in a world where banks could not be paid interest on excess reserves, these persistent high reserve balances would indeed have the potential to prove inflationary. In that world, the excess reserves are likely to lead ultimately to an overly accommodative monetary policy. The story goes like this: If banks are earning no interest on their excess reserve holdings, they will be willing to lend those reserves out to any creditworthy borrowers as long as the interest rate is positive after adjusting for risk. The borrowers would then spend these monies, thereby boosting economic activity. The funds would not disappear, but instead would flow back into the banking system as they were deposited by those who had received the income generated by the increase in spending, thus replenishing the reserves that had been lent out in the first round of lending. This would result in a new stock of excess reserves that would then lead to a second round of credit creation and a further increase in economic activity. This cycling of excess reserves into credit creation, and the corresponding increase in economic activity, would continue until the excess reserves were fully absorbed by an increase in currency outstanding and/or an increase in required reserves associated with the rise in the amount of banking deposits. Inflation would rise as the excessive credit creation generated by the excess reserves led to an overheated economy and a rise in inflation expectations…
      But that is not the world in which we now live. Because the Federal Reserve now has the ability to pay interest on excess reserves (IOER), it also now has the ability to prevent excess reserves from leading to excessive credit creation. Because the Federal Reserve is the safest of counterparties, the IOER rate effectively becomes the risk-free rate.3 By raising that rate, the Federal Reserve raises the cost of credit more generally because banks will not lend at rates below the IOER rate when they can instead hold their excess reserves on deposit with the Fed. Because banks no longer seek to lend out their excess reserves, there is no increase in the amount of credit outstanding, no redeposit of the excess reserves, no increase in economic activity and no risk that excessive credit creation will fuel an inflationary spiral.”

      The logic here is completely wrong. The issue is that payment of interest rates on excess reserves prevents rates from going to zero. That is all. Non-payment of interest would cause an immediate market adjustment whereby the risk free rate goes to zero. It would be virtually instantaneous arbitrage. The presence of excess reserves then becomes a non-issue for its influence on credit expansion, just as it is for the interest on reserves case. It is the interest rate at zero, if anything, which is associated with overheating risk, and not the presence of excess reserves. And that overheating risk still depends on tight capacity in the economy rather than the interest rate per se. And of course, banks do not “lend reserves”. So almost everything else written in this excerpt is nonsense and a complete contradiction to the first excerpt and the correct MMT interpretation, in my view. I hope you agree.

      The sole exception within the second extract that does make some sense is the following part:

      “Because the Federal Reserve is the safest of counterparties, the IOER rate effectively becomes the risk-free rate. By raising that rate, the Federal Reserve raises the cost of credit more generally because banks will not lend at rates below the IOER rate when they can instead hold their excess reserves on deposit with the Fed.”

      Notwithstanding that exception, my conclusion given the general contradiction between the two extracts is that there is no way that the same person could have written/understood these two parts of Dudley’s speech, and therefore there is no way that Dudley really understands the monetary system correctly himself, notwithstanding the fundamentally important insight in the words of the first quote.

        1. JKH

          Scott Sumner’s favorite error.

          A negative IOER rate would change the risk free rate (and bank deposit rates by connection), but wouldn’t directly affect risk lending from the supply side.

          Banks require demand from credit worthy customers, a risk premium in yield compensation, and capital to back risk taking before they will lend.

          The risk free rate is just a parameter in the pricing equation.

          Excess reserves serve no role in credit risk expansion, apart from their utility (with diminishing marginal returns) as settlement balances.

      1. rosethorn

        Come on. The key phrase in the Dudley speech is “Based on how monetary policy has been conducted for several decades”…the implication is that prior to Greenspan monetary policy was conducted differently.

      2. Matt Franko

        I think from what we’ve heard from Bernanke, Dudley and Sack, recently, those three at least of late have dropped using the exact words that the “banks lend the reserves” mistaken concept,(at least that is progress!) but like Dudley says here :”the ability to prevent excess reserves from leading to excessive credit creation.” they just cant seem to do away with this mistaken concept completely. (probably easier to quit smoking for them!)
        From Bernankes recent Congressional Testimony: “In addition, the FOMC has the option of redeeming or selling securities as a means of reducing outstanding bank reserves and applying monetary restraint.” Here he mentions the “reserve levels” and “restraint” together. So it sort of looks to me that they have moved on a bit from the “lending reserves” wording but now instead are just refering to the “levels of reserves” which to me still may give the wrong impression to the less informed public (and policymakers!). Resp,

        1. JKH

          Maybe, Matt.

          Sort of interesting to consider the possibility they may actually be learning about this on the job. But there are still disconnects in just about every Fed speech/paper. The comprehension level is weirdly schizophrenic.

      3. MacroStrategy Edge

        Agree JKH, the Fed guys cannot quite shed the textbook model, and so they are expressing some glaring inconsistencies in public.

        But I had lunch with a sell side economist last week who knows Dudley, and he swears Dudley understands the banking system is not ever reserve constrained under current operating arrangements.

        So maybe they are just partially playing the old textbook game still to keep some bondholders from flipping out. That, at least was the reason why he thought they gave the nod to Treasury to reboot the SFP program, which as far as I can tell, just moves reserves from the banking system to the Fed’s balance sheet with no material effect.

        They are behaving, or at least explaining their behavior, bizzarely, no question.

        1. JKH

          Yes, Rob. Makes sense for Dudley, particularly given his OMO background – like Brian Sack, whose latest speech was quite good.

          The market psychology strategy has occurred to me, mostly in the case of Bernanke, out of hope I guess. Definitely strikes me as somebody who learns on the job by thinking it through, if he didn’t know it before.

          The November BIS paper observed the general point:

          “In turn, there is a concern that markets may at some point, possibly based on the “wrong model”, become excessively concerned about the potential inflationary implications of these policies.”

          (Speaking of attribution, Scott was none too pleased with that paper’s oversight for some recognition due to a particular group of people, as I recall.)

          And playing to perception is probably at the fore in the case of reviving the SPF.

          But that last piece in the Dudley speech is wrong to the point of recoil. The general Fed topology on this inconsistency is mixed. Some of the regional Presidents are quite guilty. Bernanke’s ‘foot faults’ seem mild by comparison. Even Warren M. has given him credit for his awareness of how the Fed writes balances up and down on a computer screen.

          1. Ingolf

            JKH, I don’t think what you’re saying about Dudley’s second paragraph is quite right.

            While the banking sector as a whole can’t get rid of reserves, individual banks can make the attempt to do so by buying assets or lending with the hope that the proceeds (when spent and redeposited) will end up with some other bank in the system. If they’re “successful”, and if the IOER is zero (or indeed just lower than the risk-adjusted rate they obtain), then they’ve gained through the exercise even though the system hasn’t. Dudley’s second paragraph, therefore, isn’t in my view actually wrong, but it does arguably mislead in leaving out the distinction between individual bank incentives and system consequences.

          2. Matt Franko

            I hope JKH sees your post here.

            In the mean time would you engage here to run thru the accounitng of what you are describing.

            Lets say Pension Fund A sells $1B MBS to the Fed. Pension fund A banks with Bank A. PFA deposits 1B transaction proceeds in its account at BankA. Lets say that even with this large deposit, BankA is still in a large (>$1B) excess reserve position.

            At this point, BankA liabilities (deposits) increase by 1B. Are you saying that at that point, BankA can go out and buy $1B of corporate bonds (with balances out of “thin air”) and position them as an asset on BankA balance sheet to offset the liability created by the PFA deposit?

            for BankA to obtain an Asset in the form of a loan, BankA is capital constrained, so if BankA didnt have the capital, BankA perhaps could not make a loan. But Im interpreting your comment as saying that BankA has another alternative to originating a loan, ie they can just purchase bonds for instance ?


    4. Jerry Denim

      I second that motion Macro Rob.

      And I can vouch for the veracity of your statement as a party privy to your enlightening comments here last night. I was just visiting Naked Capitalism so I could cut and paste a link to the entirety of last night’s comments section complete with handles/attributions to this same post on Zero Hedge when I noticed the same GW blog entry complete with unattributed quotes here as well.

      Share the knowledge but give credit where credit is due.

  5. RueTheDay

    I don’t know why people treat this as some sort of complicated mystery. It isn’t.

    Money is used to conduct transactions, among other things. People use currency and bank deposits to conduct transactions. Thus, money consists primarily of currency and deposits at banks. Under a fractional reserve system, a bank is not required to back deposit accounts with an equivalent amount of currency. Therefore, anytime a bank makes a loan (or even spends money) they are creating another deposit, either at their own bank or at another bank. This isn’t rocket science.

    1. Alexandra Hamilton

      I think the surprising thing here is that money is not, as many people assume, based on something tangible that backs it up. In the end, it is all debt owed to someone.

      1. i on the ball patriot


        Money is simply a means of exchange. Credit is an investment risk made on the future. You need to separate the two, they are apples and oranges

        Money IS based on tangibles in that in order for it to be a workable means of exchange it must be relatively stable in terms of its purchasing power of the same tangibles over time.

        There is nothing wrong with a fractional reserve credit system, or pulling credit out of ‘thin air’. Credit is simply an allocation of present resources, an investment risk, to provide a future benefit.

        What is WRONG is to have the control of credit creation in the hands of a few self serving powerful central banks (the fed et al.) that have profit and control motives (now more control than profit) at heart, rather than the benefit of society at large. Credit bestowed is also a competitive advantage. When given to favored corporations it allows those corporations access to resources others do not have and so they flourish.

        Credit should be controlled by the people and made available to them directly, interest free, rather than having banks allowed a monopoly on credit creation, where they charge usurious and enslaving interest rates to customers and get the ‘money’ they ‘provide/create’ from the fed/treasury/congress at zero interest, which is really from the same people they are screwing – the taxpayers!

        Root problem — hijacked government and media that perpetuates the aggregate generational deceptions in voodoo bullshit economics so well that those born into the dysfunctional family of scamerica believe it is quite normal to have fucking parasites control their lives and the use of resources so that it will make the future better for them and enslaving and exploitive for the masses.


        Deception is the strongest political force on the planet.

        1. Alexandra Hamilton

          What is WRONG is to have the control of credit creation in the hands of a few self serving powerful central banks (the fed et al.) that have profit and control motives (now more control than profit) at heart, rather than the benefit of society at large. Credit bestowed is also a competitive advantage. When given to favored corporations it allows those corporations access to resources others do not have and so they flourish.
          Hhm, well. That is how capitalism works, I am afraid.

          1. i on the ball patriot

            It is how gangsterism works, not capitalism.

            Capitalism does not exist!

            Capitalism — a decoy economic system ideal — is based on free markets, open competition, and private property, none of which exist anywhere on the planet as a result of aggregate generational corruption of the now blatant, scam ’rule of law’, which is owned and controlled by the same gangsters that keep the capitalism decoy meme alive to mask their machinations and dissipate the energies and resources of those they exploit.

            When you call gangsterism capitalism you legitimize and validate the process with your good name and at the same time you give up your power.

            They are not capitalists. They are fucking; arrogant, self appointed elite, self serving, competition killing and controlling gangster scum bags!

            Deception is the strongest political force on the planet.

  6. Vangel

    A wonderful posting. It is good to read someone who makes sense and actually understands economics.

  7. Elwood Anderson

    This is not a liquidity crisis. Flooding banks with money is like pushing on a rope. They can’t make loans if people can’t qualify for loans or don’t need loans. So they buy treasuries and speculate in the currency market with the money. It’s really nice that they can use free money from the Fed to buy T-Bills or government bonds that pay interest. And, levering up a currency speculation with free money is pretty nice, too.

  8. Paul Tioxon

    The use of debit cards as a fee generator also generated loans out of overdrawn bank accounts. I have learned the hard way years ago and my children are learning now that the bank will give them 2, 5 or even 10 micro loans totaling
    $100 plus tacked on overdraft fees. Checking accounts are demand deposit accounts, not always linked to credit lines or bulging savings accounts. Multiply that by the millions of people who have been hit by these temporary grants and the money supply goes up by just how much on a monthly basis until deposits cover them? No wonder BoA is doing away with them, it accelerates the deleveraging.

  9. Mark

    Canada has no reserve requirement. Reserve requirements are not that important. It’s capital requirements that need to be payed attention to.

    The whole notion of “reserves” is ambiguous anyways. All money in modern monetary system is just a liability on somebody’s ledger. The fact that liability is in the form of a printed piece of currency, or on the fed’s ledger is not that interesting

    I don’t see how FRB is avoidable. Financial Intermediaries are needed. People demand liquidity, and are quite willing to take a lower return in exchange for having the intermediary take the risk of lending.

  10. Mark

    As for bank’s creating credit “out of thin air”, so what?

    If I sell you house for $100K cash, and a promise to pay another $900K, we just created credit “out of thin air”. How else could credit be created?

    The only difference when a bank is involved is that they sit between you and me. Instead of you owing me $900K, you owe the bank $900K, and the bank in turn owes me $900K. It’s exactly the same credit created “out of thin air” as in the case where the bank was not involved.

    In the case of the bank though, they are assuming the risk (that is why capital requirements are so important), and in exchange taking a slice of the interest you would have been paying me on that note.

    1. MacroStrategy Edge

      Mark: The difference is you created credit in the first transaction between two nonbank private parties. But you did not create money. The creditor has to wait until the debtor pays him principal and interest.

      If a bank is involved, bank makes mortgage loan by crediting a newly created checking account with the amount of the loan, borrower writes check to home seller for loan amount plus downpayment amount, home seller ends up with credit to his account equal to sale price.

      Money has been created alongside credit creation in the second transaction. In the first transaction, credit has been created without money creation.

      The distinction makes all the difference in the world – try not to miss it. The first moves part of the existing stock of money from one private nonbank agent’s pocket to another, while another increases the existing stock of money.

      I find it helps to be very clear and careful with this distinction, or else some essential characteristics are missing from the analysis.

      1. Mark

        I don’t think we disagree on what actually happens in the loan process. Calling the liability the bank has taken upon itself “money” is where the trouble lies.

        If I have a $900K note from you, secured by the home you now own which I sold to you, that note is pretty close to money already.

        Can I trade it for goods and services? Yes, I can. Is it a store of value? Most definitely. Is is a medium of exchange? Not quite. It would have to be commodity, standardized for quality and quantity, like anything else (ahem.. why are gold coins standardized?), before it would readily be accepted in trade, and that’s what banks do.

        A bank is mathematically equivalent to an insurance company. They insure debt and thus standardize it. Not entirely equivalent of course, but in their function of financial intermediary they are identical.

        Your $900K note that you have pledged to me is not fully “money” (medium of exchange), because it’s not fully trusted. That is the key distinction. But if it is insured by a well capitalized company, then the trust level is much, much higher. A bank is in essence insuring the $900K note you have written to me, keeping a risk capital cushion against losses, and making the $900K just as good as money, and as tradable as any other commodity.

        I may sound like I’m pro-banker, but that could not be further from the truth. I am pro banking, and pro “fractional” reserve banking. But a banking system must be very well regulated and transparent for it to be a benefit (a very large benefit) to society. Unfortunately that is not what we have now.

        1. Greg

          You may be able to trade it for goods and services but you probably would not be able to trade it for 900,000$ of goods and services, which is what its worth TO YOU. Thats the difference.

    2. liberal

      “So what?”

      One “so what” is that the State has granted a privileged group (bankers) the right to make easy money.

  11. scharfy

    I think a common misconception is that the banks are stewards of a finite amount of money in the system. They simply take our deposits and lend out X% of them, retain (1-x)% as a reserve requirement, then pay and collect the interest rate spread based on their ability to identify creditworthiness, in doing so – make profits.

    But, but, but, under the federal reserve system, they can “issue” 9 times that amount in credit if they are a large bank. A credit is printed on their balance sheet, a debit at the FED.

    Not 90% of deposits, liquid stocks and securities, but 9 times than amount – and still be satisfying Tier 1 capital, reserve, etc, etc.. of 10%.

    They can loan far more than they “collect”. Being a member of The Federal Reserve System enables credit creation.

    Further enabling the credit creation machine, any reserve shortfalls or surpluses can be borrowed from the FED or lent to the FED upon demand. Thus, only the respective borrowing and lending rates relative to potential loan rates actually constrain lending. The ability to add to reserves always exists, at some price, via the FED.

    Nobody yells from the back vault “WE ARE OUT OF MONEY!! NO MORE LOANS!!”

    In this manner, by adjusting the reserve lending rates, the Fed tightens and loosens the credit supply, and accordingly, the functional Money supply.

    Under current structure, the FED has incentivized the Banks to lend by forcing short rates to .25%, yet banks are not loaning given poor creditworthiness of the borrowers.

    I am no expert, so somebody please skewer anything incorrect above, because I’d really like to get my head around this. I make no moral statement about this system, only want to comprehend the functional aspect.

    1. Mark

      “Not 90% of deposits, liquid stocks and securities, but 9 times than amount – and still be satisfying Tier 1 capital, reserve, etc, etc.. of 10%.”

      The 10X multiplier is taught for simplicity, but it’s not really valid in modern banking, and only applies to demand deposits anyway (e.g. checking accounts).

      IMO, the easiest way to get your head around banking is to look at my comment above, about the $900K home loan. The banking system is just a centralized clearing house for all debt/credit relationships between individuals, businesses, and governments. Your “money” in the bank is really just a bank credit, and is somebody else’s debt, made anonymous though the system.

      ” Being a member of The Federal Reserve System enables credit creation.”

      You do not have to be part of the federal reserve system. Until fairly recently, many banks were not part of the system. And again, see my home buying example above. All it takes is two parties (and preferably a legal system) to create credit. A banking system makes the “paper” IOU created by that credit relationship liquid/spendable…”moneylike”.

  12. maniam

    USA banks profits(business model)
    -Federal reserve bank print money(turn paper to money)cost=paper cost.banks’capital.

    -1st profit-exchange paper(printed money&interest free)for gov bonds(interest paying).
    government/people become debtor.(people didn’t do anything but get debts.)
    People through government owe them(bankster) money.
    better still for banksters this new paper(money)earn interest.
    But this interest paid by people when people work,eat,drink,breath through taxes,tariff, banksters.And govenment help banksters to collect this people’s ‘debts'(in the form of-disguise- interest/taxes/tariff,etc.)

    -2nd profit-bonds earn interest.(now people/government owe the banksters principal+interest)
    government collect taxes,income tax,tariff,land sake,etc to pay this interest(to bankster).
    but bankster are very clever and never ask principal to be paid so that interest can be collected forever.
    instead keep creating debt through war,market turmoil,currency turmoil,chaos,fraud,etc.

    -3rd profit-deposit bonds with treasury&get back money(printed money)-used this money to give out loans at 10 times(fractional banking).
    Take any loan from bankster they take a cut.
    People do business bankster take a cut through loans,profits tax,etc.if people’s business fails bankster take over and own the business for free.

    Therefore bankster loot from people
    (i)directly when people get loans from them or
    (ii)indirectly through government taxes,income taxes,tariff,land sale, pay interest on government debts.
    ultimately ends up in bankster coffers.

    The beneficiaries.
    Federal reserve banks.the 12 reserve banks.
    The shareholder of these banks are jp morgan chase mahattan,morgan stanley,goldman sachs,citi,bofa,wells fargo.

    Every time money is printed or loans created,people lose and in debt without people realizing it.

    This is how a nation is conquered and enslaved silently and insidiously through debts.

  13. kevinearick

    it’s been a long time since most have looked at the family trees of global corporate ownership, with all the flunkies filterd out.

    there are still people out there that think this is all about national balances, counter-vailing special interests, and individual agendas (the divided and conquered).

    whether others see it or not, you accurately highlighted Paul Volcker’s fault line.

    enjoyed reading your stuff.

    1. kevinearick

      p.s. the banks aren’t the only ones creating money now. nearly any corporation – public, private, or non-profit can create money if it understands the system.

      1. kevinearick

        all they need to do is publish a rule that allows them to arbitrarily assign debt, which is an articulation to all the other articulations. at the end, it’s pretty much open season, a license to steal, on people that cannot defend themselves.

  14. Jesse

    There was an element of a liquidity crisis in this, although I understand the distinction you make about solvency vs. liquidity and I agree with it.

    The liquidity part enters when one considers that the credit markets seized in a banking panic, triggered by the insolvency issue. The ‘faith’ in valuation was called into question, and so certain markets just stopped out of fear. Then came the run on the money markets.

    This crisis has quite a few similarities with the Panic of 1907.

    What concerns me is that it still has not been cleared, that is the solvency issue that you referenced. Only the short term liquidity issue. That means it could happen again, at any time, given the right ‘trigger.’

    I enjoy your essays quite a bit. Thank you for them.

  15. Robespierre

    “What concerns me is that it still has not been cleared, that is the solvency issue that you referenced.”

    The reason the insolvency issue has not been cleared is that clearing it will most likely uncover enough dirt and fraud to eventually land some important financial figures in jail. The massive injection of liquidity was use to cover up financial fraud and protect the guilty.

  16. maniam

    california is not the master.

    because “money has no motherland. financiers are without patriotism and without decency”-napoleon bonaparte.

    probably the person who said this
    ‘let me control and issue a nation’s money and i care not who write its laws”

  17. maniam

    “..It is so important that our present civilization may collapse unless it becomes widely understood and the defects remedied very soon.
    –Robert H. Hamphill, Atlanta Federal Reserve Bank…1939

    the remedy is-government(people) must get back the powers to print interest free money.

  18. FESTAN

    The “Deutsche Bundesbank” recently published her revised Booklet “Geld und Geldpolitik” (

    The Bundesbank abandoned completely the old theory of “multiple credit creation”, “fractional reserve banking” and “money multiplier”. (page 88-93).

    Money is created as book-entry by purchasing assets or entering credits on the left side of the balance-sheet and corresponding deposits on the right side.

    1. MacroStrategy Edge

      FESTAN –

      Never thought I would live to see the day the BUBA would turn its back on the reserve multiplier part of the monetarist catechism. Nearly unbelievable – can you or anyone on this blogsite get us a translation into English so we can understand why the light bulb went of in this, what historically has been one of the great bastions of monetarist approaches?

      Pinch me, I must be sleepwalking.

      1. FESTAN

        Here is the translation via google:

        4.4 Creation of the banks money
        Money is created by “money creation”. Both state and private commercial banks, central banks can create money. In the euro monetary system arises mainly through the granting of loans, as well as the fact that central banks or commercial banks to buy assets such as gold, foreign currencies, real estate or securities. If the central bank granted a loan from a commercial bank and crediting the amount in the account of the bank at the central bank, created “central bank money.” The banks will require it to meet their reserve requirements, to satisfy the demand and cash for payments.

        Money creation by commercial banks
        The commercial banks can create money itself, the so-called bank money. The money creation process through which commercial banks can be explained by the related postings: If a commercial bank to a customer a loan, they booked in its balance sheet as an asset against a loan receivable
        the client – for example, 100,000. At the same time, the bank writes down the customer’s checking account, which is run on the liabilities of the bank’s balance sheet, 100,000 euros good. This credit increases the deposits of customers on its current account – it creates deposit money, which increases the money supply. The newly created commercial bank can use the bank customer to pay for the purchase of goods and services. At first glance one might think that the credit customer has become richer through the creation of money. But this is not so. Because its the Borrowing incurred credit is offset by equally high commitment, namely, the obligation to repay the loan again. He must also pay ongoing interest on the loan.
        Forced to pay interest in a strong incentive to take credit only exists if the associated funds are actually needed. For a company, this means that there needs to be productive with the credit so that it generates income from which is at least the interest expense will be covered. Lending and associated money creation thus lead to investment, increased productivity and an economic value added. However, this value is not due to the act of creation of money itself, but – inspired by the interest rate – by the productive, value-added use of the loan.
        How to increase if the borrower credit and Giralgeldschöpfung also in the commercial bank’s assets and liabilities in exactly the same extent. Even if it occurs through the act of Giralgeldschöpfung not in itself a profit. The bank, however, the commissions earned on lending and the current
        Savings. This prospect of gain, however, is the risk that a customer does not repay its loan. Then the bank takes a loss. This risk is the bank an incentive to leave for lending and Giralgeldschöpfung caution.
        Once created, the money circulates in the economy. Either it flows from account to account, for example, when paid by bank transfer. Or will it be withdrawn in cash from the account and then goes in the form of banknotes and coins from hand to hand. Will be paid off the loan and is not replaced by a new one, then that is created through him, the circulation of money withdrawn. In the jargon this is known as a “waste of money”.

        Frontiers of money creation
        The above description might leave the impression that the commercial banks are able to draw an infinite amount of money in bank accounts. If this were really so, this could be inflationary. The central bank therefore takes effect on the extent of lending and money creation. It requires commercial banks to hold the reserve.
        To illustrate the principle, will continue here the simple example from the previous section
        (in reality) are the processes more complicated:
        If the commercial bank lending increased by its customer deposits to 100,000 euros, it must increase to their account at the central bank also their minimum balance. Since the reserve ratio is currently two percent in the Eurosystem, it needs in this example, 2,000 euros of additional central bank money.
        Central banks, commercial banks can typically obtain only by the fact that the central bank granted them credit. For these loans, commercial banks have to pay the central bank interest rate. Increase this rate, the central bank, the “prime rate”, the commercial banks usually raise their part, the rates at which they lend themselves. There will be a general rise in interest rates. This, however, dampens the tendency of businesses and households, the demand for loans. By raising or lowering the key interest rate the central bank can thus influence the business sector demand for credit – and thus on
        Lending and Giralgeldschöpfung.
        The commercial banks need central bank money to cover not only for the reserve, but also to the cash needs of its customers. Each bank customer may be credit in the bank account into cash to pay off. If the stocks of the banks in cash to be in short supply, the central bank can create only remedy. Because only they are permitted to bring additional notes in circulation. To meet the cash needs of its clients, the commercial bank must therefore include, where appropriate, with the central bank for a loan. This leads to the creation of central bank money. The so-purchased assets for central bank money can pay off the commercial bank in cash
        let. Thus, the cash is in circulation: from the central bank to commercial banks and from these to the bank customers.
        Central Bank money is also to cover the non-cash payments are required: a customer transfers money from its credit to a customer at another bank, this results in many cases led to the sending bank central bank needs to transfer money to the receiving bank. The central banks then moves from one bank to another.
        Even the act of creation by central banks, no one is rich: The assets and liabilities on the balance sheets of commercial banks and the central bank to participate individually in lockstep. The Central Bank shall thereafter interest, they must pay the commercial banks for loans. Interest income goes into the profits of the Central Bank book. This gain is distributed to the state budget and is therefore ultimately benefit the public.
        In normal times, the Eurosystem provides the banking system on the weekly refinancing operations, especially with so many central banks, such as commercial banks need to cover reserve and cash needs as a whole. Then comes perhaps at short notice and on a smaller scale to ensure that excess liquidity in the banking system is available. Requires a commercial bank short-term central bank money – for example, if a customer has paid a large sum to a third bank – they occur as customers of the so-called Money market. Typically, they will find another bank that has just over a surplus of central bank money ( “liquidity”) and is willing to lend her the required amount. Should the banking system in total are short term in a surplus or a shortage of central banks, the Eurosystem has to address this market situation, additional instruments are available, such as refinancing operations with a one-day duration.
        After the outbreak of the financial crisis in the summer of 2007, the money market was at times severely disrupted. The otherwise normal balance between the commercial banks’ liquidity from the money market did not take place. For, given the general distrust many shy away from commercial banks to lend surplus cash to other banks. Other banks were not therefore able to cover their needs for central bank money. To counter the so-conditioned “Liquiditätsnot” to put the euro on the banking system available.
        The stock of reserves in the banking system exceeded by the demand that resulted from reserve and cash flow.
        This excess amount, the so-called excess liquidity is not remunerated by the Central Bank. But the commercial banks have to create the possibility of an excess of central bank money over night in a special account at the Fed. On assets in this “deposit facility”, the central bank pays interest – albeit
        relatively low.
        The commercial banks can use the surplus of central bank money and to award additional credits to businesses and households. As previously described, arises from the award of additional credits
        additional demand for central bank money – which can be covered in this special situation of great uncertainty among banks by the existing excess liquidity. The abundant supply of liquidity relief, a bank that wants to provide a loan, from the traditional consideration of how much money they
        need after the award of credit is, how it is constituted, and at what cost. Using the so-called money creation multiplier can be estimated how large the potential for additional
        Credit limit is.
        An example illustrates this: Suppose the overall surplus reserve amounted to 100 billion euros. Suppose that, secondly, that commercial banks have to keep at the central bank a reserve in central bank money equal to two percent of the deposits of their customers. Assuming that the third is that people stand out from the newly created commercial bank, on average, 20 percent in cash.
        With the money creation multiplier can be calculated that the banking system a total of around 463 billion.
        In additional loans could be forgiven. For according to the assumptions will be lifted off of which about 92.6 billion euros in cash. To the increased deposits of 370.4 billion euros to commercial banks would have an additional 7.4 billion euros to maintain minimum reserves with the central bank.

        I’ve written an article on this subjekt before. When I succeed in translating it I will post it here or elsewhere.

  19. Tom Crowl

    I’m not an economist, my limited background is in cultural anthropology.

    It’s been helpful to me to look at a civilization as a product of ‘social energy’… millions of individual and collective decisions operating within the constraints imposed by the environment as well as, of course, previous decisions. (Decision=Idea+Action)

    ‘Money’ evolved to provide a means of storing and allocating ‘social energy’…

    Viewed that way it’s obvious that ‘credit creation’ gives its creators tremendous power the allocation of a society’s most fundamental activities.

    Credit creation is inherently biased in favor of its creators… this is inescapable.

    Hence much more attention must be paid to what has happened to this process.

    P.S. A question… Who owns your ‘social energy’? And while you certainly have a right to trade or allocate your own energy… and you can even consent to abide by directed allocation of the energy of a group to which you belong…
    Can you (or such a group) legitimately allocate the energy of your children not yet born? And should they then accept that obligation?

    Just a question… but its an issue that exists in reality… and it’s very possible that cultural changes largely stimulated by ICT (Information & Communication Technology) are going to make this a politically charged question in the future.

    1. NotTimothyGeithner

      “I’m not an economist, my limited background is in cultural anthropology.”

      I think this is the real problem. Who cares? Arguments and evidence don’t change whether you are an expert or not.

      During the 50’s, Eisenhower was being pressured by all the experts to build a massive bomber fleet. They were proposing thousands of long-range bombers to rain nukes on the USSR. The costs were astounding.

      One guy said, “hey we could put nuclear missiles in subs and save a fortune.” All the experts said, “you can’t put nukes in subs. Thats stupid.”

      I’m not attacking expertise, but argument and evidence always trump expertise. Look at George Mitchell. I think his background is literature, but he was able to become a foreign policy guru and a leader in the U.S. Senate with no discernible background or expertise.

      Look at Bill Bennet. He has tons of degrees, and he’s still an idiot and doesn’t understand anything. He didn’t even play Blackjack with his gambling addiction.

      The argument needs to be supreme. Specialization is nice, but at the end of the day, the primary purpose of specialization is to reduce the time and energy it takes to solve a problem.

      Look at LBJ, he went to something like Bible College, but the one thing he really failed on was Vietnam which was the only thing in his Presidency he deferred to the “experts” on.

      Sorry, but I believe most problems in this country are the result of blind listening to experts instead of demanding sound arguments.

  20. Mindrayge

    Don’t know if anyone will see this with all the trackback spam …

    Remember that the TARP law changed the effective date where the Federal Reserve would be able to set the reserve requirements to zero from 2011 to October 2008. The Fed has had the ability to set reserve requirements ever since then.

  21. Evelyn Sinclair

    How money gets created is extremely important to understand.

    For instance, it is a factor if you’re trying to figure out whether there will be inflation coming our way or not.

    I tried to address this in reply to the March 12 article “We Can’t Inflate Our Way Out of the Debt Crisis … So What CAN We Do?” By Washington.

    That article was built upon the assumption that the Federal Reserve controls the money supply; that money “comes from” the fed rather than being generated by banks as debt.

    My comment at the time, still relevant:

    …What I don’t see addressed is the big ugly factor of the derivatives bubble, which was not created by the government, only subsidized afterwards by feeding “real” (value-based?) money into honoring the gambling-debt economy of big financial institutions.

    If I understand correctly, when a wager is made, such as a credit default swap, it amounts to a promise to pay, which is equivalent to credit. This “creates money” in exactly the same sense that a mortgage loan does by becoming an “asset” over here and a debt over there. I understand that the creation of new derivatives is still going on because it is still immensely profitable to spin money out of thin air. In the process “money” is “created.”

    So yes the Fed/Treasury team might officially put some kind of brake on inflation. But they don’t prevent the creation of debt money in massive quantities by the exact same people who created the debt-Hindenburg we’ve just stabilized by wrecking the real (non casino) economy.
    Please tell me if I’m missing something.

    If a pile of money is created as derivatives, I don’t think there’s any way to stop it from doing its inflationary harm. Its not like we did anything to reinstate regulations….

    Won’t we be called upon soon to try to bail out the next big “surprise” crash, when the banks are suddenly going into massive deleveraging shock and need blood-donors???


    It is also very important to note, as so few people have, the truth that Mindrayge just brought up about the mandated reserve requirements, which have been brought down to zero. That was a major Easter Egg in the TARP bill that was simply not discussed in the open.

    1. MacroStrategy Edge

      No Evelyn, look again. Credit is created in your hypothetical, but no money is created – here taking money to be a means of final settlement.

      I cannot tell you how important it is to get this as clear as you can in your mind.

      A credit card confers buying power qua creidt, but does not create money. The credit card holder still has to get money to pay off the credit card.

      Similarly, a money market mutual fund does not create money. Owners of the MMMF have to deliver money to own shares in the MMMF, and the proceeds are then reinvested in various pieces of short term paper, which are liabilities issued by other firms needing credit. Money is just moving from one pocket to another: the existing money stock is unchanged, though the stock of outstanding credit has increased.

      I have seen very wealthy, experienced, sophisticated, professional investors not able to get their heads clear on this, but it is of the essence.

      1. i on the ball patriot


        MacroStrategy Edge says: “No Evelyn, look again. Credit is created in your hypothetical, but no money is created – here taking money to be a means of final settlement.”

        No, credit does not create money, but when it functions as insurance (which is one function of credit) it drives markets and causes money to be moved into ‘final settlements’ that otherwise would not be made. Derivatives, “in effect”, function as counterfeit money movers, or, counterfeit ‘money’, in that they initiate and control the transaction chain.

        This gives the issuer of the credit;

        • Great power.
        • Some really great fees.
        • Control of the markets in terms of; who, what, when, where, and how, the final settlements will be made.
        • The opportunity to put selected recipients of credit in debt trap situations.

        EXAMPLE: A credit card and a home equity line of credit confer an aggregate psychological buying power that cause people to spend and move money into ‘final settlements’ that they might not otherwise make without that credit being SELECTIVELY made available to them. Many people went for the ‘big home additions and granite counter tops’ based on a prudent percentage of their available credit. When that credit was subsequently pulled they were debt trapped into poverty.

        That is what the central banks are doing all over the planet.

        Deception is the strongest political force on the planet.

        1. Evelyn Sinclair

          i on the ball patriot & MacroStrategy Edge,

          Thank you both for your input.

          I have also been interested in trying to understand quantum physics, and have been reading books for math-impaired that try to explain it. I read about particles, waves and fields of them, quarks and the search for the Higgs Boson that is the ‘particle’ that is assumed to exist because there seems to be a field that pervades the universe which grants mass (or inertia) to all of the particles that have mass. If there is a field, there is by definition a particle of it, even if the particle has no apparent characteristics other than mathematical ones.

          I also have been trying to get a little educated about string theory, despite the growing feeling among physicists that it is turning into a fruitless endeavor for a generation of Physics’ greatest minds, as it spawns multiple sub-sets of itself, and so far has been able to offer nothing that is “falsifiable” and therefore within the realm of science.

          I’m doing about as well on all this as I am on economics.

      2. Ingolf

        Rob, I don’t see why you view debts run up on credit cards as fundamentally different from other kinds of debt. All borrowers, not only those borrowing on a credit card, have to get money to pay off their loan.

        As for money market funds, to me they seem a bit of a gray area when it comes to their monetary effect. To the extent they “lend” out funds (ie buy assets) and some portion of the proceeds ends up returning to the universe of money market funds (and can therefore be “lent” out again), the process surely bears some similarities to old-fashioned banking.

        The fact that banks today effectively operate without reserve constraints (both because they’re extremely low or in many cases non-existent to begin with and because central-banks will almost always supply additional reserves when required) can perhaps lead to an overly narrow view of the process of credit and money creation. Certainly banks under this system are uniquely positioned to drive the credit creation process (that is, create credit endogenously rather than via the old money multiplier model), but I’m not sure this precludes various old-style versions of credit creation (and to a lesser degree perhaps money creation) from operating outside the banking system.

        It’s a hell of a tricky area. However, it seems fair to say money market funds (and some other financial products like brokerage accounts with checking facilities attached) serve the same purpose from the public’s point of view as bank deposit accounts and therefore have at least an indirect monetary influence. Jeff Haymond in “Are MMF’s money?” put it like this:

        “Mises considered the objective exchange value of money to be the central economic problem of money. For Mises (Human Action 1963, p. 411), this is determined by the interaction of supply and demand for money, broadly defined (i.e., including money substitutes). MMFs affect this money relation in two ways: they reduce the demand for narrow money (currency and demand deposits, as reflected in Figure 1) and they increase the supply of broad money. Both of these factors tend to reduce the objective exchange value of money, ceteris paribus. As Mises states:

        “The cash balance held by an individual need by no means consist entirely of money. If secure claims to money, payable on demand, are employed commercially as substitutes for money, being tendered and accepted in place of money, then individuals’ stores of money can be entirely or partly replaced by a corresponding store of these substitutes.” (Theory of Money and Credit 1981, p. 154)”.

        As someone else said above, the whole business of money and credit can be (indeed, usually is)remarkably slippery. I wholly agree with you that trying to be rigourous in one’s definitions and analysis is vital; sometimes, though, the edges seem to remain a little blurred.

  22. Evelyn Sinclair

    Here are a couple of ways to get more informed about “where money comes from.”

    Anyone can learn painlessly by watching this clever animation:
    “Money as Debt” video animation

    More at length with lots of charts is the DebtWatch blog entry quoted below, which explains the hydraulics of money and goes a through step by step analysis of what’s wrong with Bernanke’s apparent beliefs:
    Steve Keen’s DebtWatch No 31 February 2009: “The Roving Cavaliers of Credit”
    Published in January 31st, 2009

    ‘…we don’t live in a fiat-money system, but in a credit-money system which has had a relatively small and subservient fiat money system tacked onto it.

    ‘We are therefore not in a “fractional reserve banking system”, but in a credit-money one, where the dynamics of money and debt are vastly different to those assumed by Bernanke and neoclassical economics in general.” ‘

    (I am not trained in economics at all, having simply become more and more deeply interested over the last decade as I tried to make good investment decisions. Then in the last few years I dug deeper as the market remined so stubbornly nonsensical. I read Greider’s big book on the Federal Reserve years ago. Still, after all that research, the little video I link to above was a major eye-opener for me!)

  23. JO

    Macro Edge Strategy/Mr. Washington

    Thank you for debating and bringing attention to the most critical issue facing society. I am not a professional economist, but only a lifelong follower of markets and economics. That said, I spend a lot of time thinking about how our monetary and banking system can be restructured to work better. Here’s a very quick highlight of my current thinking. I do not consider myself from a certain school, but do lean Austrian:
    1)Focus of regulation must be on capping rate of credit growth (including all off balance sheet activities such as securitzation) so that it does not exceed rate of GDP / income growth persistently. This would be accomplished by raising capital requirements more agressively and regularly should the rate of credit growth exceed income/GDP for longer than a short time (2 quarters ?).
    2) force all derivatives to trade on an exchange similar to existing exchange traded contracts.
    3) Put very tight restrictions on derivative use where FI can only use it to hedge a valid/business risk exposure.
    4) Limit all foreign currency loans to a small amount of capital and ensure all borrowers have verifyable income earned in the currency of the loan.
    5) grdaually phase out all gov’t “insurance” (AKA Ponzi) schemes allowing speculators/weak homebuyers to buy property on extreme leverage at artificially low rates and terms. If my memory serves me correct, Texas requires all homes be bought with 20 % down and i hear their housing market has done much better (I am from Canada so not sure if this is in fact accurate)
    6) transition to underwriting requirements where the max amount of mtg/loan against a property is capped to maybe 10 times the comparable rents. Current underwriting rules are a total joke. I used to lend money until late 05 and know how easy the system can be gamed by some dishonest borrowers and lenderss. Left lending after gov’t allowed 35-40 yr amort and no DP mtgs..i refuse to participate in a Ponzi..make no mistake, Canada does have sub prime lending going on..reason it looks like a non issue is much of the problem loans are classified wrongly.
    7) gradually increase capital requirements so that banks must have all unsecured credit fully backed by solid equity capital. This would leave banks with fractional capital lending for all secured lending and fully backed unsecured lending.

    These are just some ideas floating through my mind. I hope i can engage some discussion. Although i admire the Austrian gold/100 % backed concept, reality is it has never prevented a depression nor major issues either. There is no perfect system. At the end of the day, the problem is one of politics and policy. One way or another, the transition to any new system similar to one above will require economic pain, unhappy voters, much less profitable banks, so it is not likely society makes a transition easily or on a volunteer basis. Things might turn ugly before we change the system is a true fashion. Banks must be restrained and broken’t should only borrow from a public bank..debt must never be allowed to grow out of control as it has and is now…this is the core issue facing us and most of our economic and social problems..banks must not be allowed to make policitcal donations or otherwise lend or be involved in a profit making endeavour with gov’ts..sounds ideal i know, but we face collapse if we avoid “radical” and real reform.


    1. MacroStrategy Edge

      JO – There is very little I can disagree with in your proposals. We are on similar wavelengths about the nature of the solution. The only twist I would add, at first blush, is the US also imposes a leverage ratio on financial institutions. If this is tightened up, it would probably be more effective than tightening up capital ratios, which through accounting shenanigans are a little easier to weasel out of than leverage ratios.

      I have also been thinking double indemnity might be a good thing to bring back to the financial system.

      And I suppose removing tax advantages to debt issuance over equity issuance – not that equity investors are superior risk assessors, since we live in a flip it tomorrow/rent a stock world, but at least they get wiped out if things go south, rather than coddled as bond holders were post Lehman.

  24. Ingolf


    Thanks, your response (12:17 AM) did help. I understand now you were talking about paying down debt solely at a sector level. Given George’s question was about consumers and businesses needing to repair their balance sheets, I assumed you were talking about debt more generally.

    Re: 100% reserve banking (12:21 AM), I certainly know there are many proponents who view fractional reserve banking as inherently fraudulent. I think there’s merit to their argument although using the word “fraudulent” seems counter-productive. There’s a quote from Henry Simons which seems to me to put the matter well:

    “There is likely to be extreme economic instability under any financial system where the same funds are made to serve at once as investment funds for industry and trade and as the liquid cash reserves of individuals. Our financial structure has been built largely on the illusion that funds can at the same time be both available and invested—and this observation applies to our savings banks (and in lesser degree to many other financial institutions) as well as commercial, demand-deposit banking.” [Economic Policy for a Free Society (1948), p 320]

  25. Evelyn Sinclair

    Isn’t here something basically WRONG with a system of economics that’s harder to understand than particle physics.

    But going to that for an analogy:

    In the electromagnetic spectrum, the answer to “is it a particle or a wave?” is “Yes.”

    Do we live in a “Money Economy or a Credit Economy?”

    Sometimes the economy acts like it’s money-based, but most of the time it certainly seems credit-based.

    Credit seems to be much more important than money. (E.g. if I have mere money, putting it in the bank gets me no interest; it has no time value. Credit debt is high paying.) Money is fudgeable, gets created and destroyed as a matter of policy, balancing the transactions in credit that the economy at large actually transacts in. Debts endure.

    A friend of mine who has a degree in economics told me not to worry about the building derivatives bubble, back before the Great deleveraging/TARP event. He said that the CDS’s and other derivatives would “cancel each other out” or otherwise be made to disappear. I said, “But what if they try to honor those debts?” He said it just wouldn’t happen. It was to him literally unthinkable. Well, the Goldman people got in power and MADE us honor those gambling debts, and even gave AIG the money to do it with. That monetization made the derivatives debt into what certainly acts a lot like money.

    I think.

    If what was done wasn’t “monetizing” then what was it?

    If debt does NOT create money, and debt appears to be the more weighty factor, then maybe we should be asking whether money creation is as important to the actual economy as debt creation. we certainly should have discussed retiring some of those derivatives bets rather than paying them off!

  26. Ingolf

    Matt Franko (re: your comment on March 19 at 7:39 AM)

    Sorry about the long delay. I didn’t get into this thread until now.

    In your example, Bank A, in receiving a deposit of $1 billion from Pension Fund A, not only now has a liability for that amount because of the deposit, but also has $1 billion in reserves that it didn’t have before the deposit. Those funds can of course be spent, or lent, as it chooses.

    My point in the earlier comment was simply to draw attention to the fact that individual banks might well have an incentive to spend or lend reserves even though the system as a whole can reduce overall reserves unless the Fed chooses to do so.

    Hope that helps.

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