Except that they don't have to source that currency from somewhere - it really is literally magicked up out of thin air! When you come to spend it, that amount is transferred to another bank, that they can then offset against their own magic money.
The only relationship with deposits (which are actually liabilities) and assets is that enforced by regulators.
This is how money creation works in the modern economy - so the money supply can grow as economic activity increases, all guided by central banks / governments with levers such as interest rates, open market activities (QE), and regulations.
Again - banks really do create money from nothing, all day, every day.
No they don't, banks have accounts with the central bank. They also have their assets and liabilities. They have to manage the system so that they can manage external withdrawals. When assets outweigh liabilities it's a bankruptcy. When current demand for withdrawals exceeds short term liquid reserves it's a liquidity issue. At no point do banks create base money. A balance in a bank is just an iou for base (central bank's) money.
The only entity that creates money is the central bank. They may even accept mortgages from banks as collateral (including repurchase agreements) to inject new money into the system.
Regulations are supposed to prevent bankruptcy and liquidity issues, but even without any regulations regarding asset ratios, banks can go bankrupt or illiquid.
So if someone pays you using a credit card, or using money they derived from a bank loan, presumably you don't accept that money because it's not a loan from the central bank - it's not "base money"?
Incidentally, the only claim you as a lowly individual ever have on central bank money in most (all?) current currency areas is as physical currency, and even then for the most part you only ever get to exchange it for commercial bank money. For the purposes of this discussion, all digital money between most normal entities is commercial bank money. Commercial bank money _is_ money.
I trust that my bank is well-enough managed to provide me with physical currency up to the amount of my account balance, so I’m happy to accept any form of payment that results in an appropriate increase in that number— Just because I draw a distinction between currency and commercial money doesn’t mean that I don’t believe that the latter is money.
And I rarely exchange physical currency for digital money these days— Usually I’m exchanging it for food instead.
> I trust that my bank is well-enough managed to provide me with physical currency up to the amount of my account balance
It (probably) is, but if all of your bank's account holders asked for that at the same time it would be what's known as a "run on the bank" and you'd very quickly find out that they don't have anywhere near enough physical currency to cover even a fraction of their account holders.
Citation needed. I do not believe this for even a single moment.
The only institution that can "create" money from thin air is the government. And even that is a polite fiction when you realize that "printing more money" also inherently devalues the money already in the system.
I only skimmed this briefly (no time), but things operating as suggested (eg the banks loaning money they do not have) would fall into the category of fraud IMO.
Whether that's currently legal or not is another matter that I cannot comment on.
What he wrote is a popular myth that originated in a misunderstanding how fractional reserve works, it just means they have long term assets to cover short term liabilities. There's a lot of this stuff on youtube.
If it was true no banks would ever fail, qed.
Ultimately being fundamentally wrong in how the financial system works is extremely unlikely to impact anyone's daily life.
You can only really hold the "printing more money" analogy in your head, if you are prepared to balance your thinking and accept that taxation and loan repayment "shred money" and that financial savings is "putting money in a drawer".
At which point you will realise there can be no devaluation since money is destroyed as it moves around, and money in drawers may as well not be there.
I see money as units of resource allocation. There are only so many available resources at any given moment. More units of allocation means less resources allocated per unit.
There isn't and never has been a one-to-one relationship between money and stuff. At best it is inductive.
Just as with electrical engineering, the real world requires a reactive supply, which is what allows electrical innovation beyond direct resistive loads.
Electrical supply engineers hate reactive power, but without it we don't get iPhones.
The power triangle gives the best engineering analogy to the way the monetary system works.
Clearly that's not true as the bank note analogy shows. If you print trillions of £50 pound notes and stuff them into an empty coal mine guarded by many competent people with guns, that's not going to have any impact on prices whatsoever.
While I disagree with somewhereoutth and mostly agree with you, it is true that banks can create money.
However banks don't create money out of thin air. However they can create it out of assets.
As a silly thought experiment: if your bank has a vault full of valuable assets, like diamonds and deeds to houses in prime real estate, stocks etc, they can in principle create loan/deposit pairs (ie make loans and credit the borrowed funds to the borrower account).
When people make withdrawals, especially when they make more withdrawals than the bank has reserves, they just sell some of their assets to cover the difference. That's all pretty normal and boring.
Customers think of their deposits of 100% like money and economically behave as if that was true, but in practice they are backed by 10% money, ie reserves, and 90% other assets.
(The percentages are for illustration only.
Also we ignore minimum reserve requirements and other laws here. Many countries don't have minimum reserve requirements anyway.)
That's a long PDF. What do you want to refer to in particular?
Btw, you might want to study the section 'Managing the risks associated with making loans'.
The pdf is pretty vague about the limits of creating these loan/deposit pairs in general. But there's eg this:
> One way in which they do this is by making sure
that they attract relatively stable deposits to match their new loans, that is, deposits that are unlikely or unable to be withdrawn in large amounts. This can act as an additional
limit to how much banks can lend. For example, if all of the
deposits that a bank held were in the form of instant access
accounts, such as current accounts, then the bank might run
the risk of lots of these deposits being withdrawn in a short period of time.
In general, the limit to loan/deposit pair creation is withdrawals and transfers of the new deposits.
---
Btw, I agree that fractional reserve banking can create money. (Just not base money, and not without limits.)
Fractional reserve banking does not work like this.
You still need assets in fractional reserve banking. Those assets just don't need to be reserves.
Ie 90% of your assets could be diamonds in the vault, and 10% could be reserve cash in the vault. That would be fractional reserve banking, but you still have 100% assets. (In practice, you have more than 100% assets. The excess is your equity cushion.)
If your liabilities outstrip your assets, that's when you are bankrupt. Fractional reserve banking doesn't help you there.
Yes, IOUs of credit worthy people can be part of your assets. But so can be diamonds or stocks.
> B borrows $500, which for simplicity's sake he deposits in his account.
If you stop there, your analysis is indeed correct. However, people don't typically take out loans to stuff the borrowed money into their accounts until the loan comes due.
They go out and buy stuff with the proceeds. So B withdraws the money.
So now you have:
- Assets: 1000$ cash in your safe plus an IOU of 500$ from B = 1500$.
- Liabilities: 1000$ deposit from A + 500$ deposit from B = 1500$.
So far so good.
You can repeat that game two more times, and then you run out of cash to withdraw.
So if you repeated it a third time, you'd need to sell the loan from B to a third party for cash, so you can fulfill B's withdrawal request.
If B is credit worthy, you will generally be able to make that sale. (But it takes time and hassle to organise.) Ie you have short term liquidity trouble, but you ain't insolvent.
If B is a deadbeat, you won't be able to sell that loan for enough to cover the withdrawal request, and now you are insolvent, and go into bankruptcy.
B is creditworthy. That’s why I leant it to him. If I have an issue with liquidity I go to the discount window of my central bank and they will lend me the money.
That’s why central banks typically make the rules about reserves, etc.
> B is creditworthy. That’s why I leant it to him. If I have an issue with liquidity I go to the discount window of my central bank and they will lend me the money.
Yes. But that means you got newly created base money from the central bank. Which sort of goes against the original claim.
> When you come to spend it, that amount is transferred to another bank, that they can then offset against their own magic money.
No. The other banks demand settlement in outside currency. In the olden days, they shipped gold around every so often. Nowadays, in the end you settle in central bank deposits.
The only relationship with deposits (which are actually liabilities) and assets is that enforced by regulators.
This is how money creation works in the modern economy - so the money supply can grow as economic activity increases, all guided by central banks / governments with levers such as interest rates, open market activities (QE), and regulations.
Again - banks really do create money from nothing, all day, every day.