Fractional reserve banking...recipe for disaster?

Since they can create and destroy money at will, what is the point of auditing it?
 
Here is an explanation about money usage from another forum:


rayiner :

"The Fed paranoia is pretty retarded. What people don't understand is that you need money to facilitate transactions, that the US dollar is the international standard for that money, and the world grows really fast.

At moderate rates of population/economic growth (2.5% and 1%, respectively):

The economy generates about $14 trillion per year of value, or about $40 billion a day. All the transactions involved must be facilitated with cash. The economy grows by about $350 billion per year, or on average about $1 billion a day. The population grows by about 3 million a year, or 8,200 per day.

Money is just a proxy for goods and services. If you're creating $1 billion more goods every day, you need to print more money to serve as a proxy for their value. If you've got 8,200 new workers each day, you need to print more money to serve as a proxy for their labor.

People talk about the gold standard, but the fact that they do so shows they don't understand what is going on. We got off the gold standard because we just can't mine the stuff fast enough to keep up growth. In the 1949 the US already held 70% of the world's gold in Fort Knox. How were we supposed to accommodate any more growth without introducing massive distortion from limitations of gold supply?

I'm not saying that Fed policy is great, but rather that the conspiracy theorists just don't understand the underlying problem the Fed is there to solve. They think of the central bank like their personal checking account --- a place where they squirrel away whatever they earn. That's why they gasp at the idea of "creating money." They don't understand what the function of money is.

As an aside, I'd also like to talk about the function of debt, b/c I see lot's of people who are like "reserve banking is a fraud because nobody could ever pay off all their debt." What is debt? Debt is just a proxy for future goods and services. Say I'm a baker and you build houses. We reach an agreement where you build me a house in return for a 5 years supply of bread. Obviously I can't make and you can't take delivery of all 5 years worth of bread at once, so you agree to take delivery of one fresh loaf every day. At the same time, I can't really be homeless for 5 years until I'm done paying you in bread! So you agree to build my house now in return for my promise to bake you bread every day for 5 years. You've just made me a loan --- you've agreed to trade goods and services in the present for goods and services in the future. You probably want to charge me interest, to factor in the reduced value of future bread versus bread in the present, etc.

What happens when we introduce money? I can just take out a mortgage on the house and use my bread-making skills to pay off that mortgage over 5 years. You can in turn, use the money to buy bread (or whatever else you want). Notice a curious thing however. There had to be enough currency in the system to serve as a proxy for my 5 years of services. If there was only enough currency in the system to represent the goods and services then in existence, then there wouldn't be enough to serve as proxies in transactions where people commit to future production of goods and services! Indeed, the amount of currency in the system needs to fluctuate as people's appetite for speculation* changes. If everything is going great people are willing to make commitments further out (maybe a bigger house in return for 10 years supply of bread!) but if things are rough people are less willing to make such commitments. The gold standard can't handle, but a reserve system (where money is created when it is lent and destroyed when it is paid off) can.
 
Syzygys said:
... The gold standard can't handle, but a reserve system (where money is created when it is lent and destroyed when it is paid off) can.
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Thank for the link. I quoted the last sentence of it above.

I understand how the gold standard fails to provide the flexibility in the money supply and how the Fractional Banking aids the FED in the creation of new money (thin air money, if you like); but I don't understand how the FED can destroy money.

In principle, the government could destroy money by collecting more in taxes than it spends, but I am not holding my breath for that to happen.

Bernanke, when pressed, suggested he can pay interest on funds deposited with the FED (even got Congress to authorize that a couple of years ago); but that is borrowing from the public (or banks or firms) and they expect to get not only their money back but more when the interest is added. I don't see how that is destroying money.

The only way I can think of for the FED to destroy money is to get some presidential pardons, and hire bank robbers. Perhaps giving them the pardons to use if they are caught by police and if not caught threating to turn them into the police if 90% of what they stole is not given to the FED (who burns it up)

Not a bad deal for the bank robbers - no risk and keep 10% of what you steal without getting caught. Hell I might come out of retirement. (Not for the 10% of course) but as my patriotic duty to help my country destroy money.

Can any one explain to me how the FED can destroy any of the thin air money it has created?

If for example when the FED tells one of it 12 participating banks to add $1000 to its books that bank, via the FBS creates up to $9000 more. Conceivably, the FED can ask for its $1000 back (if it really was just a loan?) but what about the $8000 or so that was made from it?
 
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The Fed destroys and replaces "unfit" money. But that's it. I think the author meant reducing the money supply. If that is the case, the fed reduces the money supply by selling Fed assets like Treasuries and or increasing bank deposit/reserve requirements at the Fed. That effectively removes money from the economy.
 
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joepistole said:
the fed reduces the money supply by selling Fed assets like Treasuries and or increasing bank deposit/reserve requirements at the Fed.
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What he said. By increasing the deposit requirements, they remove money from the circulation.

The only valid criticism for the existence of the Fed is that it is not 100% a government institution and they are not fully accountable to the President or Congress. (they set policy independently)
But these idiots who complain about the Fed don't get that basicly every other country has a central bank. Now we can argue about its policy (like not curtailing early enough certain bubbles), but there is nothing wrong with its existence...

The best way to compare a central bankless situation is too look up the US history in the 1800s. There was a systematic failure in every 8 years, and banks were going bankrupt all the time...
 
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I am amazed at the elasticity of the US dollar- how it can take a direct hit like TARP etc... for Trillions yet spring back and still be a viable currency. Our fiat dollars are very flexible.

And personally, if I had a fortune, I would open my own bank and play the game of Fractional Reserve Banking.
 
Syzygys said:
Here is an explanation about money usage from another forum:


rayiner :

"
The economy generates about $14 trillion per year of value, or about $40 billion a day. All the transactions involved must be facilitated with cash. The economy grows by about $350 billion per year, or on average about $1 billion a day. The population grows by about 3 million a year, or 8,200 per day.

Money is just a proxy for goods and services. If you're creating $1 billion more goods every day, you need to print more money to serve as a proxy for their value. If you've got 8,200 new workers each day, you need to print more money to serve as a proxy for their labor.

.
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I seriously question some of post 65..especially the above...And even if it were the case it's NOT RELATED to the current issues.

They were/are printing money because people are NOT working..just the opposite of what this post says.
The audit issues are in regards to "secret bailouts" to firms and governments that were previously NEVER even considered..Correct me if I'm wrong.
Thus putting much more money in circulation than anyone knew about.
 
joepistole said:
The Fed destroys and replaces "unfit" money. But that's it. I think the author meant reducing the money supply. If that is the case, the fed reduces the money supply by selling Fed assets like Treasuries and or increasing bank deposit/reserve requirements at the Fed. That effectively removes money from the economy.
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Yes the FED can take money out of circulation with larger bank reserve requirements, but they must be small compared to 100% if banks are to function. Every increase means the banks have less funds to lend so the bank must charge higher interest rate on each loan it does make or reduce their profits. I would guess that the total the FED could remove from circulation would be much less than the new, thin air, money it has recently created.

Yes the FED can sell treasury bonds it owns, but they have a maturity date, when face value must be paid, so that is identical with the FED allowing interest paying deposits at the FED -I.e. Not only will the capital come back into circulation, but the interest will too.
 
Billy T said:
Yes the FED can take money out of circulation with larger bank reserve requirements, but they must be small compared to 100% if banks are to function. Every increase means the banks have less funds to lend so the bank must charge higher interest rate on each loan it does make or reduce their profits. I would guess that the total the FED could remove from circulation would be much less than the new, thin air, money it has recently created.
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I think QE1 has been vastly over blown for political reasons.

"Now, let us examine what happened to combined Federal Reserve and commercial banking system during the Fed's first round of quantitative easing that covered the 16 months ended March 2010. Chart 3 shows the net change in total Federal Reserve credit, Federal Reserve outright holdings of securities and Federal Reserve credit excluding outright holdings of securities in the 16 months ended March 2010 (the shaded area in the chart). Notice that although Federal Reserve outright holdings of securities increased a net $1.5 trillion during the first round of Fed quantitative easing, total Federal Reserve credit increased by only a net $200 billion during this period because other elements of Federal Reserve credit contracted by a net $1.3 trillion. Chart 4 shows that commercial banking system credit contracted by a net $875 billion in the 16 months of the Fed's first round of quantitative easing. Thus, when we sum the net change in Federal Reserve credit and commercial banking system credit in the 16 months ended March 2010, the period encompassing the Fed's first round of quantitative easing, we find that the net change in credit was minus $675 billion. Is it any wonder, then, why the response of nominal GDP growth was so restrained to QE1? We would argue that QE1 was a misnomer in that there was no quantitative easing, but rather a quantitative contraction."

http://www.safehaven.com/article/18821/qe2-is-likely-to-more-successful-than-qe1

Yes, the Fed can retract or void every dollar it has ever put into circulation. But as you point out that would have some very adverse consequences. Managing the money supply is a balancing act.

Billy T said:
Yes the FED can sell treasury bonds it owns, but they have a maturity date, when face value must be paid, so that is identical with the FED allowing interest paying deposits at the FED -I.e. Not only will the capital come back into circulation, but the interest will too.
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Yes if the Fed sells debt, the interest on the debt will be returned to the money supply but over a long period of time. And the money supply needs to grow with the economy, so that is a good thing.

And if you look at the broad measure of money supply (M2) from Jan 08 to Jan 09 it has only increased by 542 billion dollars...an average growth rate of about 3 percent. That is not unmanagable by any stretch of the imagination.

http://www.federalreserve.gov/releases/h6/hist/h6hist1.txt
 
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joepistole said:
... http://www.safehaven.com/article/18821/qe2-is-likely-to-more-successful-than-qe1...
Yes if the Fed sells debt, the interest on the debt will be returned to the money supply but over a long period of time. And the money supply needs to grow with the economy, so that is a good thing.
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Thanks for the informative link. I will need some time to digest it.

Yes the fact that the money pulled from circulation returns with interest later may be OK but only if the economy is growing and needing more circulating money. If there is a run on the dollar and then a deep long lasting depression this returning money will just add to the hyperinflation problem; but of course that is how the debt will be paid off - with near worthless money.
 
jmpet said:
how it can take a direct hit like TARP etc...
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TARP was basicly a loan and it has been paid back. An excellent example when the Fed created money, it was used, then when paid back it disappeared from usage...
 
clusteringflux said:
They were/are printing money because people are NOT working..just the opposite of what this post says.
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Post #65 explained how it works theoretically. TARP and my above post explained how it sometimes works practically...

Now one could argue that the whole TARP business shouldn't have been done and it wasn't for the Fed to bail out failing banks, (and I might agree) but there is a counter argument that without that, we could have got a systematic failure and the whole system could have collapsed.... The too big to fail thingy....
 
Syzygys said:
TARP was basicly a loan and it has been paid back. An excellent example when the Fed created money, it was used, then when paid back it disappeared from usage...
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That is no doubt technically correct, but look at how it was paid back: The FED has both taken low real value assets off the banks books paying them falsely high values AND given them credits on their books at little or no interest cost. The banks did not lend this money out, or seldom did. Instead they bought Treasury bonds with no risk and considerable profits.

Effectively TARP was paid back by assured profit deals given to the banks.
 
My thread, which started with post #57 was an allusion to Social Security. How can we take FICA monies and invest them in something when the Fed is handing out money at a 10:1 ratio? They can't- nothing is more profitable than the banks creating money out of thin air.
 
http://money.cnn.com/2010/12/01/news/economy/fed_reserve_data_release/index.htm

some interesting data here
The Federal Reserve made $9 trillion in overnight loans to major banks and Wall Street firms during the financial crisis, according to newly revealed data released Wednesday.

The loans were made through a special loan program set up by the Fed in the wake of the Bear Stearns collapse in March 2008 to keep the nation's bond markets trading normally.

The amount of cash being pumped out to the financial giants was not previously disclosed. All the loans were backed by collateral and all were paid back with a very low interest rate to the Fed -- an annual rate of between 0.5% to 3.5%.

Still, the total amount was a surprise, even to some who had followed the Fed's rescue efforts closely.

"That's a real number, even for the Fed," said FusionIQ's Barry Ritholtz, author of the book "Bailout Nation." While the fact that the markets were in trouble was already well known, he said the amount of help they needed is still surprising.

"It makes it very clear this was a very serious, very unusual situation," he said.

Sen. Bernie Sanders, the Vermont independent who had authored the provision of the financial reform law that required Wednesday's disclosure, called the data that was released incredible and jaw-dropping.

"The $700 billion Wall Street bailout turned out to be pocket change compared to trillions and trillions of dollars in near zero interest loans and other financial arrangements that the Federal Reserve doled out to every major financial institution," Sanders said.
 
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