Let's get the basics correct, already!

JohnfrmClevelan · Oct 25, 2018

Lately I have seen a few misinformed claims on various things that end up as tangential sub-threads in other posts, so I thought a good, basic, economics-minus-the-politics thread was in order. So I will start off with a few points for consideration, and maybe debate (if you consider them incorrect).

Banks do not lend out pre-existing money (like money from our savings accounts). Instead, banks create M1 money by expanding their balance sheets via loans.

The government spends not by borrowing, but by simply creating and spending liabilities (assets to us, though) into the economy. There is no debt to be "repaid," only liabilities (in the accounting sense only) that may or may not be extinguished by taxation.

The economy can only grow with an addition of new demand, which requires increased private sector debt and/or federal deficit spending and/or a trade surplus and/or net dis-saving. And in the U.S., the latter two almost never happen. See Circular Flow of Income for an additional explanation.

A greater disparity in income generally leads to increased federal deficits, in order to make up for lost demand.

Entitlement programs are a boon to the economy, while tax cuts for the rich are costly to the economy.

Have at it.

Harshaw · Oct 25, 2018

JohnfrmClevelan said:
A greater disparity in income generally leads to increased federal deficits, in order to make up for lost demand.

Entitlement programs are a boon to the economy, while tax cuts for the rich are costly to the economy.

I thought this was minus the politics.

Beaudreaux · Oct 25, 2018

Harshaw said:
I thought this was minus the politics.

Yeah, I was pretty much with his post's points, up until those two.

JohnfrmClevelan · Oct 25, 2018

Those weren’t meant to be political, just conversation starters. If you don’t think something is correct, then make an ECONOMIC argument supporting your position. Because I can defend both of those claims with economic arguments.

OrphanSlug · Oct 25, 2018

Welcome to the money multiplier.

JohnfrmClevelan · Oct 27, 2018

Harshaw said:
I thought this was minus the politics.

So let me restate the same thing in hopefully a more palatable way:

savings are a drag on the economy, while spending - even forced spending through taxation - is a boon for the economy.

ludin · Oct 30, 2018

Beaudreaux said:
Yeah, I was pretty much with his post's points, up until those two.

The op is semi-confused on this topic.

https://www.investopedia.com/terms/b/bank-reserve.asp
A bank reserve is the currency deposit that is not lent out to the bank's clients. A small fraction of the total deposits is held internally by the bank in cash vaults or deposited with the central bank. Minimum reserve requirements are established by central banks in order to ensure that the financial institutions will be able to provide clients with cash upon request.

Banks do not lend out the reserve. The reserve amount is the x% of the loans that a bank does.

According to the Federal Reserve Board's regulation, the required reserves represent the amount of funds a bank must hold in its cash vault or deposit with the central bank against certain liabilities. The reserve ratio determines the required reserve, and it varies by the amount deposited in net transaction accounts, which include demand deposits, automatic transfer accounts and share draft accounts. Net transactions are calculated as the total amount in transaction accounts minus funds due from other banks and less cash in the process of collection.

At the end of the day a bank must meet the federal reserve ratio.

so lets say the reserve rate is 10%.

and lets say that i have lent out 10m dollars. i must have at least 1m dollars of cash on hand.
how i get there are multiple ways.

if by the end of the day i do not have 1m dollars of cash on hand i have to do 1 of 2 things.
1. Borrow cash from another bank that has an excess on hand
2. Borrow cash from the Federal reserve itself.

now if i have excess reserves i can loan that money out to other banks.

banks don't lend reserves.

JohnfrmClevelan · Oct 30, 2018

ludin said:
The op is semi-confused on this topic.

https://www.investopedia.com/terms/b/bank-reserve.asp
A bank reserve is the currency deposit that is not lent out to the bank's clients. A small fraction of the total deposits is held internally by the bank in cash vaults or deposited with the central bank. Minimum reserve requirements are established by central banks in order to ensure that the financial institutions will be able to provide clients with cash upon request.

Banks do not lend out the reserve. The reserve amount is the x% of the loans that a bank does.

According to the Federal Reserve Board's regulation, the required reserves represent the amount of funds a bank must hold in its cash vault or deposit with the central bank against certain liabilities. The reserve ratio determines the required reserve, and it varies by the amount deposited in net transaction accounts, which include demand deposits, automatic transfer accounts and share draft accounts. Net transactions are calculated as the total amount in transaction accounts minus funds due from other banks and less cash in the process of collection.

At the end of the day a bank must meet the federal reserve ratio.

so lets say the reserve rate is 10%.

and lets say that i have lent out 10m dollars. i must have at least 1m dollars of cash on hand.
how i get there are multiple ways.

if by the end of the day i do not have 1m dollars of cash on hand i have to do 1 of 2 things.
1. Borrow cash from another bank that has an excess on hand
2. Borrow cash from the Federal reserve itself.

now if i have excess reserves i can loan that money out to other banks.

banks don't lend reserves.

You are the one who is confused. In one breath, you (correctly) say that banks don't lend out reserves. Then, in the next breath, you say that they loan out excess reserves. This is completely wrong.

When is the last time anybody went into a bank for a loan and walked out with a duffel bag full of cash? Banks don't lend out reserves, excess or otherwise.

I asked you in another thread to explain how a bank could possibly lend out a liability, and you couldn't do it. Because our deposits are bank liabilities.

Bank assets consist of reserves, promissory notes, and capital. Banks don't lend out their capital, and they can't lend out promissory notes. But they also don't lend out reserves.

When a bank creates a loan, they simply mark up their balance sheet; they mark up borrower's account (a bank liability), and they add borrower's promissory note (a bank asset) to their asset side. Reserves don't come into play until it's time to disburse the loan, and even then they are only used if a) the loan is disbursed to a different bank, and b) the bank's outgoing transfers are larger than their incoming deposits. Reserves are settlement funds, nothing else. If net interbank transactions all add up to a net of $50 that Bank A owes Bank B, then $50 of reserves will be transferred at the end of the day to settle up, even though there could be millions of dollars of new loans created and disbursed that day.

That is what is meant when it is said that banks create M1 money "out of thin air." No pre-existing funds are used to create a bank loan. The money is created when the bank marks up borrower's account. Nobody's deposit account is debited, not even the bank's. A $1000 loan results in a $1000 addition to the M1 money supply, which is mostly account balances.

In countries without a reserve requirement, banks only need enough reserves to be able to settle up at the end of the day. In countries that have a reserve requirement, that just means that the 10% requirement is more than sufficient to ensure smooth settlement at the end of the day. And when we withdraw cash from the bank, that itself is a form of settlement; our bank's liabilities (the account balance) and our bank's assets (the cash (reserves)) both go down by the amount of the withdrawal.

So if there is a reserve requirement of 10%, the bank has to have total reserves (a reserve balance at the Fed + vault cash) at least equal to 10% of their total M1 liabilities (basically, checking accounts). If customer accounts total $2 million, then the bank should have $200,000 in total reserves. THEY ARE TWO DIFFERENT THINGS, AND TWO DIFFERENT CLASSES OF MONEY.

JohnfrmClevelan · Oct 30, 2018

ludin said:
https://www.investopedia.com/terms/b/bank-reserve.asp
A bank reserve is the currency deposit that is not lent out to the bank's clients. A small fraction of the total deposits is held internally by the bank in cash vaults or deposited with the central bank. Minimum reserve requirements are established by central banks in order to ensure that the financial institutions will be able to provide clients with cash upon request.

That Investopedia article is riddled with mistakes.

A fraction of total reserves (not deposits) is held internally by the bank as vault cash. Minimum reserve requirements are there to ensure smooth settlement, not just cash withdrawals. Settlement includes interbank transfers, handled by the Fed at the end of the day.

ludin said:
Banks do not lend out the reserve. The reserve amount is the x% of the loans that a bank does.

No, the reserve amount is the % held against total M1 liabilities (short-term deposits), not loans.

ludin said:
According to the Federal Reserve Board's regulation, the required reserves represent the amount of funds a bank must hold in its cash vault or deposit with the central bank against certain liabilities. The reserve ratio determines the required reserve, and it varies by the amount deposited in net transaction accounts, which include demand deposits, automatic transfer accounts and share draft accounts. Net transactions are calculated as the total amount in transaction accounts minus funds due from other banks and less cash in the process of collection.

This information from the Fed is correct. Notice that the Fed references the amount held in net transaction accounts (that's the short-term accounts, or M1 liabilities, that I mentioned above). They also mention net transactions - that's settlement.

ludin said:
At the end of the day a bank must meet the federal reserve ratio.

so lets say the reserve rate is 10%.

and lets say that i have lent out 10m dollars. i must have at least 1m dollars of cash on hand.

This is incorrect.

If you lend out $10 million, you don't need any reserves until it's time to disburse the funds to a different bank. And even then, you only need enough reserves to cover the net settlement amount at the end of the day. Which might mean that you need the full $10 million in reserves; if you have a $10 million loan being disbursed to a different bank, and no deposits coming in, then disbursing that loan will require a $10 million transfer of reserves from lender's bank to depositor's bank, via their reserve accounts at the Fed. After which, you will still need to meet reserve requirements.

Your reserve requirement isn't calculated by looking at the loans you make, it's calculated by looking at your total account balances

Neomalthusian · Oct 30, 2018

JohnfrmClevelan said:
Those weren’t meant to be political, just conversation starters. If you don’t think something is correct, then make an ECONOMIC argument supporting your position. Because I can defend both of those claims with economic arguments.

You can pivot to economics after making an inherently political comment, but the cat's out of the bag at that point if skeptics know one of your foundational tenets includes partisan rhetoric. The big offender in your list was "tax cuts for the rich." That's a partisan cliche that people are triggered to equate with Republicans.

ludin · Oct 30, 2018

Neomalthusian said:
You can pivot to economics after making an inherently political comment, but the cat's out of the bag at that point if skeptics know one of your foundational tenets includes partisan rhetoric. The big offender in your list was "tax cuts for the rich." That's a partisan cliche that people are triggered to equate with Republicans.

This is simply not doing great. I kind of figured the direction of the thread knowing the OP.
still that doesn't change that the OP's initial arguments are flawed as i have shown.

JohnfrmClevelan · Oct 30, 2018

Neomalthusian said:
You can pivot to economics after making an inherently political comment, but the cat's out of the bag at that point if skeptics know one of your foundational tenets includes partisan rhetoric. The big offender in your list was "tax cuts for the rich." That's a partisan cliche that people are triggered to equate with Republicans.

Bring on the skeptics, then. There is a reason why conservatives generally fall on one side of the argument, and progressives fall on the other, even in economics.

My foundational tenets are all grounded in economics. I became more liberal once I understood that the government isn't in true debt. Once you realize that, it's pretty hard to justify being frugal.

JohnfrmClevelan · Oct 30, 2018

ludin said:
This is simply not doing great. I kind of figured the direction of the thread knowing the OP.
still that doesn't change that the OP's initial arguments are flawed as i have shown.

The only direction this thread is supposed to take is one in the direction of getting some things about economics correct. That is not a political question.

Did you bother to read my last posts that explained where you went wrong? This shouldn't be a fight, ludin. There is a correct answer to operational questions, no matter what your politics are. You seem to have some interest in this stuff, and you also seem to have made some progress over the past year, so I'm trying to have a discussion in good faith.

Neomalthusian · Oct 30, 2018

ludin said:
This is simply not doing great. I kind of figured the direction of the thread knowing the OP.
still that doesn't change that the OP's initial arguments are flawed as i have shown.

Whether you've shown all those arguments to be flawed, or he has shown yours to be flawed, the point is partisanship poisons academic discussions of economics, and I would go farther as to say it foments deep distrust of academic institutions altogether among anyone who isn't aligned with that clear partisanship.

Social sciences other than economics have all sorts of research bias issues too, in my impression. The overwhelming Democratic partisanship of social science fields (psychology, history, sociology, social work, the identity studies, and so forth) is a key indicator of this. And what I've found is they will often try to display a pretense that they are purely scientific and objective, but they set up what they want to observe in just such a way as to confirm the pre-existing bias. Some also finesse into their comments and research their standard little partisan jabs, to the delight of partisan readers and audiences, and rely on the research jargon and other ethereal jargon to place themselves above counter-partisan criticism, as anybody who balks will be accused of denying evidence and hating knowledge.

Focusing back in on economics, probably the most notorious example is Paul Krugman. I recently listened to a speech in which he decided to pinpoint the exact change of direction in the U.S., and the end of the post-WW2 economic boom in general, precisely on 1980, with a wink and a nod. What happened in 1980? Paul Krugman the Nobel Laureate economist, who could spin me in circles with his Princeton-caliber macroeconomic jargon, talks about U.S. economic history in just such a way as to play right into a partisan narrative. "I'm speaking strictly in terms of economics! (Vote Democrat, *wink)"

Neomalthusian · Oct 30, 2018

JohnfrmClevelan said:
My foundational tenets are all grounded in economics. I became more liberal once I understood that the government isn't in true debt. Once you realize that, it's pretty hard to justify being frugal.

Becoming more liberal is one thing. Deploying standard partisan talking points is another. You said entitlement programs are a boon the economy, yet lately the Democratic Party is putting up this pretentious display of concern for the burden on taxpayers as a result of some workers also receiving federal benefits, as if we need to reduce federal spending by figuring out how to pin the cost on private sector businesses. How does this square with your observations?

As to the reference to income inequality, what is the mechanism enabling that inequality of income? I think the biggest thing is equity compensation. Most of us out there in society are grappling for a foothold in an organization and trying to earn decent W2 wages and salaries and other employment benefits. And there aren't many jobs that pay wages and salaries into the several hundreds of thousands or millions. People making the big bucks are paid in equity. Most of the income inequality references are pointed at one thing, which is "we should raise income tax rates." What can't the federal government do as a result of not having high enough upper income tax rates? I don't see this really squaring with your other comments. It's just sort of a slide away from economic/monetary observations to partisan banter.

You stated your objective was to discuss economic basics minus politics. Given today's rhetoric, I think that objective would be better accomplished without talking point trigger words like "income inequality" and "tax cuts for the rich." Just my opinion.

JohnfrmClevelan · Oct 30, 2018

Neomalthusian said:
Whether you've shown all those arguments to be flawed, or he has shown yours to be flawed, the point is partisanship poisons academic discussions of economics, and I would go farther as to say it foments deep distrust of academic institutions altogether among anyone who isn't aligned with that clear partisanship.

Social sciences other than economics have all sorts of research bias issues too, in my impression. The overwhelming Democratic partisanship of social science fields (psychology, history, sociology, social work, the identity studies, and so forth) is a key indicator of this. And what I've found is they will often try to display a pretense that they are purely scientific and objective, but they set up what they want to observe in just such a way as to confirm the pre-existing bias. Some also finesse into their comments and research their standard little partisan jabs, to the delight of partisan readers and audiences, and rely on the research jargon and other ethereal jargon to place themselves above counter-partisan criticism, as anybody who balks will be accused of denying evidence and hating knowledge.

Focusing back in on economics, probably the most notorious example is Paul Krugman. I recently listened to a speech in which he decided to pinpoint the exact change of direction in the U.S., and the end of the post-WW2 economic boom in general, precisely on 1980, with a wink and a nod. What happened in 1980? Paul Krugman the Nobel Laureate economist, who could spin me in circles with his Princeton-caliber macroeconomic jargon, talks about U.S. economic history in just such a way as to play right into a partisan narrative. "I'm speaking strictly in terms of economics! (Vote Democrat, *wink)"

Well, Krugman wasn't wrong.

Economics is inextricably tied to politics, so sometimes politics is part of the answer. Reagan listened to Hayek, which led to the infamous "starve the beast" policy choices. Happily, Hayek was wrong; he didn't understand government finance, so all of his torpedoes couldn't sink the ship. But Republicans are still following his lead to this day.

How do I know that Hayek was wrong? Because I can point to some objective operational realities that won't square with his economic theories.

I really don't care to get into political discussions; they are too often like arguing about religion. But when some political views are based on a demonstrably incorrect understanding of economics, that's a place I'll go, because it's possible to make some headway.

ludin · Oct 30, 2018

Neomalthusian said:
Whether you've shown all those arguments to be flawed, or he has shown yours to be flawed, the point is partisanship poisons academic discussions of economics, and I would go farther as to say it foments deep distrust of academic institutions altogether among anyone who isn't aligned with that clear partisanship.

Social sciences other than economics have all sorts of research bias issues too, in my impression. The overwhelming Democratic partisanship of social science fields (psychology, history, sociology, social work, the identity studies, and so forth) is a key indicator of this. And what I've found is they will often try to display a pretense that they are purely scientific and objective, but they set up what they want to observe in just such a way as to confirm the pre-existing bias. Some also finesse into their comments and research their standard little partisan jabs, to the delight of partisan readers and audiences, and rely on the research jargon and other ethereal jargon to place themselves above counter-partisan criticism, as anybody who balks will be accused of denying evidence and hating knowledge.

Focusing back in on economics, probably the most notorious example is Paul Krugman. I recently listened to a speech in which he decided to pinpoint the exact change of direction in the U.S., and the end of the post-WW2 economic boom in general, precisely on 1980, with a wink and a nod. What happened in 1980? Paul Krugman the Nobel Laureate economist, who could spin me in circles with his Princeton-caliber macroeconomic jargon, talks about U.S. economic history in just such a way as to play right into a partisan narrative. "I'm speaking strictly in terms of economics! (Vote Democrat, *wink)"

I agree economics has become less scientific and more political over the years.
which i agree is a bad thing. It should viewed in a neutral light but that takes away
from the attempt to influence people.

JohnfrmClevelan · Oct 30, 2018

Neomalthusian said:
Becoming more liberal is one thing. Deploying standard partisan talking points is another. You said entitlement programs are a boon the economy, yet lately the Democratic Party is putting up this pretentious display of concern for the burden on taxpayers as a result of some workers also receiving federal benefits, as if we need to reduce federal spending by figuring out how to pin the cost on private sector businesses. How does this square with your observations?

As to the reference to income inequality, what is the mechanism enabling that inequality of income? I think the biggest thing is equity compensation. Most of us out there in society are grappling for a foothold in an organization and trying to earn decent W2 wages and salaries and other employment benefits. And there aren't many jobs that pay wages and salaries into the several hundreds of thousands or millions. People making the big bucks are paid in equity. Most of the income inequality references are pointed at one thing, which is "we should raise income tax rates." What can't the federal government do as a result of not having high enough upper income tax rates? I don't see this really squaring with your other comments. It's just sort of a slide away from economic/monetary observations to partisan banter.

You stated your objective was to discuss economic basics minus politics. Given today's rhetoric, I think that objective would be better accomplished without talking point trigger words like "income inequality" and "tax cuts for the rich." Just my opinion.

You are taking this way too far into politics. I'll answer your questions, but then I'm stepping back.

It is all about where money flows, and where it stops flowing. In general, anything that keeps money churning in the domestic economy is a plus, while anything that shunts that money into savings is a minus. The lower end, and the businesses that service them, is where the churning happens. At the higher end is where the savings happens and the money stops churning.

Income inequality is a product of the weak demand for labor. Raising taxes and spending those taxes on the lower end is an artificial way to churn money, but it doesn't completely solve the labor market problem.

Mainstream Democrats have no answers, but at least they aren't actively trying to tear the house down.

Neomalthusian · Oct 30, 2018

JohnfrmClevelan said:
Well, Krugman wasn't wrong.

Economics is inextricably tied to politics, so sometimes politics is part of the answer. Reagan listened to Hayek, which led to the infamous "starve the beast" policy choices. Happily, Hayek was wrong; he didn't understand government finance, so all of his torpedoes couldn't sink the ship. But Republicans are still following his lead to this day.

How do I know that Hayek was wrong? Because I can point to some objective operational realities that won't square with his economic theories.

I really don't care to get into political discussions; they are too often like arguing about religion. But when some political views are based on a demonstrably incorrect understanding of economics, that's a place I'll go, because it's possible to make some headway.

I get it, but using the counter-partisan trigger phrases makes skeptics believe you're just another partisan shill who just happens to have a lot of economics jargon in your war chest.

imagep · Oct 30, 2018

ludin;1069227218 Banks do not lend out the reserve. The reserve amount is the x% of the loans that a bank does.[/QUOTE said:
Actually, that's not correct. There is no reserve on loans. The reserve is a percent of deposits, not loans. A bank can acquire the money it lends, and as long as it didn't acquire it from customer deposits, then there is no additional required reserves needed.

The federal reserve literature is very clean on the fact that the reserve is a percentage of deposits.

The claim that "banks don't lend reserves" isn't quite true either. That claim is based upon some incorrect assumptions. The first assumption is that the word "reserves" means the same as "required reserves". It doesnt. Every dollar that a bank deposits with the fed is part of it's reserves. When a bank has more reserves than it is required to have, then the bank can use that money to fund loans, or it can loan it out to other banks through the interbank lending system.

And technically, a bank can't lend reserves because if the money was lent, it would no longer be that banks reserves, but that's really a silly semantic issue.

JohnfrmClevelan · Oct 30, 2018

imagep said:
Actually, that's not correct. There is no reserve on loans. The reserve is a percent of deposits, not loans. A bank can acquire the money it lends, and as long as it didn't acquire it from customer deposits, then there is no additional required reserves needed.

The federal reserve literature is very clean on the fact that the reserve is a percentage of deposits.

The claim that "banks don't lend reserves" isn't quite true either. That claim is based upon some incorrect assumptions. The first assumption is that the word "reserves" means the same as "required reserves". It doesnt. Every dollar that a bank deposits with the fed is part of it's reserves. When a bank has more reserves than it is required to have, then the bank can use that money to fund loans, or it can loan it out to other banks through the interbank lending system.

And technically, a bank can't lend reserves because if the money was lent, it would no longer be that banks reserves, but that's really a silly semantic issue.

No, banks don't "fund" loans with anything. It doesn't matter what a bank's reserve position is at the time a loan is made, because banks don't use reserves, excess or otherwise, to fund loans. Loans are "funded" simply by marking up borrower's account.

Take the case of two loans, one for $1000 and one for $1050. Andy takes out a loan for $1000 from Bank A; Bank A marks up Andy's account by $1000, and holds Andy's promissory note as an asset. Bob takes out a loan for $1050 from Bank B; Bank B marks up Bob's account by $1050, and holds Bob's promissory note as an asset. At this point, no reserves are necessary, and no reserves move.

IF Andy and Bob simply let their loans sit in their own accounts, liabilities have increased by $1000 and $1050; Bank A's reserve requirement has gone up by $100, and Bank B's has gone up by $105. Maybe they already had enough reserves, and maybe they didn't.

IF INSTEAD Andy writes a $1000 check that somebody deposits in Bank B, and Bob writes a $1050 check that somebody deposits in Bank A, then for settlement, the Fed will transfer $50 from Bank B's reserve account to Bank A's reserve account. $50 being the net of the interbank transactions for the day. Bank A's required reserve number will increase by $105, and Bank B's required reserve number will increase by $100. (This is assuming that those checks were written right as the loans were created, and were not in borrower's accounts long enough to be counted, which is normal.)

IF INSTEAD Andy writes a $1000 check that somebody deposits in Bank A, and Bob writes a $1050 check that somebody deposits in Bank A (Bank A gets both checks), then Bank A's reserve requirement goes up by $205; for settlement, the Fed will transfer $1050 from Bank B's reserve account to Bank A's reserve account, as $1050 is the net of the interbank transactions for the day. Due to the transfer of $1050, Bank A has not only gained enough reserves to cover it's increased requirement of $205, but they also have gained excess reserves in the amount of $845 ($1050 - $205). Bank B, having transferred $1050 in reserves to Bank A, may have to obtain or borrow $1050 in reserves in order to meet their reserve requirement (which did not change).

Because there is $2050 in newly-created M1 money, the system-wide reserve requirement went up by $205, and system-wide excess reserves went down by $205. Total reserves did not change.

The ONLY thing a bank gets from having excess reserves is the ability to meet a greater reserve requirement. It doesn't give them more money to lend (because banks don't lend out pre-existing money), and it doesn't even make them operationally more able to create loans from credit (because banks are not reserve-constrained).

Neomalthusian · Oct 30, 2018

JohnfrmClevelan said:
You are taking this way too far into politics. I'll answer your questions, but then I'm stepping back.

It is all about where money flows, and where it stops flowing. In general, anything that keeps money churning in the domestic economy is a plus, while anything that shunts that money into savings is a minus. The lower end, and the businesses that service them, is where the churning happens. At the higher end is where the savings happens and the money stops churning.

Income inequality is a product of the weak demand for labor. Raising taxes and spending those taxes on the lower end is an artificial way to churn money, but it doesn't completely solve the labor market problem.

What does?

If we want money churning in the domestic economy, should we be thinking about ways to make sure money makes its way into the people at the lowest rungs of the income ladder, or forget about those at the lowest rungs and try to foment class struggle between the "middle class" and the "ownership class?" I notice a distinct lack of advocacy (whether economic or political) for the tens of millions of Americans who aren't even in the labor force.

imagep · Oct 30, 2018

JohnfrmClevelan said:
No, banks don't "fund" loans with anything. It doesn't matter what a bank's reserve position is at the time a loan is made, because banks don't use reserves, excess or otherwise, to fund loans. Loans are "funded" simply by marking up borrower's account.

Take the case of two loans, one for $1000 and one for $1050. Andy takes out a loan for $1000 from Bank A; Bank A marks up Andy's account by $1000, and holds Andy's promissory note as an asset. Bob takes out a loan for $1050 from Bank B; Bank B marks up Bob's account by $1050, and holds Bob's promissory note as an asset. At this point, no reserves are necessary, and no reserves move.

IF Andy and Bob simply let their loans sit in their own accounts, liabilities have increased by $1000 and $1050; Bank A's reserve requirement has gone up by $100, and Bank B's has gone up by $105. Maybe they already had enough reserves, and maybe they didn't.

IF INSTEAD Andy writes a $1000 check that somebody deposits in Bank B, and Bob writes a $1050 check that somebody deposits in Bank A, then for settlement, the Fed will transfer $50 from Bank B's reserve account to Bank A's reserve account. $50 being the net of the interbank transactions for the day. Bank A's required reserve number will increase by $105, and Bank B's required reserve number will increase by $100. (This is assuming that those checks were written right as the loans were created, and were not in borrower's accounts long enough to be counted, which is normal.)

IF INSTEAD Andy writes a $1000 check that somebody deposits in Bank A, and Bob writes a $1050 check that somebody deposits in Bank A (Bank A gets both checks), then Bank A's reserve requirement goes up by $205; for settlement, the Fed will transfer $1050 from Bank B's reserve account to Bank A's reserve account, as $1050 is the net of the interbank transactions for the day. Due to the transfer of $1050, Bank A has not only gained enough reserves to cover it's increased requirement of $205, but they also have gained excess reserves in the amount of $845 ($1050 - $205). Bank B, having transferred $1050 in reserves to Bank A, may have to obtain or borrow $1050 in reserves in order to meet their reserve requirement (which did not change).

Because there is $2050 in newly-created M1 money, the system-wide reserve requirement went up by $205, and system-wide excess reserves went down by $205. Total reserves did not change.

The ONLY thing a bank gets from having excess reserves is the ability to meet a greater reserve requirement. It doesn't give them more money to lend (because banks don't lend out pre-existing money), and it doesn't even make them operationally more able to create loans from credit (because banks are not reserve-constrained).

I realize that we will just have to agree to disagree on this. I am not conceding though. I still believe that our primary disagreement is largely semantic. You don't seem to agree with the particular words that I am using, yet the net result of both of our understandings of how this works is pretty much exactly the same - with the only real difference being that I believe that banks CAN and do lend excess reserves without having to replace those reserves over night, while you think that every penny deposited in a particular bank remains in that particular banks reserve account.

JohnfrmClevelan · Oct 30, 2018

imagep said:
I realize that we will just have to agree to disagree on this. I am not conceding though. I still believe that our primary disagreement is largely semantic. You don't seem to agree with the particular words that I am using, yet the net result of both of our understandings of how this works is pretty much exactly the same - with the only real difference being that I believe that banks CAN and do lend excess reserves without having to replace those reserves over night, while you think that every penny deposited in a particular bank remains in that particular banks reserve account.

I will admit, I'm still not 100% sure what you are describing here.

I understand that when you look at a single loan by itself, it can look like reserves are part of the loan, or even fund the loan, because taken by itself, a $1000 loan will result in a transfer of $1000 of reserves. That's why I try to include examples where reserves don't come into play at all, or are equal to just a tiny fraction of the loans. That should be enough to distinguish "funding" from "settlement." In real life, with thousands of interbank transactions happening every day, the net of interbank transactions is a tiny fraction of all transactions. And that's the only place that reserves really come into play - so reserves obviously can't be what funds loans.

"...while you think that every penny deposited in a particular bank remains in that particular banks reserve account."

Nothing really gets deposited in banks; it's just an exchange of liabilities (account balances going up and down), with an exchange of reserves only representing the net of many transactions. Even if you deposit cash, which sure feels like a solid asset, that cash instantly becomes vault cash (reserves) upon deposit; your deposit is now just a bank liability, and the accounting is no different than if you deposited a check.

******

I find it helpful to think of reserves as the scorekeeping chips on a wire above the pool table. The balls are M1 money, the stuff we transact with. You are three ahead, and I am three behind on the table; this is represented by a movement of the chips. But the two never mix.

imagep · Oct 30, 2018

JohnfrmClevelan said:
...
...Even if you deposit cash, which sure feels like a solid asset, that cash instantly becomes vault cash (reserves) upon deposit; your deposit is now just a bank liability, and the accounting is no different than if you deposited a check.

Whether one deposits cash or a check, only 10% of it has to be held by the bank (or deposited into the banks reserve account at the fed) as required reserves. The rest can be utilized by the bank for whatever purpose, including lending it out. While my deposit is a bank liability, the money itself that I deposited is a bank asset. Reserves are an asset to a bank, so if I deposit cash/check or electronic money into a bank, that bank's reserve increases. As long as the banks total reserves are in excess of it's required reserves, then the bank simply transfers digits from it's own reserve account to the borrowers account (which may or may not be at the same bank). The bank didn't simply just add digits to the borrowers account, it added digits to the borrowers account AND subtracted an equivilent amount of digits from it's reserve account.

The total reserves held by the fed may not change, but the lending banks reserves decreased (but is still above the required reserves).

If banks don't utilize depositors money, then where do banks get the money to lend to other banks on the interbank lending system?

If banks simply add digits to accounts to make a loan, without having to reduce digits in it's reserve account, then why would any bank ever need to borrow on the interbank lending system?

It simply wouldn't be possible for a banks reserve to be below the required reserve, if banks held every penny of deposits in their reserve account at the fed, we wouldn't have a "fractional reserve banking system", we would have a 100% reserve banking system. But we all know that we have a fractional reserve system. If banks could not lend from reserves, then no depositors deposit would ever be at risk, and that government insurance on deposit account of up to $200k wouldn't even exist. Bank runs would be impossible, although people withdrawing their deposits would have to be willing to accept cashiers checks.

Just because a bank doesn't have to have any reserves to make a loan (or stated MMT style - just because a bank isn't reserve constrained), doesn't mean that banks can't or don't lend from reserves, they just can't loan or lend from required reserves.

Let's get the basics correct, already!

JohnfrmClevelan

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