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Money creation (from wikipedia) << http://en.wikipedia.org/wiki/Fractional-reserve_banking >> -- Scroll down to "money creation"
The regular type here is from wikipedia. The words and numbers by Martin Carbone use bold type and are preceded and terminated by [[ & ]]
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Money Creation
Modern central banking allows multiple banks to practice fractional reserve banking with inter-bank business transactions without risking bankruptcy.
The process of fractional-reserve banking has a cumulative effect of money creation by banks, essentially expanding the money supply of the economy.[6]
There are two types of money in a fractional-reserve banking system operating with a central bank:[12][13][14]
[[ This is a misleading statement, which I believe is meant to confuse the reader. Money held by the Central Bank and money held by commercial banks are not significant different types of money -- except that they are owned by different groups ]]
[[ These two types of money are called "central bank money" and "commercial bank money" below. ]]
1. central bank money (money created or adopted by the central bank regardless of its form (precious metals, commodity certificates, banknotes, coins, electronic money loaned to commercial banks, or anything else the central bank chooses as its form of money)
[[ Although all of these things can be used as money, there does not seem to be any point in listing them here. By the way, most of things are not legal tender]]
2. commercial bank money (demand deposits in the commercial banking system) - sometimes referred to as chequebook money[15]
[[ This is an incomplete list of commercial bank money. Certainly, the bank’s capital and its profits are commercial bank money, as are its assets that can be converted easily to cash ]]
When a deposit of central bank money is made at a commercial bank, the central bank money is removed from circulation and added to the commercial banks reserves [[ Isn't the money still "in circulation" when it is added to the commercial banks reserves ]] (it is no longer counted as part of m1 money supply). Simultaneously, an equal amount of new commercial bank money is created in the form of bank deposits. [[ Note that word "banks" on the second line of this paragraph is a plural and not a possessive. does that mean the money is not owned by the commercial banks? ]]
[[ This is a complicated way to say that money owned by the central bank can be deposited in a commercial bank and will then be called a bank deposit. It is not clear if this newly deposited money is still an asset of the central bank (on loan to the commercial bank), as well as both an asset and a liability of the commercial bank. ]]
When a loan is made by the commercial bank (which keeps only a fraction of the central bank money as reserves), using the central bank money from the commercial bank's reserves, the m1 money supply expands by the size of the loan. [5] This process is called deposit multiplication.
[[ Which "process"? (a) all loans made by a commercial bank or (b) only loans using the central bank money? ]]
[[ Why is the "process ... called "deposit multiplication" when it clearly is only an adition? ]]
[[ Why are you telling us "the commercial bank ... keeps only a fraction of the central bank money as reserves?" Our studies of our banking system tell us that "reserves" have absolutely no relevance or function with regard to modern bank lending (mrc) ]]
The table below displays how loans are funded and how the money supply is affected. It also shows how central bank money is used to create commercial bank money from an initial deposit of $100 of central bank money. In the example, the initial deposit is lent out 10 times with a fractional-reserve rate of 20% to ultimately create $400 of commercial bank money. [[ I believe those preceding sentences in this paragraph are all total nonsense - that is not how money is handled, or new money is created. It does not comport with existing “reserve” requirements ]] Each bank involved in this process creates new commercial bank money on only a portion of the original deposit of central bank money, ensuring that it always has enough reserves on hand to meet the inter-bank business demands, and also ensuring that multiple banks participate in the inflation process so that all banks are inflating at the same rate. [[ I believe that is all untrue for a number of reasons, (a) most banks do not have significant “interbank demands” that should not be able to handed easily by petty cash. Almost all of a normal bank’s business is with depositors and borrowers and in neither case is there likely to be an unexpected demand for money that these two want. (b) the reserve requirements currently run from Zero% to 10% -- depending on the size of the bank -- so keeping 0 to 10% as a reserve should be easy. The demand for reserves do not fall out of the sky and come as a surprise to normal banks. They should be prepared to meet their obligations ]]
The process begins when an initial $100 deposit of central bank money is made into Bank A. Bank A then takes 20 percent of it, or $20, and sets it aside as reserves and then loans out the remaining 80 percent, or $80.
[[ That is nonsense and patently false on its face. Bank’s are no longer constrained by the reserves they hold -- reserves are an antiquated and unnecessary artifact from the days of goldsmith banking when goldsmiths had to keep a certain amount of gold reserves on hand to redeem a sudden influx of their outstanding notes that were redeemable for gold. Now that we use paper money and electronic transfer -- it would be foolish to keep paper or electronic reserves for paper or electronic money. ]]
At this point there is actually a total of $180 in the system, not $100; because the bank has loaned out $80 of the central bank money, kept $20 of central bank money in reserve, and substituted a newly created $80 IOU claim for the depositor that acts equivalent to and can be implicitly redeemed for central bank money (the depositor can transfer it to another account, write a check on it, etc.).
[[ I believe the above to be false and misleading. You are faking and shifting pretty quickly -- but I think I can follow you as you move things under different cups. See the following --
(1) Why would one bank lend 90% of “reserves” it just received from the Fed to another bank when it has the right to lend at least 10 times that amount to a worthy borrower? See the reserve requirements at
<<http://www.primeronmoney.com/fdicfrblaw.html>> SEC. 19(b) and 19(c) + SEC. 204.9 where it shows a reserve requirement of 0% to 10% depending on the size of the bank.
(2) Also see my words in my preceding entry.
(3) In your example -- there would not be $180 in the system. Bank (A) received $100 but it owes the Fed that same $100 -- so it has broken even under that transaction (can I call it each transaction a cup?) and Bank B received a loan for $90 but owes that $90 to bank A -- so it has broken even under that cup. And the Fed placed $100 -- but it received a note for $100 -- so it broke even under that cup. As a matter of fact -- it looks like “this 3-cup system” has $00 dollars -- everybody in the “system” broke even. Of course everyone in the 3-cup system had some private money before the system started -- but they do not have any more now that the system started. And I don’t care how many iterations or recursive operations you make -- you will still have $00 .
In my opinion, here is how the system works. It is simple.
1) Bank A finds a worthy borrower with good collateral and a good idea for creating wealth with the money he wants to borrow
2) The borrower and the bank sign a contract that makes the borrower responsible for repaying the loan plus interest. That contract is enforceable by the powers of the government
3) No reserves come into this transaction. It is not up to the bank to make that loan “good” in any way.
4) When the loan check shows up at the Fed -- the Fed makes the check good in accordance with at least an implicit agreement with the Bank.
5) The bank collects its interest.
6) The borrower is successful -- he creates wealth that is worth more than the money he borrowed.
7 The loan is paid off -- but the wealth remain for the common good.
I will stop my argument -- I hope I have proven my points.]]
[[ Most of the rest is pure nonsense in my opinion.]]
These checkbook IOUs are termed commercial bank money and are simply recorded in a bank’s register as an asset (specifically, an IOU from the loan recipient) next to the reserves. From a depositor’s perspective, commercial money is central bank money -- it’s impossible to tell the two forms of money apart until a bank run happens (at which time everyone wants central bank money). At this point Bank A still holds $100 of central bank money reserves on its books, but $80 of those reserves are soon going to be needed to satisfy the loan recipient. The loan recipient soon spends the $80. The receiver of that $80 then deposits it into Bank B. Bank B demands $80 of central bank money be delivered from Bank A to Bank B in satisfaction of the loan recipient’s check. Bank A now only has $20 of central bank money on its books.
Bank B is now in the same situation as Bank A started with, except it has a deposit of $80 of central bank money instead of $100. Similar to Bank A, Bank B sets aside 20 percent of that $80, or $16, as reserves and lends out the remaining $64, creating $64 of IOUs to its depositors. As the process continues, more commercial bank money is created. To simplify the table, a different bank is used for each deposit. In the real world, the money a bank lends may end up in the same bank so it then has more money to lend out.
Table Sources: [13][14][15][9]
See table at "wikipedia can't be trusted" and at Wikipedia's website under "Fractional Reserve Ranking"
The expansion of $100 of central bank money through fractional-reserve lending with a 20% reserve rate. $400 of commercial bank money is created virtually through loans.
Although no new money was physically created in addition to the initial $100 deposit, new commercial bank money is created through loans. The 2 boxes marked in red show the location of the original $100 deposit throughout the entire process. The total reserves plus the last deposit (or last loan, whichever is last) will always equal the original amount, which in this case is $100. As this process continues, more commercial bank money is created. The amounts in each step decrease towards a limit. If a graph is made showing the accumulation of deposits, one can see that the graph is curved and approaches a limit. This limit is the maximum amount of money that can be created with a given reserve rate. When the reserve rate is 20%, as in the example above, the maximum amount of total deposits that can be created is $500 and the maximum amount of commercial bank money that can be created is $400.
For an individual bank, the deposit is considered a liability whereas the loan it gives out and the reserves are considered assets. The deposit will always be equal to the loan plus the reserve, since the loan and reserve are created from the deposit. This is the basis for a bank’s balance sheet.
The creation and destruction of commercial bank money occurs through this process. Whether it is created or destroyed depends on what direction the process moves. When loans are given out, the process moves from the top down and money is created. When loans are paid back, the process moves from the bottom to the top and commercial bank money is canceled out, effectively erasing it from existence.
This table gives an outline of the makeup of money supplies worldwide. Most of the money in any given money supply consists of commercial bank money.[9] The value of commercial bank money comes from the fact that it can be exchanged at a bank for central bank money.[9][10]
This is a general outline of how it works. The actual increase in the money supply through this process may be lower, as (at each step) banks may choose to hold reserves in excess of the statutory minimum, borrowers may let some funds sit idle, and some borrowers may choose to hold cash, and there may be delays or frictions in the process.[16] It may also be higher if the reserve requirement is lower or if there are no reserve requirements[17]. Government regulations may also be used to limit the money creation process by preventing banks from giving out loans even though the reserve requirements have been fulfilled.[18]
Money multiplier
The expansion of $100 through fractional-reserve banking with varying reserve requirements. Each curve approaches a limit. This limit is the value that the money multiplier calculates.
The most common mechanism used to measure this increase in the money supply is typically called the money multiplier. It calculates the maximum amount of money that an initial deposit can be expanded to with a given reserve ratio.
Formula
The money multiplier, m, is the inverse of the reserve requirement, R:[19]
m=\frac1R
Example
For example, with the reserve ratio of 20 percent, this reserve ratio, R, can also be expressed as a fraction:
R=\tfrac15
So then the money multiplier, m, will be calculated as:
m=1/\tfrac15=5
This number is multiplied by the initial deposit to show the maximum amount of money it can be expanded to.
The reserve requirements are intended to prevent banks from:
1. generating too much money by making too many loans against the narrow money deposit base;
2. having a shortage of cash when large deposits are withdrawn (although the reserve is a legal minimum, it is understood that in a crisis or bank run, reserves may be made available on a temporary basis).
[[ In my opinion -- the above makes a couple of serious errors in 1) and 2) above. It makes no difference how much money the bank has -- what matters is (a) how much money the borrower is going to pay back, (b) how good the collateral is (c) and the chances of success of the borrower’s project.]]
The money creation process is affected by the currency drain ratio (the propensity of the public to hold banknotes rather than deposit them with a commercial bank), and the safety reserve ratio (excess reserves beyond the legal requirement that commercial banks voluntarily hold—usually a small amount). Data for “excess” reserves and vault cash are published regularly by the Federal Reserve in the United States.[20] In practice, the actual money multiplier varies over time, and may be substantially lower than the theoretical maximum.[21]
In addition to reserve requirements, there are other required financial ratios that affect the amount of loans that a bank can fund. The capital requirement ratio is perhaps the most important of these other required ratios. When there are no mandatory reserve requirements, the capital requirement ratio acts to prevent an infinite amount of bank lending.
[[ The capital requirement ratio does no such thing -- it is simply a very complex formula that arrives at almost the same percentages that has no functional reality in modern banking, As we have said elsewhere -- it is an antiquated artifact from the times of goldsmith banking that has no modern application. On top of that -- it is a European gimmick that would rise to the status of an International Treaty only if it were signed by the President with the advice and consent of Congress. When did that happen?]]
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