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I'll try again. It's called the fractional reserve system. The dollars are created through loans. If we start off with 100 dollars that are deposited into a bank by Person A, the bank only needs to keep a fraction of that, let's say 20%. The bank then has 80 dollars to lend out. So now 80 dollars will go to Person B who deposits the money into another bank. This bank then keeps a portion of it and lends that out to someone else and then it goes on.
But I'm missing a piece of the puzzle. Where does Person B get 80 dollars from to pay off his loan if there was only 100 dollars to begin with?
If he doesn't spend the money and just pay it back then he's fine.
This leads to another question, interest is tacked on. Suppose interest is only 5$. If he pays $85, then the bank has $105 which is impossible. Where would the extra $5 dollars come from? Either Person A loses it or Person B defaults.
Hi sheenie2000,
This is a great post. If you have not studied the issue much it is fantastically insightful.
I think it's just a matter of semantics though. Since money is backed by debt, and debt is created out of thin air, so is the money. I mean, most debt is not backed by anything hard. Sure, a portion of it is. Hey, sometimes the whole loan is at the time it was made, but what about the rest of it? Thin air, no? If the economy is expanding, no problem. but when it starts contracting, it wreaks all sorts of havoc, as you said.
Hi AnesthesiaMD,
I want to try and stay out of the way. I like people to talk about it. I think most people think we have too much or not enough of what we call dollars. I just want people to know what it is. It is the only defense since even gold was confiscated by Roosevelt thus "hard money" may also be breeched. However I cannot resist entirely.
This only applies to new government deposits and not most commercially credit created:
Now it does have a level of semantics and I call the Federal Reserve a banking facade. The reason why is was not before was gold OR government securities could back a Federal Reserve Note. Now however since the 30s domestically and the 70s internationally only Government securities back up Federal Reserve Notes. In reality we could scrap Federal Reserve notes and pass around treasuries since they are now effectively one and the same.
This debt again is a facade when owed to the FED which is really book keeping debt. The only time it is real debt is when the Fed sells bonds. All that really happens is treasury notes are created and placed in a Federal Reserve bank which then provides an equal amount of deposits of Federal Reserve Notes. This in reality is not the bulk of the problem. The political and policing power backs up these notes. Force of law runs the stop lights or legal tender laws just the same. They are real.
The problem is even though our government backs the currency most of it is created elsewhere. That is the root of the problem. It is not the fiat nature of the currency that is the issue but who reaps the benefit of the full faith an credit of the US. We the people cosign for the benefit of a plutocracy.
Actually it does a good job on the money and the economic hit men. The techo utopia stuff is really off the rails though. I would like to add that only the banking system as a whole creates money with little risk especially the big banks who get the bail outs. However keep in mind the default threat for the individual banks since they do create a liability they must make whole if there is a default. However what this does is consolidate the banking sector since any bank failures tend to benefit the last banks standing who are under the protection of the Fed they control. That has been one of the questions that has come up such as "why do banks fail then"?
Ok so now the money supply has increased to 180. But then what about interest/fees/penalities. Just based on this scenario, Person B couldn't pay the interest, fees etc. It's not there.
Well, firstly if a bank has $100 has of reverses then it can loan out $400 with a reverse ratio of 8:2. Only loaning out $80 makes it seem like the bank is loaning out money it actually has in reverse, but its not. Its creating new money.
So say person A takes out a loan of $400 which is deposited in the bank. Now say this person pays 10% interest ($40) to the bank and uses the rest ($360) for some service from person B. Now suppose the bank buys something from person B for $40 (the interest income) who now has $400 which in turn buys something person A allowing them to pay off the loan. We are back to the bank having a reverse of $100.
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Humanoid: Its created from debt, either in terms of government debt or personal debt. New money doesn't get created unless someone goes into debt. So, in that sense its not created out of "thin air". Its just an complex system of IOUs.
In this sense its impossible for everyone to get out of debt under the current money system. It would collapse.
I think many that get that there is something funny with all the massive debt, don't understand the fundamental problem is the entire monetary system. And not simply a matter of people changing their behavior.
OK. Since I'm far more focused on the government issuing debt. Let's stick to that.
So let me ask you and gwynedd1. Do you think there is a level/point where issuing government debt becomes detrimental for our country??........for our society?
Can the government truly cover most of what we need to in this current downturn until the private lenders feel more confident to lend? And if so. How long do you think it will take for us to pay down that debt? Not to zero mind you. Just to take it down a bit.
Actually some other questions.
Do you believe that the system of Debt/wealth will be force to change in some way after this downturn? If not...........then will there be a time when this system will be thrown off? And what do you feel will successfully replace this system?
Last edited by baystater; 11-14-2008 at 06:47 PM..
OK. Since I'm far more focused on the government issuing debt. Let's stick to that.
So let me ask you and gwynedd1. Do you think there is a level/point where issuing government debt becomes detrimental for our country??........for our society?
Can the government truly cover most of what we need to in this current downturn until the private lenders feel more confident to lend?
And if so. How long do you think it will take for us to pay down that debt? Not to zero mind you. Just to take it down a bit.
I think the government has a limit on the amount of debt it can issue in the form of treasuries/bonds/US Notes. And, if treasuries/bond debt = money... then the government can only create so much money even if they wanted to create more. Ultimately, a Country also has a credit rating. In terms of Countries, it's their production to debt ratio or GDP to debt ratio. The US was around ~61% in 2007 amongst its' peers of Germany (63%), Canada (65%), UK (43%), etc. Of course 2008 would show a huge leap as GDP slows while US public debt goes up.
But, on another note... if ALL countries increase their GDP to debt ratio... then in a sense it's alright for the US to increase that ratio as well. In a global economy... all things are relative to each other among peers.
Once things improve, the government can take in taxes, increase reserve requirements to reel in it's notes... just as long as the private sector is likewise able to expand its' credit (or bank money) to fill the void. It's a see-saw...
And this leads me to believe why I think gwynedd1 is saying that he/she prefers that only the government issues debt/notes rather than the banks issuing their own (through the fractional reserve system) by requiring banks to have 100% reserve requirement, banks therefore can not lend or create their own IOUs.
At least then there would be only one entity able to essentially create IOUs (US fiat money) therefore supposively eliminating or reducing rapid (multiplier) expansions and contractions (credit destruction) in the credit/money supply.
The thing is though, if only the government is able to issue "debt" or notes... then the government would have to carry ALL the debt or collateral that all the banks are currently holding... which... at it's fullest extent would be 10 times whatever the banks currently hold at the Federal Reserve as reserve. So, if we want 100% Reserve requirement, then the Fed has a lot of debt issuing and printing to do.... and essentially the government would destroy it's credit rating... while all the banks would have pristine credit since it issued zero IOUs. Otherwise... like we are seeing now... major deflation/contraction... the government can't print and issue debt fast enough.
The first $1 notes (called United States Notes or "Legal Tenders") were issued by the Federal Government in 1862 and featured a portrait of Secretary of the Treasury Salmon P. Chase (1861-1864).
The first use George Washington's portrait on $1 notes was on Series 1869 United States Notes.
The inclusion of "In God We Trust" on all currency was required by law in 1955. The national motto first appeared on paper money in 1957 on $1 Silver Certificates, and on all Federal Reserve Notes beginning with Series 1963.
The first $1 Federal Reserve Notes were issued in 1963. The design, feauturing George Washington on the face and the Great Seal on the back, has not changed.
Of all the notes printed by the Bureau of Engraving and Printing, $1 notes make up about 45% of currency production.
Well, firstly if a bank has $100 has of reverses then it can loan out $400 with a reverse ratio of 8:2. Only loaning out $80 makes it seem like the bank is loaning out money it actually has in reverse, but its not. Its creating new money.
So say person A takes out a loan of $400 which is deposited in the bank. Now say this person pays 10% interest ($40) to the bank and uses the rest ($360) for some service from person B. Now suppose the bank buys something from person B for $40 (the interest income) who now has $400 which in turn buys something person A allowing them to pay off the loan. We are back to the bank having a reverse of $100.
Ok I get it. The initial $100 is used by the bank to create say an additional $400 to loan out. And the bank is only required to keep say 20% (in 'hard currency') of the initial $100 for reserves.
Ok I get it. The initial $100 is used by the bank to create say an additional $400 to loan out. And the bank is only required to keep say 20% (in 'hard currency') of the initial $100 for reserves.
No, the $100 is the reverses. The loan for $400 is based on having $100 in high powered money. On the other hand the bank can only loan out 80% of deposits (with a ratio of 8:2).
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It's called the fractional reserve system. The dollars are created through loans. If we start off with 100 dollars that are deposited into a bank by Person A, the bank only needs to keep a fraction of that, let's say 20%. The bank then has 80 dollars to lend out. So now 80 dollars will go to Person B who deposits the money into another bank. This bank then keeps a portion of it and lends that out to someone else and then it goes on. 
Who is the one created dollar bill?
