Debt Question

[chockfullofthat]

What happens when they lend out more money then they actually have? The overall debt can't exceed that initial stock of money? Meh. I have to stop reading stupid books like Web of Debt and start with an introductory banking concepts book.

 

[DSGE]

What happens when they lend out more money then they actually have? The overall debt can't exceed that initial stock of money? Meh.

Banks? Well you can't lend out more money than you have. You need to have money before you can lend somebody said money. But if people take that money a bank has lent them, and deposit it in a bank, the bank can just keep lending that money out. But, as a bank, at any point depositors are going to want access to some of their deposit. Not everybody is going to come and withdraw from the bank at once (unless there's a bank run!), so the bank can lend out lots of money, but it also has to keep reserves - liquid money on hand at the bank - for the people who want to withdraw. The amount of reserves the bank has to hold limits the amount of lending it can do.

I have to stop reading stupid books like Web of Debt and start with a introductory banking concepts book.

Good call. I'd strongly suggest The Economics of Money, Banking and Financial Markets by Frederic Mishkin. Probably the best textbook I've ever encountered.

 

[ERGO]

how does fractional reserve system make it impossible to pay off debt?

Our fractional-reserve, fiat financial system is built upon debt-based money. In this perverse arrangement, new dollars come into existence through the creation of government and private debt. Going the other way, if the private sector and the federal government ever began seriously paying down their debts, the supply of US dollars would shrink. Money is loaned into existence. Put simply, under a fractional reserve banking system all money is created out of debt.

Not all money. Inside money is debt, outside money isn't. But your post makes no sense anyway. In aggregate, if there were no debt that would mean the stock of inside money would be zero, but there's still outside money. Currency isn't money as debt. So it doesn't matter anyway, even if there were no debt. But individual actors, like you, me or the government, can completely pay down our debt without impacting the money supply. Inside money grows endogenously. If Treasury debt stops getting created, other debt will expand automatically to fill the demand for money. Fractional Reserve has nothing to do with paying down debt.

If ALL debts were paid, public and private, there would be no money in circulation. When money is created under the fractional reserve system it is loaned into existence at interest by the banks. That money has to be paid back at interest, but the interest is never created.So, the fractional reserve system makes it inherently impossible to pay off ALL debts, public or private and to still have money in circulation.
The American dollar is a Federal Reserve note and it is loaned into existence by the FED at interest to the government and commercial banks in the beginning. The commercial banks after getting this money (fiat currency) from the private central bank, the Federal Reserve, then can loan out 9$ dollars, at interest, for every 1$ dollar it has in capital reserve. This is the fractional reserve banking system. This is how all money in the United States is created. When the government spends more than what it gets in tax revenue, it either has to raise taxes and/or cut spending or borrow it from the private central and/or by selling treasuries (debt obligations) at interest. The Treasury Dept. creates treasuries, T-bills, Notes, and 30 yr. bond and participating banks auction off these treasuries every Monday. Interest/yields are paid to the purchasers of these treasuries. When there aren't enough purchasers of treasuries to cover the governments debt. The Federal Reserve will monetize the debt by exchanging the government treasuries (debt obligations) for federal reserve notes (check book money).The Federal Reserve doesn't print all this money of course, it's checkbook money made by key strokes on a computer at the FED... ledger book entries.
The federal government will never pay off the debt. As it has been for a very long time, the federal government has been only paying the interest on the debt. This interest is paid out to the purchasers of the treasuries and it is part of the annual budget. The amount of interest paid out is determined by the Federal Reserves' interest rates. If the Federal Reserve raises it's interest rate more money will have to be allocated out of the government's annual budget just to pay the interest.


To expand on this, Borrowing from wikipedia:
"In monetary economics, a money multiplier is one of various closely related ratios of commercial bank money to central bank money under a fractional-reserve banking system. Most often, it measures the maximum amount of commercial bank money that can be created by a given unit of central bank money. That is, in a fractional-reserve banking system, the total amount of LOANS (at interest) that commercial banks are allowed to extend (the commercial bank money that they can legally CREATE) is a multiple of reserves; this multiple is the reciprocal of the reserve ratio, and it is an economic multiplier."
"If banks LEND OUT (at interest) close to the maximum allowed by their reserves, then the inequality becomes an approximate equality, and commercial bank money is central bank money times the multiplier (i.e.10:1). If banks instead LEND LESS than the maximum, accumulating excess reserves, then commercial bank money will be less than central bank money times the theoretical multiplier." End of wikipedia quote

So you see money is created at interest in the form of loans by the commercial banks by maintaining a minimum reserve requirement. The money created is checkbook money, a ledger book entry. This money is created by creating debt to a borrower, who must pay it back at interest, which again, is not created. There are inherent problems with a fractional reserve banking system and having a private central bank creating money out of thin air (fiat currency).
Example:
The 1929 stock market crash was caused by foolish investors who had BORROWED money from the BANKS to invest in the markets when times were good expecting to make a hefty return, but, the markets slowed down, there were bank runs and bank failures the stocks dipped instead of climbing, there were margin calls and along with that, the investors defaulted heavily on their loans. The stock market crash and the subsequent Depression were actually caused by tight monetary policies that the Federal Reserve instituted at that time. The Fed began raising the FED FUNDS rate in the spring of 1928, and kept raising it through a recession that began in August 1929. This led to the stock market crash in October 1929. When the stock market crashed, investors turned to the currency markets. At that time, dollars were backed by gold held by the U.S. Government. Speculators began selling dollars for gold in September 1931, which caused a run on the dollar.
The FED raised interest rates again to preserve the value of the dollar. This further restricted the availability of money for businesses, causing more bankruptcies.
The Fed did not increase the supply of money to combat deflation. As investors withdrew all their dollars from banks, the banks failed, causing more panic. The FED ignored the banks' plight, thus destroying any remaining consumers’ confidence in banks. Most people withdrew their cash and put it under the mattress, which further decreased the money supply. Bottom line...thanks to the FED, there was just not enough money in circulation to get the economy going again. Instead of pumping money into the economy, and increasing the money supply, the FED ( Federal Reserve bank)allowed the money supply to fall 30%.

 

[ERGO]

One person takes out $100. At some point he will pay back that $100, but not before two others have borrowed another $100 each.

Wait...what about the INTEREST on the debt?

$100 was created when the debt was assumed, but the outstanding debt is for an amount GREATER than the $100 created.

Where does the additional money to pay the interest on that originaal $100 come from?

More debt, right? ALSO at interest, right?

I think THAT is his point.

Except it's not true. There's already a stock of money. You get paid income out of the existing stock of money and use that to pay the interest. Simple example where we start off with no inside money, only $100 in outside money.

$100 in currency is held by a firm, you have no money. You work for the firm. The firm puts the currency in the bank. The bank lends you $20. You go buy stuff. The firm withdraws $30 currency from its account. You get paid a wage of $30 working for the firm. You give $20 in principal back to the back, along with $5 interest. At the end of the day, the firm has $70 currency. You have $5 currency. All debt has been paid off, including interest.

Operating under the assumption that the firm has an account at the bank that pays it interest for maintaining a minimum balance, like a money market account. When the firm deposits money into the bank, that raises the banks capital reserves which the bank in turn can loan out at interest as long as it maintains the required ratio. Let's say the banks pays the firm 3% interest for it's market fund and charges 6% on loaning that money. The bank makes it money on the 3% spread.
Let's say the firm maintains a balance of $100,000 dollars. The bank can then loan out $90,000 dollars of that at interest by creating ledger book entries. They don't actually use the savings or money market funds to loan out.They expand the money supply by loaning out money they don't actually have. They can do this as long as they maintain the required capital reserve requirement.
The stock of money you're referring to is money that has been accumulated through earnings or savings. There's a big difference between money accumulation, stock money, and money creation through the fractional reserve banking system at interest.
There isn't enough "stock money", in the macroeconomic scheme of things, to pay back all the debts public and/or private at interest. i guarantee you if you added up all this "stock money" and added up all the debts at interest. The debts at interest would far exceed this "stock money". Again, the interest is not created.

 

[Mr. Jones]

This is probably a pretty basic question here. If it is impossible to payoff the debt because of our fractional reserve system, what does the government want to do with the debt? Do they simply want to trim it down from it's current levels right now?

how does fractional reserve system make it impossible to pay off debt?

An economy based on debt, and dependent on debt to grow is a pyramid scheme, doomed to fail.

[ame=http://www.youtube.com/watch?v=mIIAvdJvCes]Money As Debt 1-4 - YouTube[/ame]

 

[itfitzme]

This is probably a pretty basic question here. If it is impossible to payoff the debt because of our fractional reserve system, what does the government want to do with the debt? Do they simply want to trim it down from it's current levels right now?

What happens when they lend out more money then they actually have? The overall debt can't exceed that initial stock of money? Meh. I have to stop reading stupid books like Web of Debt and start with an introductory banking concepts book.

It is sustainable, because the money supply endogenously expands as real output, and hence real income grows. The money supply only expands as our ability to service that debt expands.

And there you have it.

The key term is endogenous money if we want to do a Google search.

The obvious issues in perception come out of the "debt and the debt plus interest must be paid back" concept. As editec says, "Wait...what about the INTEREST on the debt?" And, "If ALL debts were paid, public and private, there would be no money in circulation". These create the conflict.

The simple but unsatisfying answer is that someone already thought about this and it doesn't work the way we think. Our initial perception is simply wrong.

My interest is in the balance, the equilibrium.

The money multiplier is straight forward. One bank loans to ten more that loan to a hundred that loan to ten thousand businesses. The reserve requirement is 10% so it goes up exponentially.

Then there is the other part. I borrow $500,000 with which I purchase a house. The seller takes that and puts in in his account. Now his bank has $500,000 from which to loan.

Something DSGE said gives me pause. "Well you can't lend out more money than you have." It is opposition to what I understood as the money multiplier.

Does this apply to commercial banks? Are there two different banks with different reserve requirements? It is a minor point, though, because it just becomes a multiplicative factor of 1 instead of 0.1.

Basics are found here;

http://en.wikipedia.org/wiki/Money_multiplier
Money supply - Wikipedia, the free encyclopedia
Money creation - Wikipedia, the free encyclopedia

Everyone has already studied and memorize those, no doubt.

 

[itfitzme]

On the "Wait...what about the INTEREST on the debt?", I can say this.

Lets take the money multiplier at .5 for Bank 1 loans to Banks A and B. Bank A and B have a reserve requirement of one.

Bank 1 has $100,000 and loans $100,000 to each of Bank A and B.

Now there is $200,000 at the point where it can be borrowed for consumption.

We will take it that there is already $20,000 in circulation, what I was calling M0.

A bunch of consumers borrow the $200,000 of which they will owe 10% in interests. When they pay it back, they pay back the $200,000 plus the $20,000. $110,000 to each of Bank A and B.

Bank A and B do own $100,000 each to Bank 1 at 5%. That is $5000 for a total of $10,000.

So Bank A and B each pay $105,000 each for a total of $210,000 to Bank 1.

The interest that Bank A and B have made, minus the interest they paid to Bank 1 is income for salaries. It amounts to $10,000 or $5,000 each. These pay salaries to employees that now have $10,000 to spend.

Bank 1 has $10,000 for salaries.

All the salaries from all three banks is $20,000. So, the original amount of M0 = $20,000 remains in circulation.

In the end, after all the debt has been unwound, the same money remains in circulation.

 

[DSGE]

Something DSGE said gives me pause. "Well you can't lend out more money than you have." It is opposition to what I understood as the money multiplier.

Yeah I probably wasn't especially clear on that. I didn't mean banks can't create money, I just meant that if a bank is going to create a liability by lending somebody money, if that money gets deposited at another institution the bank needs reserves to back that money. That doesn't necessarily, mean they have them to begin with, but they know they can get them. When they need them to maintain a positive balance on their exchange settlement account, they just borrow in the Fed Funds market. It was a poor choice of words.

 

[DSGE]

If ALL debts were paid, public and private, there would be no money in circulation.

There would be, because there'd still be base money. The Fed doesn't have to and doesn't just buy debt at interest to inject money. They can buy other assets. Gold, foreign exchange, etc. That is, non-interest bearing assets. That means that when the Fed holds gold and foreign exchange reserves, there's base money permanently floating around in the economy that is not related to debt or interest. That base money serves as a base with which to service debt at interest.

The Treasury Dept. creates treasuries, T-bills, Notes, and 30 yr. bond and participating banks auction off these treasuries every Monday. Interest/yields are paid to the purchasers of these treasuries. When there aren't enough purchasers of treasuries to cover the governments debt. The Federal Reserve will monetize the debt by exchanging the government treasuries (debt obligations) for federal reserve notes (check book money).

Bullshit. Complete bullshit. It's illegal for the Federal Reserve to buy treasuries in the primary market (that is, directly from the Treasury). The Fed can only buy already issued treasuries in the open (or secondary) market.

The amount of interest paid out is determined by the Federal Reserves' interest rates. If the Federal Reserve raises it's interest rate more money will have to be allocated out of the government's annual budget just to pay the interest.

More bullshit. The Federal Reserve controls one interest rate: the Federal Funds rate. That's the rate at which banks lend to each other overnight. It's capable of controlling this interest rate since the market for Fed Funds is relatively small and the Fed has a monopoly over the issue of base money. Markets for long treasuries are the deepest and most liquid in the world. They're just huge. The Fed has almost no control over long rates. Hell, it took hundreds of billions of dollars of QE and the Fed only managed to budge long rates down a few basis points. The interest rate on long government debt is determined by the market for that debt, in which the Fed is a small player.

 

[sealybobo]

This is probably a pretty basic question here. If it is impossible to payoff the debt because of our fractional reserve system, what does the government want to do with the debt? Do they simply want to trim it down from it's current levels right now?

The GOP keep cutting social programs as ways to deal with the deficit but none of them are talking about solving the debt. The $14 trillion debt. Only Ron Paul is. Now I don't like Ron Paul, but I do like his idea of taking back our Federal Reserve from the private bankers that run it now. They are ripping us off.

Just google 9 trillion or 2 trillion unaccounted for from Federal Reserve or 2.7 trillion missing from Pentagon.

Or just remember when Bush said the bankers needed to be bailed out. They said it themselves. They are too big to fail.

So when Obama wins, lets lean on him and whoever runs the Senate and House to take back the Federal Reserve. We don't need Ron Paul to get this done.

 

[DSGE]

This is probably a pretty basic question here. If it is impossible to payoff the debt because of our fractional reserve system, what does the government want to do with the debt? Do they simply want to trim it down from it's current levels right now?

The GOP keep cutting social programs as ways to deal with the deficit but none of them are talking about solving the debt. The $14 trillion debt. Only Ron Paul is. Now I don't like Ron Paul, but I do like his idea of taking back our Federal Reserve from the private bankers that run it now. They are ripping us off.

Just google 9 trillion or 2 trillion unaccounted for from Federal Reserve or 2.7 trillion missing from Pentagon.

Or just remember when Bush said the bankers needed to be bailed out. They said it themselves. They are too big to fail.

So when Obama wins, lets lean on him and whoever runs the Senate and House to take back the Federal Reserve. We don't need Ron Paul to get this done.

What are you talking about? The Chairman of the Fed, Ben Bernanke, isn't a private banker. He's an academic economist. He was a Great Depression scholar who taught at Princeton. The Board of Governors is appointed by the President and confirmed by the Senate. What's the problem?

 

[EdwardBaiamonte]

What are you talking about? The Chairman of the Fed, Ben Bernanke, isn't a private banker. He's an academic economist. He was a Great Depression scholar who taught at Princeton. The Board of Governors is appointed by the President and confirmed by the Senate. What's the problem?

The problem is that many liberal and libertarian screwball conspiracy theorists have spun that narrative about the Fed as if to show sane people that they are perfectly ignorant.

Not surprising given that millions followed Hitler Stalin Mao.