So I posted this question in the Austrian_Economics subreddit but I figured I'll post it here since it hasn't been answered:
Hey AE,
So when a bank enters into some derivatives contract where they get to mark the agreement as an asset, is this an inflationary action? Do they get to count that asset as a reserve? What do they get to count as a reserve?
More specifically, when the TARP funding, and the secret preliminary FED funding occurred in 2007-2009, did those banks get to count the loans as reserve and then multiply it up?
I started thinking about this when people asked me "Hey, well the banks paid us back right? The taxpayers made a profit!" This answer seems a little specious to me. If the banks got to count those loans as reserves and then multiply the money 10x, then obviously they would easily be able to repay.
When do banks get to count what as reserves, and thus enact the inflationary nature of fractional reserve?
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Only actual US currency and demand deposits held by the central bank are monetary base, i.e. can be held as "reserves". But the Fed creates such things out of thin air, and then uses them to buy government bonds normally, and commercial bank "assets" in times of 'quantitative easing'.
It wasn't only money lenders which were bailed out by TARP. There were also investment banks, insurance companies, mutual funds etc. They didn't have a reserve requirement... Just obligations which were coming due.
Fractional reserve banking is only inflationary because the Federal Reserve has the power to print its own money. If the Fed itself couldn't buy government bonds, and other things, with its own money, then fractional reserve banking wouldn't be inflationary... Just risky.
Say Abe deposits $40,000 into The First National Bank of Blah. Blah Blank then lends out $20,000 of that to Charlie as a car loan. Abe's demand deposit has not changed. He still has $40,000 in the bank, but only half of it is held in reserve. Charlie spends the money at Dave's Car Lot. Dave deposits the $20,000 in Blah Bank. Blah Bank's total demand deposits have increased by $20,000. No money-printing by a central bank has happened, yet the money supply has increased. How is this not inflationary?
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He still has $40,000 in the bank, but only half of it is held in reserve.
Abe doesn't actually have it. The bank has half of it, and Charlie has the other half. This is the M0 money supply we're talking about... The base.
What Abe has is a promise from the commercial bank to be paid $40 000 on demand. They call this promise part of the M1 money supply under the system we've got. The commercial bank will only be able to fulfill its promise provided Abe doesn't come and ask for it at exactly the same time everyone else decides to ask for it.
It's exactly the same difference between actually having a mowed lawn, and having someone promise you that they will mow your lawn whenever you ask them to. :p
Despite their best intentions, they might not be able to. Indeed, they shall not be able to if you make your request at the wrong time, say, at precisely the same time everyone else he has promised comes to ask for their favour.
Unless this bank could print its own money, or perhaps credit everyone's computer account with limitless imaginary numbers, it would have to declare insolvency in the event of a bank run, and most of its customers would be out of luck - no growth of the money supply there, just a lot of very angry people.
James: This is the M0 money supply we're talking about... The base.
This is the M0 money supply we're talking about... The base.
Normally, when one talks about the money supply, one is referring to M0 plus demad deposits. Your limiting it to only M0 is very unusual, but that's neither here nor there. Are you saying that only M0 increases are inflationary?
Yes, I am... It's only measured M0 + commercial demand deposits, because the commercial deposits are legally guaranteed by a system that prints its own money. :/
Of course. Otherwise you're saying that credit itself is inflationary... A commercial bank can only lend what it has... If the reserve requirement is 10%, and it receives a deposit of $100, it lends out $90 and keeps $10 as its reserve... It doesn't keep the $100 and invent $900 to lend out.
Is gambling inflationary? If a betting shop has really bad luck one day, and all the wrong horses come in for them, they will have pledged to pay out more money to their clients than they received... But they haven't created money by issuing betting slips, have they? How is this different to a bank which only holds 10% reserves on hand, betting on the odds that it will never need more than this to satisfy demand withdrawels in the normal course of business?
If a betting shop has really bad luck one day, and all the wrong horses come in for them, they will have pledged to pay out more money to their clients than they received... But they haven't created money by issuing betting slips, have they? How is this different to a bank which only holds 10% reserves on hand, betting on the odds that it will never need more than this to satisfy demand withdrawels in the normal course of business?
There is a difference. Betting slips are not accepted as money by anyone. But checks issued by a bank are.
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