Similar questions probably get asked a lot, but this one is very straightforward.
I am curious about how fractional reserve banking is inflationary but yet 100% loan banking is not.
Loan banking would be where you place your savings in an interest paying loan account from which the bank would make loans to third parties with. These loan banking accounts would be used to make loans to customers which must be paid back during a certain time window and depositors would also not be able to withdraw their funds during that same window of time. Bunk runs would be impossible.
Fractional Reserve banking is still a bit mysterious to me on how it is inflationary while the above banking is not. I realize that a fractional reserve bank is subject to runs, but how is it inflationary? If a bank has a $1000 deposit and loans out $900 of it under the full extent allowed with a 10% reserve requirement. How is this inflationary? I know that the bank now has $1900 on its books but the original depositor is not using his $1000. It doesn't seem like any new credit has been created. So as long as the bank does not experience a run, how is this inflationary?
I am very interested in clearing this up for myself so that I can more properly explain this to others.
Juan:So, you deposit $1000 fiat dollars. The bank lends out $500. Total money supply $1500.
I think that I agree with you, but let me give the the argument that my banker father gives:
You deposit $1000. The bank lends out $500. The total money supply is still $1000 with the bank now having only $500 on reserve to satisfy potential customer demands and the lent out $500 that the debtor now has. No new money created. The only risk is that the original depositor will try to redeem anything more than $500 and the bank will be proved insolvent. Now, where does inflation come into play? It does now appear to anywhere.
James Greene:You deposit $1000. The bank lends out $500. The total money supply is still $1000...
...with the bank now having only $500 on reserve to satisfy potential customer demands and the lent out $500 that the debtor now has.
Now, where does inflation come into play? It does now appear to anywhere.
February 17 - 1600 - Giordano Bruno is burnt alive by the catholic church. Aquinas : "much more reason is there for heretics, as soon as they are convicted of heresy, to be not only excommunicated but even put to death."
James Greene:Lets say that there are 10 depositors at a bank who all have $100 on deposit for a total of $1000. And lets also say that one single customer takes a $900 dollar loan. This therefore leaves $100 left at the bank for its 10% reserve
I think that you were correct if there existed only one single bank in the economy! But we have a banking "system".
The trick is that the $900 loans can be deposited as cash in other banks. These banks keep 10% reserve and lend $810 to other banks. Those banks keep 10% reserve and lend $729 to still other banks and so on and so on. As a geometric sum it adds up that with x% reserve, FRB can create 1/x% dollars out of every initially deposited dollar, like 1/10% = 1/0.1 = 10 FRB money multiplier.
Such multiplier maximas are quickly reached because most money stays in the banking system all the time nowadays. If someone has deposited $1,000,000 in a bank, and you borrow $900,000 from that bank to buy a house, you don't withdraw it in cash. You just transfer it electronically to the house sellers account in another bank. Those $900,000 is thereby deposited in the house sellers bank, which uses it as reserve for lending $810,000 to a Ferrari buyer. The Ferrari seller deposits his recieved payment of $810,000 in yet another bank, which uses it as reserve for lending $729,000 to whatever and so on.
The problem is that loans are considered to be money reserves. When a bank is required (by the government) to hold reserves, it suffice if those reserves consist of money loaned from other banks. If $1,000 is all cash dollar which exist, then there exist $10,000 FRB dollars deposited. When people want their deposited FRB dollars back in cash, their overall loss will be 90%. (But with first-come-first-served or government "rescue packages" the losses will of course not hit everyone proprotionately).
For sure, those loaned money used as reserves in every step, have securities in the shape of the customers owning the money. It could be houses or cars or just obligations to pay in the future once based on the individuals income and credit history. So if everyone claimed all their deposited money back from the FRB-system, total losses will be 100% minus 10% ultimate cash reserve, minus the second hand value of the securities of the borrowers. Since all this credit-money-multiplying boosted the prices and imaginary values of the assets used as securities to begin with, the whole bubble mechanism does get quite interesting...
It's not fascism when the government does it.
“We must spend now as an investment for the future.” - President Obama
krazy kaju: I have $100 in a demand deposit and $90 is loaned out. I buy something online for $50, the money is transferred from my bank account to the online vendors. In this situation, we have the borrwer using my $90 and myself using $50 for a total of $140, even though there is only $100 in bank deposits. If fractional reserves weren't inflationary, there wouldn't be a difference between M0, M1, and M2.
I have $100 in a demand deposit and $90 is loaned out. I buy something online for $50, the money is transferred from my bank account to the online vendors. In this situation, we have the borrwer using my $90 and myself using $50 for a total of $140, even though there is only $100 in bank deposits.
If fractional reserves weren't inflationary, there wouldn't be a difference between M0, M1, and M2.
Those diffferences are irrelevant. The relevant is whether there is a difference in one of them between time t_1 and t_2.
Inflation is the debasement of the value of money which sometimes is reflected in rising prices for a particular good. Rising prices for a particular good are not neccessarily due to inflation; and inflation will not neccessarily cause a rise in the price of a particular good.
Fractional reserve banking tends to inflate the money supply as explained in the prior posts.
All other things being held equal, if there are $1,000 dollars in the entire world which will buy say the only pound of unobtanium in the world and then the fractional reserve bank artificialy expands the world's money supply to $1,500, then that pound of unobtanium would now cost $1,500 because the newly created additional units of money are not backed by true capital.
We are the soldiers for righteousnessAnd we are not sent here by the politicians you drink with - L. Dube, rip
bbnet:Fractional reserve banking tends to inflate the money supply as explained in the prior posts.
But so what? Mining and coinage inflates too.
bbnet:artificialy
Is it a synonym for naturally?
Mining and coinage inflates the money supply very marginally since it takes a lot of capital to get the gold out of the rock and into a coin. It does not appear magically with a stroke of a pen as in fractional reserve banking.
artificialy would be an antonym for naturally
Apologies if my terminology is off, it has been many years sibce I crunched on Mises and Rothbard. If you do follow their writings though, the logic is sooo clear.
But without mining and coinage the money supply does not expand neither under fractional reserves.
Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81. As the process continues, the banking system can expand the initial deposit of $100 into a maximum of $1,000 of money ($100+$90+81+$72.90+...=$1,000). In contrast, with a 20% reserve requirement, the banking system would be able to expand the initial $100 deposit into a maximum of $500 ($100+$80+$64+$51.20+...=$500). Thus, higher reserve requirements should result in reduced money creation and, in turn, in reduced economic activity.
That $1000 is the end of the world. No more money can exist without increase in the base money.
While the amount of actual gov. paper and coinage (m0) does not increase with fractional reserve banking. The virtual money supply (M1,2,3) does increase through bank issued paper.
Reduced money creation will not reduce economic activity, it will only increase the value of a money unit. Likewise Increased money creation will decrease the value of a money unit.
scineram:But without mining and coinage the money supply does not expand neither under fractional reserves.
Banks are not allowed to issue paper money. And the money supply cannot increase without increase in base money. Reserve ratios cannot be too small.
scineram:Banks are not allowed to issue paper money.
Reserve ratios cannot be too small.
Juan:Mining gold increases the supply of commodity money (assuming gold is being used as money).
Then it is inflationary just as fractional reserves.
Juan:Under fractional reserves, by definition, the supply of paper money increases.
Not indefinetly.