Scratch

  By Mystic | July 21, 2012 - 04:40 | ,

Getting back into posting has caused me brain-ache.
So, I am going to share my brain-ache with you~!
Audio -

17:02 min.

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Written by: Mystic on July 21, 2012.
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  • Lyle

    Time in the figgerin’. Oy…

    and Interest paid on our pretend  loan too?

    I wonder how high in any banks management would one have to take this simple scenario before one would get a plausible repsonse. Probably pretty high huh. :)  If at all.

    • Lyle

      and after each payment made on the loan, wouldn’t that reset the entire paradigm?

      well hell… in the time-space continuum it’s impossible to really balance their books.Hows that?  :)

      • Lyle

        OK – watched again. So the interest paid goes toward bank operations and main question regards drawing from reserves. I hold no grandiose illusions that I’ll come up with a coherent response but it’s all in the seeking. :)  Maybe a meditation session on the back porch with more coffee and the cats will bring revelations. Those cats are pretty smart ya know. So far I just keep coming up with more questions.

        So Mr. Central Bank says here’s ya some bucks should you have a run on – but you can’t use it otherwise. It’ll mess up your bookkeeping ??? Sounds more like… if you actually need to use the bucks we give – we best look into shutting your bank down.

        • http://overthepeak.com/wordpress/ Mystic

           All you need to bother about (and I would not recommend it) is the fives coming and going.
          One deposit in.
          One loan out.
          That is tricky enough~!

      • http://overthepeak.com/wordpress/ Mystic

         I would say that ….. the asset (loan agreement) is written down as the capital is repaid.
        Interest just goes to assets / equity / running costs.

        • Lyle

          Now if I happen to be an employee of the bank being paid from the banks interest earned… and I cash my payroll check with the same bank that just paid me… and then make a payment on the loan I have with them…

          yes… maybe I should just stick with philosophy.  Hell – this is philosophy.  :)

          • http://overthepeak.com/wordpress/ Mystic

            It used to work for most everyone concerned ……. Now, it doesn’t.  

            • Lyle

              That doesn’t part – surely Keen isn’t suggesting the doesn’t is hinged on the question posed here. ?

              I’ll watch some more Keen.

              Seems like quantum physics – it works as long as you don’t look at it. If you look at it… oops!

              • Lyle

                Scratch the last. I’m watching Keen.

                • Lyle

                  so you’re someplace near or at 23:05 on this vid…http://www.youtube.com/watch?v=xfXimjtz4GA&feature=related Keen Cambridge Lecture 2011 plus questions,

                  This one is more my speed – definitely more ‘user friendly’ – and with enough ( lots of ) pauses I might actually store some of this in a few remaining accessible memory cells.http://www.youtube.com/watch?v=nGQBOi3xSM4&feature=relmfuKeen Behavioural Finance 2011 Lecture 10 Financial Instability Hypothesis Part 1.

                  Off to enjoy a sternwheeler boat ride on the Ohio river. Every time I see the number 5… eh well.

                  • http://overthepeak.com/wordpress/ Mystic

                     Why, I ask myself, would anyone want to go on a sternwheeler boat ride on the Ohio river~?

                    • Lyle

                      It’s part a once a year week-end long AA convention type thing held locally labeled “Meeting on the River”. About 250 sober folks enjoying a little cruise while a special speaker tells their story.

                    • http://overthepeak.com/wordpress/ Mystic

                       Ah good.
                      I can understand that~!

    • Jetser

      Interest:

      If you borrowed a 3-year-old hen for a year would you expect to be able to repay with a 4-year-old hen (ie. to hand back the same bird)? What’s in it for the lender? You’d at least have to give them some of the eggs. You feed it and run the risk of it dying, whilst having the rights to maybe 90% of the eggs, the owner gets 10% of the eggs, everyone’s happy.

      Now introduce a bank. It extends credit to you equal to the value of a 3-year-old hen, you buy a hen and the seller deposits the purchase price into the same bank. Everything balances but the seller still needs more than the value of a 3-year-old hen at the end of the period, otherwise they’d not bother with the transaction. It’s the same situation as before, but with a bank assessing credit risk, enabling the transaction and enforcing contracts.

      You get the benefit of having something now instead of later, so you should be prepared to pay for that. The seller has the opposite and should be compensated. So even on the “pretend loan” you still need to pay interest.

      • Lyle

        Hi Jetser – sorry I didn’t notice until now your comment was in response to me. Maybe you didn’t either. I’m just a piece of popcorn in the peanut gallery around here. I do understand your comment. Chickens and eggs I got it. :)

        Why just last night a friend mentioned the age old comment: What came first the chicken or the egg?
        I advised it was neither. Both were simply functions of the aims of DNA.

        I love the looks after.

  • John_by_the_creek

    Dear Mr. Mystic:
     
    I’ve listened to this video twice through, and I’m sorry, but I’m missing the “problem”.  I”m good up through the “four fives”.  But when you move in to the “fresh air money” part of the discussion, I can’t latch-on to the point you are trying to get across.  Might you restate the issue in a more detailed fashion?

    • http://overthepeak.com/wordpress/ Mystic

       My main problem here is that I don’t now know what my point is.
      I could see the Steve Keen logic for saying banks can’t lend from reserves …… But then, extending that logic says that banks can’t lend from their asset side at all.
      I was happy with that for a while, imagining that all loans are always `fresh air loans`.

      But, in making the video before this one, I ran into the possibility that Keen logic is wrong.

      So, we have 5 / 5 and I go in for a loan.   Loan granted (naturally).
      I have 5 in checking account (liability) and they have my signature on (asset) side. (full 5 square).
      I spend my 5 out from the asset side and my signature asset remains. 
      Here we can cross out the first asset 5 and it as though I borrowed it….
      …leaving first liability 5 and my signature 5.
      So, you are happy with that~!

      Now back to 5 / 5 and we make a fresh air loan.  Just add 5 to me liability and signature to assets.  Full 5 square.  I take the money and the books have to be balanced, so something on the asset side has to be crossed off.  The only thing to cross off is your asset 5.
      Exactly the same as the above.

      It would be the same with excess reserves as well.
      Bottom line ….. and this is what is making me scratch ….. Steve Keen is wrong.

      He goes -
      5 / 5.  Then make a loan from reserves (cash on asset side) = assets  -5 and the normal 5 to me liabilities.
      This makes the liability side 10 (deposit + my loan in checking) and only 5 on the asset side (deposit cash 5 + my signature 5, minus the 5 reserve cash used). 

      Something like that.

      • Blackstone100

        Would the reserves not be on the liability side as well ?

        • http://overthepeak.com/wordpress/ Mystic

           Blackstone,
          Yes, in the way that every one side has a twin on the other side.
          The reserves could be `old` deposits, or bank borrowings that have just stacked up.

          I think I see what you mean …….. If a reserve goes to a loan, should some other liability not be scratched~?

          Frankly my dear …….  I dooon’t knooooow~!

        • http://overthepeak.com/wordpress/ Mystic

           Thinking about it …….. no.  The bank can’t go messing with the liability side.

          • Blackstone100

            I was thinking more like this, only the middle asset would be the one crossed out.

            • http://overthepeak.com/wordpress/ Mystic

               Sorry (nice pic and all), but I don’t know which is what~!?
              (I only had two lots)

              • Blackstone100

                Your two lots are the bottom two.
                The top lot is my deposit,that creates the reserve,

                • Blackstone100

                  should have added that my deposit should not be available for loan,as that would mean using reserves for loans.

                  • http://overthepeak.com/wordpress/ Mystic

                     Sorry, I am lost.
                    (it is not surprising really)
                    If you like …… please start again.

                    • lgrinaker

                      It seems that the key is that reserves are not to be used for *loans* because that would cause a subtraction on the asset side and a plus on the liability side, which would violate double-entry bookkeeping.

                      Whereas, the “creation” of an IOU makes for something new, an addition, on the asset side, and the “creation” of the deposit makes for something new, an addition, on the liability side.  That balances out – no violation of double-entry bookkeeping.

                      But that says nothing about the use of reserves once a person wants to spend from their deposit account.  (And that also speaks to reserves coming into play *after* a loan is created.)

                      In that case, if I use the $5 in my deposit account (the bank’s $5 liability, made not with the use of reserves, but from the creation of an IOU), the bank is then free (from a double-entry bookkeeping perspective) to use reserves.  (In that way, it also makes sense that a bank is issued reserves *after* loans are created.) 

                      Crossing off $5 from reserves (from the bank’s asset side) when crossing off $5 from the already existing customer’s deposit (from the bank’s liability side) doesn’t violate double entry bookkeeping in that instance, and that’s because the reserves weren’t used to create the deposit in the first place (which is where the problem would arise).

                      Yes?  (at least from looking at this with double-entry book-keeping in mind)

                      Linda

                    • http://overthepeak.com/wordpress/ Mystic

                       As for reserves ….. as for any `cash` on the asset side.  That is to say, banks never lend deposits (as per Keen …. so far so good).
                      But when the deposit is taken out (as you say) something is crossed off (any `cash` on) the asset side …… and this looks exactly like that asset `cash` was loaned out. ….. maybe like  deposits (or reserves) have been loaned out.
                      Two ways to get the same result, but in words can sound totally contradictory. 

                    • lgrinaker

                      But you also have to keep in mind that an IOU *is* in play, which won’t always be simply a piece of paper.  That IOU isn’t simply a placeholder on the asset side of things, which never becomes usable.  Slowly, but surely, that IOU is converted into cash as it is slowly, but surely paid back.

                      And there are lots of IOUs becoming monetized slowly, but surely, within a bank over time, as people pay back their loans.

                      So there can be lots of cash within a bank, as a part of its reserves, that has nothing to do with using somebody’s deposit to loan to somebody new.

                      ~~~~

                      That’s a very important wrinkle that happens when IOU’s and corresponding deposits are created “out of thin air.” 

                      That “thin air” IOU and multiple other IOU’s within that same bank do become usable cash slowly, but surely over time, which is added to the cash/spendable reserves of a bank to be subracted from bank’s assets (via reserves) when depositors want to spend from their accounts, yes?

                      And that wouldn’t become a part of things if loans were created solely out of existing deposits; there would never be any of this new “cash” (coming from IOUs slowly, but surely becoming monetized) to be used when depositors want to spend from their accounts.

                      Linda

                       

                    • lgrinaker

                      And it’s important to remember that when these IOUs slowly, but surely become monetized (paid back), there are no new additions to the asset or the liability sides of the bank’s balance sheet; an existing asset is simply being converted from one form to another (IOU to cash).  And it’s cash that is not dependent on new outside deposits. 

                      And the only way such cash could come into being is when loans and deposits are newly created “out of thin air,” apart from already existing reserves.

                      Linda

                    • lgrinaker

                      Ah, I can see I’m getting myself trapped too, ;-).

                      For although I can begin to see how a bank might not ever *have* to use a new depositor’s funds to make a loan (they can gain reserves through loans from other banks and from the CB), they still can’t simply create IOUs and deposits and leave it at that.  

                      They have to have backing from somewhere for when the folks with the deposits (due to the loans freshly created) want to spend those funds, even if the bank’s backing isn’t necessarily from other depositors (but from loans that that bank gets from other banks and/or the CB).

                      I can see that problem in a theoretical sense when you start at the very beginning (as you did in your illustration), the first loan or two that a bank makes.  Even if the banks don’t need assets beforehand to make the loans, they still need to get funds to cover the spending from the deposits newly created by the loans (otherwise their balance sheets will lessen liabilities, but without a corresponding lessening of assets, also as you show in your illustration).

                      So, it must all go back, ultimately, to the CB?… which truly can lend money, to not only the treasury, but also to private banks, without ever having to go to yet another lending institution to get the funds they need to cover the spending of the deposits created via their own lending.

                      ~~~~

                      So how does the CB’s balance sheet work?  What happens when one of the entities that borrowed from the CB (creating an IOU as an asset and a deposit as a liabilty on the CBs balance sheet) begins to spend from that deposit account?  How does “the end of the line” work in that situation?  Does the CB just keep a balance sheet in which the liabilities (deposits) go down, but the assets do not (at least not at the same time as the deposits are depleted… is the CB allowed a “lag” in their “balance sheet,” with the assets being allowed to catch up to the liabilities as debt is paid down)? 

                      But then that begs the question of why wouldn’t the end-user banks be allowed to do that with their balance sheets, allowed the lag time between liabilities going down (as loan deposits are used) and the corresponding asset going down as the IOU is paid down?

                      ~~~~

                      Yep; I’m lost too, ;-). 

                      Linda 

                    • lgrinaker

                      Yeah, I definitely got myself all messed up in this thread.  I think I’m going to try again, but not in this particular thread (that’s getting skinnier and skinnier, ;-)).

                      Linda

                    • http://overthepeak.com/wordpress/ Mystic

                       ………………………..and skinnier~!!

                    • http://overthepeak.com/wordpress/ Mystic

                       Again.  Stop first paragraph stop.  IOU not monetized stop. IOU paid from liability side …. as liability side is reduced (mortgage payment) …. so IOU is equivalent reduced on asset side.  Stop.

                    • http://overthepeak.com/wordpress/ Mystic

                       To be more precise on the timing –
                      The loaned 5 is checked out …..
                      and checked in to another bank ……
                      which will demand the reserves are transferred
                      to cover it.

                    • Blackstone100

                      Start again.  No thanks
                      I am happy in the “ all loans are always `fresh air loans` ” camp

      • Jester

        Is the point “if double-entry accounting can look like cash is being lent then could banks lend cash and fit within the double-entry accounting model?” But doesn’t that lead to the question “is lending cash what banks do?”

        Presumably they could lend all their cash and then sell some loans to the central bank to get some more cash, which they could then lend out. But I’m not sure where you’d go with this line of analysis as it’s not what banks do, although it could prove Keen wrong in theory. Do you have a link to his work? It would be useful to see why he wants to show that reserves can’t be lent when it should be enough simply to show that they’re not.

        • http://overthepeak.com/wordpress/ Mystic

           http://overthepeak.com/wordpress/archives/8148
          at 47 mins ……

      • windslice

        Hmm.

        Maybe we have to separate two cases.

        1. Internal loans to banks’ customers. These, I think, we have discussed and are happy with the conclusion that the creation of the loan also creates the funds to balance the balance sheet. The balance sheet has expanded on both sides equally.

        The bank’s reserves are not lent out.

        2. External loans to non-deposit account customers. Only the asset side of the balance sheet is affected, and cash is moved from sitting at the CB as excess reserves to a customer who does not hold a deposit account.

        The balance sheet of bank 1 neither expands nor contracts.

        What happens is that the money is paid into a deposit account in bank 2, which expands that bank’s liabilities and also its reserves held at the CB, as the five money are moved onto the asset side of the balance sheet and the depositor’s account as a liability to pay him the five money.

        The balance sheet of bank 2 has expanded on both sides by five money.

        If we look at the two banks then, although the reserves of bank 1 are shown as being lent out, they have created new reserves in bank 2. The net change in reserves across the banking system is zero.

        Ergo effectively the whole banking system does not lend from reserves as the creation of the loan simultaneously creates the necessary funds somewhere in the system.

        Your example

        “5 / 5.  Then make a loan from reserves (cash on asset side) = assets  -5 and the normal 5 to me liabilities.
        This makes the liability side 10 (deposit + my loan in checking) and only 5 on the asset side (deposit cash 5 + my signature 5, minus the 5 reserve cash used).”
        should read

        ”
        5 / 5.  Then make a loan from reserves (cash on asset side) gives

        (reserve assets  – 5) + (loan assets + 5) = no net change.

        Then add the 5 to my liabilities as a deposit.

        BUT

        this 5 is then swept off into the reserve assets (+5) leaving a liability to pay 5 and a 5 asset in the reserves.

        Finally the liability side has increased by 5, asset side by 5 and reserve assets have no change.

        Maybe you oversaw that whenever an amount is deposited into a customer’s account, this same amount is also added to the bank’s asset side. It does not matter where the deposit comes from, a loan or salary or whatever. The bank’s balance sheet expands on both sides.

        • http://overthepeak.com/wordpress/ Mystic

           Today’s video will clear up 1. for you.

          We can start on 2. when we are happy with 1.
          (I would start by thinking the process will be similar (and you do not have it right)).

          • windslice

            I’ll meander over to the video later.

            Yes, I realise that the description I gave is not the way it works. I was just coming at it from another angle, where reserves are could be lent out directly as commercial or individual loans, but maybe that was a waste of effort.

            I believe the excess reserves are lent out on the money market and also used to buy high rated bonds such as, well, hmm, Spanish debt….

            In both cases the balance sheet total is not affected, only the allocation of the excess reserves from cash to MM or bonds, as the bank tries to squeeze an extra bit of profit from its lending activities.

            • http://overthepeak.com/wordpress/ Mystic

               Hi Windy,
              I’m not sure on the `lent out to money market`, but the rest must be right enough (just a swap from cash to bond).
              Repo and reverse-repo must be mentioned somewhere, but I’ll be buggered if I am going to get that going anytime soon.

              • windslice

                Repo and reverse-repo is the same thing. The name depends on whether you are a seller or buyer of the instrument.

                I think it is a bit like a pawn shop.

                Drop the bicycle off at the shop to get some cash and and then get it back later by paying the agreed repurchase price. The bicycle owner has made a repo agreement and the pawn shop a reverse-repo agreement.

  • windslice

    Hi,

    I thought we had moved on a bit with “our” understanding of the banking system.

    - Merv King did not, as far as I know, ever say what he thought was bad about the present system nor postulate about a better system.

    - This was all good about the maturity transformation that is the banks’ business. Borrowing on short term and lending long term.

    - There is some confusion about what reserves are and I think we need to define them more precisely.

    - – Fractional reserves on depositors’ cash. These are at a regulatory zero (or 1% in Europe, 0% in the UK and some derisory single figure percent in the States). This is cash or similarly liquid stuff that the banks have to hold against depositors’ money. It is for all intents and purposes almost zero and only enough is kept to meet day to day needs. We have already agreed that we do not have a fractional reserve banking system.

    - – The money the banks keep at the central bank in their account. This is also called the reserves, but is not the same as above.

    - – Capital reserves based on the ratios defined by the Basel agreements. These can a mix of very liquid instruments.

    Now, in your last example, a customer comes along a borrows five money. In the first instance the five new money would be dumped into his account and a loan would be created on the other side of the balance sheet. Everything balances.

    The problem occurs when the customer takes his newly issued five money and transfers it to somebody else outside of his bank. Now here is the key that you may have missed.

    At this point the bank has lost the liability of the customer’s deposit, but now has the liability of paying the other bank the five money transferred. This transfer takes place through the accounting at the central bank.

    So how much cash does the bank have in its reserve account? Generally they try to keep this at a minimum as they don’t earn any interest on it. Assuming this, the bank has to go and find the funds from somewhere else. It can either sell some asset or borrow the money from the interbank market or the central bank or even attract more depositors to lend them the cash.

    So when you talk about banks not lending reserves, you have to define what reserves are meant.

    In a full reserve banking system banks would have to keep 100% of the depositors’ money in cash. In this situation they could not lend out anything but would have to charge customers for looking after the cash. So you might as well keep it notes under the bed.

    • http://overthepeak.com/wordpress/ Mystic

       Nope, hit a snake on the bank stuff I have.

      I don’t think there is any confusion about what reserves are (and they are not important).

      When the money goes out from the deposit, is exactly what I did not miss.  This point is the point of the video point.
      I said it just like you said it.

      Note: Banks have all their money at the central bank (except for a bit of change).
      Note the European bank example.  They had their cash as `excess reserves` but moved them to their deposit account when interest was not paid any longer.  All at the central bank.
      It does not matter about `reserves` or `excess reserves` or `deposits` as such …. they are all held in CB accounts and if they should be `lent out`, surely the accounting would be the same in whichever case~?!

  • CSArichardo

    1.  A balance sheet is merely a moment in time to see what the company or organization is actually worth.  It is static.  I am no accountant but I have keep the books and you do not record transactions in a balance sheet !? 

    • http://overthepeak.com/wordpress/ Mystic

       Thank you, yes, true.
      Keeping it simple.  The transactions will be recorded on the balance sheet.

  • CSArichardo

    Reserves are cash (a portion of deposits) that are held by the central bank on behalf of the bank.  Right ?  So a bank cannot lend out something it does not have access to lend out ?!

    • http://overthepeak.com/wordpress/ Mystic

       Keeping it simple ……. call them `excess reserves` then.
      Call it cash ….. call it what you like.

  • axionication1

    Have felt like I was going around the twist when looking at some of this in the past ( afternoon spent at clean desk, pen and paper, simple stuff…rattled) when making a concerted effort to understand Keen ( this was on the publication of his nice endogenous money paper- linked by mystic)

    Will have another go this afternoon…

    Some more stuff (useful or not, I have not looked at it any depth myself)

    mikenormaneconomics.blogspot.co.nz/2012/07/steven- keen- to- mish

    • axionication1

      Chance to look through properly. Tricky stuff.

      The link I sent possibly not direct enough (dumb with this stuff). The comments are very interesting. Arrested by the comments of both Marris & Viorel (especially Viorel).

      Try search “Mike Norman Economics: Steve Keen to Mish-Why banks can’t lend reserves”

      Have promised myself to go back to basics and get a proper grip on the accounts side. Feel like I am trying to run before I can crawl. That been said, me gut says “this is very very strange stuff and is the root”.

      • http://overthepeak.com/wordpress/ Mystic

         It is probably very simple ….. when you know how~!
        Normally who would bother with it~?
        We are only bothering now, because something is rotten in the state of banking.

  • CSArichardo

    Balance Sheet rules and tricks !    So what happens when a bank or corporation buys an asset for more than it’s market value ?  That is called an intangible asset.  That means you can carry this obvious loss by depreciating it over future years.  Great accounting trick.  What it still boils down to is that if a company can manage the cash flow (in/outs) the accounting system is generally prepared to allow it to operate as a viable company especially if shareholders go along with it ??! 

    http://en.wikipedia.org/wiki/Intangible_asset

  • joebhed

    Jeezum, Nick,
    You’re bravely going where only fools and saints have gone before.
    Probably right good ground for a mystic.
    OMG, reserve accounting.
    Please be sure to keep track of the goal here.
    I haven’t seen Keen’s video.I NEED to look it up.
    And I promise to get back on the details.

    First, your kindness runneth over by calling it “Fresh-Air” money.
    As if the air was fresh.
    As if it was money.

    I know you know that original fiver was a debt from someone to someone before someone put it in the bank as cash. Cash comes into circulation as a debt. I know, you know and that’s not the point.

    Whenever I really need a word for that special privilege of the bankers to create money where none exists, it is to conjure.

    While I have to agree with Keen that banks don’t lend reserves _ I guess he said they “can’t” – under this system, it’s for a completely different reason – the same one that the Fed uses to explain what happens.
    The Fed says, “If they did, they would not create any new money.”.
    The real game that is in play while studying the fractional-reserve book entries is the creation of brand new purchasing power.
    All of the money in existence on the first day of the rest of our lives (pre-fiver-one) belongs to someone.
    If the banks lent their reserves created when some depositor walked in with that fiver, then they would not create new money.
    They would conjure up nothing.
    That’s why they can’t lend their reserves.
    With full-reserve banking, they could.

    While it is worthwhile to understand the complexity of the book-entries in order to understand the workings of the bank and the banking system, it is the money system that we must ultimately be concerned with, that must be stabilized and sound in order to support the real economy, including the banking system.

    Put bankers out of the conjuring business, and the complexity becomes much clearer and the solutions much closer.

    With so-called ‘full-reserve’ banking, the conjuring is off the table.
    The significance of bank reserves is far less consequential.
    Actually, they are all inconsequential today, but that’s another story. 
    The bank can only lend the deposits (or balances)  on which they are paying interest.
    They can’t lend the deposit in your checking account, regardless of its origin.

    If you read all the reasons why Fisher called for full-reserve banking, and all the advantages of same, especially in regard to the present chaos, one is hard pressed to understand why we are not there.

    The only reason is because the brittleness extending through the house-of-cards ponzi scheme cannot stand any more stress – like changing the system.

    So, please.
    Shhhhhhh.       ; – )

    Yeoman’s work there.
     

    • http://overthepeak.com/wordpress/ Mystic

       Another video coming Sunday~!
      I give you a mention, but I will have to get back to knowing what people posit as replacements for this fine system wot we got now.

      As I remember, your system will be wrong if it dials in a growth rate.

      If we are going to do the jump, it may as well be a worthwhile jump.
      The future is not going to be growth and that will have to be sold, somehow, as a good thing.

      To make the jump to a centrally dictated growth in money supply would be a positive on the asset side and a negative on the liability side ………….. it would not balance.
      In short, it would be a huge mistake~!

      • joebhed

        My system is simply about public money issuance without associated debt.
        It is actually the opposite of the parasitic growth paradigm driven by compounding interest on all debt-money in circulation.
        It IS akin to fully-reserved banking, but not the same.
        Importantly, whichever way goes the economic potential goes the money supply.
        Whereas, debt-based money has no “reverse” without a suffering populus, debt-free money is fluid in transmission.
        Thanks.

        • http://overthepeak.com/wordpress/ Mystic

          I have always wanted to get some issues sorted before moving on …… and I can feel a bunch of questions welling up.

          The main drive is, as I say, growth should probably be negative from here on in …….. would that ever be reflected in the money supply (knowing the effect it will have on asset values)~?

          Or, to put it another way – Could you accept negative growth~?

          • joebhed

            For the real economy, the driver for achieving potential growth is available, and sustainable, “throughput” capacity.
            Population, labor and productive/distributive capacity are all available.
            Resources can be the only real constraint (for US).
            All need an exchange means to distribute the wealth created.
            That’s where money comes in – or the lack of it.
            Money should ‘serve’ as the means for exchange, not drive the outcomes.
            A decision about resource sustainability must first be determined by public policy and then the money supply should be engaged to achieve the desired outcome, primarily preserving the purchasing power of the money used.
            The effect on asset values is already in the mix – whatever it is.
            Again, money is a means for exchange of goods and services, not a protector of asset values, even monetary assets.
             

            • http://overthepeak.com/wordpress/ Mystic

               I think you will find that `growth` is going to be both, unachievable and inadvisable.
              In the end, this will trump the money problem.
              But we will probably both be dead before this is realized.

              • joebhed

                Nick
                If you can only lean out far enough from the present paradigm you will see that all four of those could be true – we’re gone and ‘growth’ as we know it neither advisable nor achievable -  and the solution for the money system  will be left for the grandkids.
                Some points for the 6 year-olds.
                Frederick Soddy, credited with starting both the study of ecological economics and the broad social sciences, had an understanding of the true Role of Money – the distributive economic mechanism -  and the relationship between physical science and state stewardship of our natural environment.
                Growth – in the sense of an accelerated churning of naturaal resources into wants, is ending.
                We still need a money system.

                • http://overthepeak.com/wordpress/ Mystic

                   Yes Joe, we need a money system; but the one we have, has been developing over hundreds of years.
                  It fitted the fossil fuel based growth paradigm of those centuries.
                  It could be said, that it started by accident and developed in a `survival of the fittest way`.  It was, as the young things now say ……. an organic development.

                  To put in a replacement, that would work, would have to be a work of genius …… or, a system that is so elastically adaptable, that it will bend to any future outcomes.

                  Have you got one of them~!?

                  • joebhed

                    Nick
                    A lot of real wealth was created in the last hundred years, not so much enabled by the money system as the technology driven magnitudinal increase of the labor-energy input.
                    I wouldn’t call the power-run-amok organic, so much as survival of the powerful.
                    Take the time to read Soddy’s Cartesian Economics : The Bearing of Physical Science Upon State Stewardship.
                    It lays the foundation for an organic money system, the antithesis of which is the profit-driven model of modern finance we have today.
                    And it is not ending politely..
                    Thanks..

                    • Lyle

                      One helluva great exchange guys! Thanks!

  • lgrinaker

    Okay, I think I’m going to try to tackle this from a different angle.

    ~~~~

    Maybe it works something like this:

    The bank makes a $5 loan, and an IOU/promissory note is put on the asset (left) side of the bank’s ledger.  At the same time, the IOU is monetized with newly “created money,” such that there is a promissory note along with $5 of new cash, both created at the same time.

    The bank, at the same time, also creates a deposit account for the customer, to whom the bank has agreed to loan $5.   The customer, once the loan is agreed upon, can spend up to $5 from her newly created account, which the bank must cover, and that puts $5 on the liability (right) side of the bank’s ledger.

    The customer shortly thereafter spends $5, which is covered by the money that had been created by monetizing the IOU.

    ~~~~

    I’m thinking that it’s at this very beginning stage that the IOU is monetized.  And it’s that initial money created “out of thin air” when the promissory note is initially created that is used to cover any spending that the customer does from that $5 account (rather than anything else already in existence before this particular loan arrangement came about) . 

    That then cancels out the $5 of liability and $5 in cash of asset.

    But what about the IOU/promissory note? 

    Well, it’s a special creature, it seems to me. I could imagine it existing hand in hand with the money created (from monetizing the IOU) directly after the IOU itself is created. 

    The IOU wouldn’t be monetized as the note is paid back (that’s already happened, as far as I see it, when the note is first created; it’s that initial monetization that, I think, is used to cover that initial spending from the deposit). 

    Instead, as the IOU is paid pack, both the money coming back to the bank *and* the corresponding amount on the IOU would be destroyed.

    ~~~~

    Basically, I’m now thinking of the IOU/promissory note as a stand alone record that the whole earlier arrangement and subsequent transactions have taken place. 

    But it also stands for the fact that the other side of that “creation” still needs to take place.  It stands for the fact that that initial “new money” has a time limit, and is set to come to an end. 

    And as that initial amount of created, spent money, is sent back to the bank, the whole earlier arrangement winds down. 

    ~~~~ 

    At this point, nothing new can be created via this loan arrangement as far as assets/liabilities for the bank. 

    In that sense, the IOU/promissory note seems to be a kind of remnant, basically a kind of “promise,” or place-holder, associated with the earlier funds from the asset side that have already been used to cover and with the earlier funds from the liability side that have already been spent.

    It’s the remaining *promise* that the money creation and spending that was earlier initiated, and has had time to do its thing (provide funds for investment into a new secret recipe, perhaps, which has since made a thriving business possible) is still to be brought to a close.

    It’s hard for me to see the IOU/promissory note as an asset outside of the earlier things it was/is still associated with, so that it’s a kind of a “special asset” perhaps? 
     
    ~~~~

    Just a note:  I’m thinking of the above while still thinking of Keen’s discussion of how significant bank created debt money can be.

    Keen’s description of the growth of debt has to do with rate of new debt taken on (being created) in relation to the rate of existing debt being paid back (being destroyed).  As long as the first is greater than the 2nd, the amount of debt money, or bank created money, in the economy grows (and can grow to a huge amount).  And he also discusses the fact that that growth of debt money in the economy can’t go on indefinitely, so that at some point, there will be a reversal, and there will be less new debt money coming into the economy than there is debt money leaving it.  And, as he discusses, both sides of that coin matter.

    Linda  

    • http://overthepeak.com/wordpress/ Mystic

       I had to stop at the first paragraph.
      No.
      I don’t like it. 
      We had it good before this.
      There is no need to make up new stuff.  Putting IOU and new cash on the asset side is unnecessarily weird.
      Scream.
      Sunday ruined.
      I think I’m gonna die~!

      • lgrinaker

        I do understand that, I do, ;-).  I knew in my initial try at it (the skinnier and skinnier thread), I had no idea. 

        So I knew that my 2nd try would be a stab in the dark as well, ;-).  I think it was a couple of weeks ago when I mentioned I get lost when venturing very far into the private banking part of things (and I clearly demonstrated that yesterday, ;-).)  And I’ve never really had any experience with double entry bookkeeping.

        So that should clue you in from the start that a try from me may end up far from the mark.

        ~~~~

        (I’m having a bit of trouble with the site, so I haven’t yet listened to your most recent post, perhaps that will help me.)

        But here’s at least one thing that stumps me.

        At first I was thinking that when the loan is paid back, the IOU (piece of paper) gets slowly, but surely converted into cash (monetized), and can, itself then be used by the bank as reserves to cover when deposits (liabilities) need to be covered.

        I was thinking that works because it doesn’t add to the asset side of the ledger, it just converts it from one form to another (IOU -> cash).

        ~~~~

        But then, that left me without knowing how the initially created money that happens when the loan is first created gets destroyed (or taken out of the system) when the loan is paid back.

        For with a bank loan, it’s only when the money is out in the world that there is “new money.”  But a loan is meant to be temporary.  As it gets paid back, the net “new money” goes back to zero.

        Linda

        • lgrinaker

          I began to think that the only way that could happen is if when it’s being paid back, the money coming back to the bank is destroyed (or taken out of the system) and the corresponding amount on the IOU is destroyed (deleted) – something like what happens with taxes (MMT style).

          If so, it would mean that the IOU does not become monetized (converted into cash) as the IOU is paid back; instead, or so I was thinking, it would simply get erased, and the money destroyed (or taken out of circulation).

          ~~~~

          That led me to thinking that if it doesn’t get monetized as the money gets paid back, maybe it gets monetized when it is initially created. And maybe it’s that cash, new cash, that is used to cover when the deposit gets spent.

          That would leave simply a promise (an IOU that’s already been monetized and can’t be again), a promise to pay the money back (so that it can be destroyed as it is paid back), and as the money is destroyed, that means the promise to do so is destroyed as well.

          That would allow a temporary addition to net money in the economy *and* the subtraction of that money (or taking it out of circulation) as it gets paid back – no new money once the loan has been paid back.

          ~~~~

          What causes the swell in the money supply (at least via banks) is that new loans are created (funds put into the system) faster than existing loans are paid back (funds taken out of the system). What causes contraction in the money supply (at least via banks) is when the opposite occurs – the rate of pay back happens faster than the rate of new loans being created.

          Linda

          (And yes, I can certainly understand if anyone who started to read this  – part 1 and part 2 comments - stopped at the first paragraph of the first part, ;-); just trying to explain my conundrum – and how I thought I might find my way through it, ;-))

          • http://overthepeak.com/wordpress/ Mystic

             Bingo.
            ~~~~~~
            When the loan is still live, there is more money out there.
            ~~~~~~
            As far as I can see, you and I are now singing the same song (in perfect harmony).

        • http://overthepeak.com/wordpress/ Mystic

           I don’t see any reason to go with the Linda monetization model.
          Unless you can say why I shouldn’t, I will stick with thinking it is rubbish.

          The money is destroyed, but the predilection to make more and more new loans isn’t~!
          (that is why we are in deflationary doodoo now.  they want to make the loans, but can’t because the economy is not right to be lending in to). 
          It is like a ball thrown in the air (the loaning system).  It has a natural desire to come back down to earth.  Incredible effort has to be made to keep that ball getting higher and higher, but as all things that can’t keep going ….. it has stopped going (and down will come the ball, banking, government and all~!).

          • joebhed

            Nick,
            It’s a staggering thought.
            Remember?

            ” Someone has to borrow every dollar we have in circulation, cash or credit. If the Banks create ample synthetic money we are prosperous; if not, we starve. We are absolutely without a permanent money system. When one gets a complete grasp of the picture, the tragic absurdity of our hopeless position is almost incredible, but there it is.”

            There it is.

            • http://overthepeak.com/wordpress/ Mystic

               Aye Joe, and that is the most understated `there it is` that there is~!

  • CSArichardo

    Are reserves not a transaction with a central bank ?  The bank moves 5 money to the central bank as a reserve.   It shows up as 5 money as an asset (on deposit at the central bank) and 5 money as a liability (as part of capital called a statatory reserve ?) Interesting slide deck below.

    http://www.slideshare.net/divinvarghese/bank-schedules-balance-sheet-presentation

    • http://overthepeak.com/wordpress/ Mystic

       When you have read it all …… please do us a simple explanation posting.
      Thank you~!

  • CSArichardo

    Modern Money Mechanics Fed Reserve of Chicago before the crash !

    http://www.slideshare.net/seet2005/modern-money-mechanics

    I now understand excess reserves better and other stuff like the following actions increase reserves.  Public reducing it’s currency holdings, decrease in treasury deposits at FR, SDR issues, gold buying, a gold value that increases, etc.  Lots of creat T accounts to those asset and liability things.

  • Jasp

    I’m glad we are talking about this, because I had been wondering about how banks could best unravel all the crap on their balance sheets. I think Sned mentioned this in a previous comment section or something similar? I didn’t write anything because I really got myself in knots and wouldn’t have known what to ask. Listening to the posting I think we are missing one step at the beginning (sorry if it has been covered in other comments):

               Assets                                                           Liabilities

    Cash Paid in by Blogs(in Reserves?)                          Cash paid in by Blogs

    Loan to you                                                         Loan to you
    Cash to you                                                         Cash to you

    This is how I was thinking about it: When a loan is made the cash is created in 2 steps, first the entries relating to the loan and then the cash entries (if you take out a loan you have the cash going to your normal bank account and the bank creates a separate loan account).

    I thought of this in terms of the credit creation cycle. At the moment the reserve activity is separate from this. As the loan is repaid the loan entries are cancelled out. There are also separate entries coming in for the interest being paid, does this go into the bank’s reserves? I started getting in a muddle when I wondered if the Cash to you is snaffled by the bank as reserves and You is using the cash to pay immediately for the goods the loan was wanted for. Then to add to the muddle the bank goes off and uses the cash to you to buy other assets (is this right?). And when trying to think how you deal with the Bank’s loan (backed by an asset; e.g. house) would affect everything, my brain was fed up and not interested in doing 100s of little double entry…….

    I am left with the impression that the simple loan cash cycle sort of works (in the whole money supply question the interest has to come from somewhere) but the complexity comes from the credit cycle going off into other assets and liabilities.

    Can anyone help with the next step, please?

    Thanks

    • http://overthepeak.com/wordpress/ Mystic

       Hopefully today’s video will clear some of this up.

      (some of what you write looks wildly wrong, but it is hard to know for sure (it is hard to put into words in’it~?)).