Wednesday, November 3, 2010

The Far Side of the Moon


I have a question.

This isn't it: The U.S. Dollar is backed by federal debt.

When you walk around that fact, inspect it, kick the tires and such, you get to the far side of it, where you can see what it means that the dollar is backed by debt. What it means is, for every dollar of money -- every dollar of base money, I think -- there must be a dollar of federal debt to back it up. There has to be that debt.

Okay?

So now, the question: Does there also have to be a dollar of money, for every dollar of federal debt? No... But I'm thinkin there has to be a dollar of money for every dollar of federal debt held by the Federal Reserve. Is that right?

Any thoughts? The fate of an upcoming post depends on your answer.

6 comments:

Greg said...

Ive been tossing around something a little different but probably related. I've been thinking about what the balance sheets of the fed and Banks would look like if all Americans asked for their pay in cash for a while? In a related thought, what if we took out a loan from bank A , made the deposit at bank B ad then took the loan out in cash?

When you convert your bank balance to cash, the end result is a debit at the federal reserve, right?. If all bank balances were converted to cash, banks would have no deposits and the fed would have debts equal to the amount of outstanding cash.

This seems to jive with your statement "our money is backed by govt (federal reserve) debt"

The Arthurian said...

I have a terrible time with technical terms... Truly.

I think if a bank has cash, this cash is "reserves" ... it is cash on hand, or cash in reserve. If you withdraw cash, they have less in reserve.

If we all withdraw cash, they have a lot less in reserve. And that affects the amount of outstanding loans they are allowed to have. So they might have to "call in" some loans, or they might have to borrow reserves from some other bank or from the Fed.

If we all demand cash, and there isn't enough cash, that's a problem, a run on the bank.

When you convert your balance to cash, the bank is left with less cash. If they withdraw cash from their account at the Fed, there is less left in their reserve account...

Both cash and reserve-account balances count as part of "base money." And if the bank has the money in its reserve account, or as cash, then it can lend a multiple of that amount of money. But if YOU have the money, the bank doesn't have it, so the bank cannot lend a multiple of it.

That's what I think is true. God I hope somebody that KNOWS for sure stops by and feels like talking.

I think if all bank balances were converted into cash, we would run out of cash before we ran out of bank balances. We can't withdraw more than is in our accounts. And banks can't withdraw more than they have in their reserve accounts at the Fed. But they can lend a multiple of that much....

I don't have it clear in my head yet, Greg! It's a jumble.

Greg said...

I obviously dont have it all clear either but this;

"Both cash and reserve-account balances count as part of "base money." And if the bank has the money in its reserve account, or as cash, then it can lend a multiple of that amount of money. But if YOU have the money, the bank doesn't have it, so the bank cannot lend a multiple of it."

is not quite right. This makes it sound like a bank acquires deposits and then can loan out a multiple of those deposits.... the money multiplier. One thing MMTers have proven is that the multiplier is false. Loans are demand driven. A credit worthy customer will get a loan and the bank will then adjust its reserve position after the fact. Loans create deposits, its one of the mantras of MMT.

I agree with the rest of your post.

What I was trying to get at is that if everyone had all their money converted to cash, banks would have no deposits so the only record of the cash would be a debt in the same amount as the outstanding cash at the federal reserve. I think this means our money IS backed by the federal reserve debt. Just like you said.

jbpeebles said...

It's late but I'll try.The shadow banking system created cash from nothing by forward selling future streams of income, from let's say, a mortgage.
The sale creates money where none existed. Money goes to the originator from the financial institution buying the mortgage WITHOUT a transfer of an asset of equivalent value (this is the shadow part.) is created out of free air.
The value of the mortgage exceeds the price of the house sold because of the promise of interest payments on the house. Therefore dollars are created when the mortgage is sold exceeding the value of the house (asset). Now let's say the bank that originated the loan and sold it takes that money and uses it as a deposit from which it gets a loan 10 times larger.
With that loan, it buys other banks' mortgages, then resells them. It can use that profit to pay off its debts. Using fractional reserve banking, and near zero costs of borrowing, a financial entity can use shadow banking to make money, both figuratively and literally. With capital requirements low enough--Morgan Stanley, for instance, was leveraged forty to one or more at the height of the commodities bubble in 2008--all a big bank needs is near zero rates and the ability to borrow to ride a bubble of its own making. The Commodities Futures Trading Commission (CFTC) lowered the capital requirements as part of a Bush/GOP de-regulation mantra that encouraged speculation in a greedy abuse of fractional reserve lending, as in the example I gave with mortgages.

The Arthurian said...

...the multiplier is false. Loans are demand driven.

Greg -- MMT looks at the same economy as everybody else, and tells everybody else they have things backwards. When I stop and look at an MMT observation, I can see that it makes sense or that it might make sense if I delve into it... But when I'm running with an idea, I rely on habit and I end up running the wrong way, you might say.

Can you point me to a link or two that discuss "the multiplier is false" ?

Loans create deposits, its one of the mantras of MMT.

My argument (to go off on a tangent here) is that economic policy has not changed for a long time, and that policy encourages the use of credit. Fifty or sixty years back, this policy worked well, because at the time we were making insufficient use of credit. Today, however, after too many years of the same policy, we are making excessive use of credit. Now... Given this view of the world, when I look at what you have written here --

Loans are demand driven. A credit worthy customer will get a loan and the bank will then adjust its reserve position after the fact. Loans create deposits...

-- what I see is, MMT is looking at current conditions. Yeah, the bank can adjust its reserve position after the fact. But the bank never had to do that, until the use of credit became excessive. So to me, MMT describes the conditions arising from long-term encouragement of the use of credit.

MMT describes the result of bad policy.


Hi, JB... It WAS late, but you did well. Reading your remarks, I had a couple objections -- but you dealt with them. It is satisfying to read something like that. I like this, too:

...to make money, both figuratively and literally.

That's a good line. Anyhow, it seems the crux of your argument is that interest is the problem:

The shadow banking system created cash from nothing... WITHOUT a transfer of an asset of equivalent value... The value of the mortgage exceeds the price of the house sold because of the promise of interest payments...

I agree, of course, that interest is the problem. But man has used interest in his dealings since the first caveman-farmer loaned seeds to his neighbor... So why is it only now, or only occasionally, that interest leads to the sort of problems you describe?

The only answer I can see is that now, and occasionally, the reliance on credit becomes excessive.

So, again: Economic policy has not changed for a long time, and it encourages the use of credit. Today, after too many years of the same policy, we rely excessively on credit. This problem can only be solved by changing our policy in regard to credit use.

Greg said...

"Can you point me to a link or two that discuss "the multiplier is false"


Here ya go.


http://bilbo.economicoutlook.net/blog/?p=1623


What gets ignored is the direction. When you look at static situations you see "Loans 1000" "Reserves 100" and then say "Oh see the reserves are levered up 10 to 1 therefore that is a multiplication of the reserve level, all a bank needs is reserves and then they create 10 time the amount of loans" and then further " OOOOH this policy of increasing the reserves the last few years is GOING to result in ten times that amount of loans .......HYPERINFLATION!!!"

What MMT sees, via understanding the real way loans happen first creating the deposit and leading to the seeking of necessary reserves ,10% in this case, is that simply raising reserves will not stimulate lending in and of itself because there is no way that action will make more people come to the door seeking funds. People dont come to the banks for loans when they THINK the banks have money to lend, they come to the banks seeking loans when they have INCOME to service the loan.

A person with enough income knows they will always find a bank somewhere that will lend. Its in the banks interest to create a loan for a credit worthy customer. The only difference over time is the price of the loan