So, let’s wrap up our discussion about the
banking system by reviewing the bank loan from the beginning, where X bought a house
from S for 300 thousand dollars and took out a loan of 200 k in the process. We assumed
that the commercial bank in our example had neither deposits nor cash reserves yet. Nevertheless
it is regulated by the central bank and thus has to keep at least a 10 % reserve of base
money for all checking accounts. In our example as a first step X deposited his money with
the bank and subsequently took out a loan of 200 k. As I pointed out, the bank did not
have the 200 k it promised to X but it gave him the loan anyway – and why shouldn’t it?
After all it could actually make a loan of 900 thousand dollars and still be within the
mandated reserve requirements. Now X used a check to transfer his funds from his checking
account to S and in return he got the deed to the house. So after all transactions have
taken place, X owns the house and has a debt of 200 thousand to the bank. S has a checking
account of 300 thousand dollars with the bank. The bank has 100 thousand dollars in cash
and a loan worth 200 thousand dollars to X. At the same time it has a liability of 300
k to S – which makes for a reserve ratio of 33 %. This lending process might look different
than what the goldsmith did – after all he never invented deposits for gold he did not
have when extending a loan, but only lent out a fraction of the gold he actually had
in his possession. But this observed difference is only a mirage. Upon closer inspection one
finds that both approaches to lending yield exactly the same outcome in the end. Anything
that can be achieved with the first one can also be achieved with the second one – and
vice versa – so they are actually equivalent. Let me demonstrate:
If the commercial bank were to operate like a gold smith, X would have to start out by
paying S for the first third of the house. Now S could take the money he received by
selling the first part of his house and deposit it in the bank. Then the bank could loan X
90 thousand dollars. Its reserve ratio would drop to 10 % right at the legal limit. Now
X could use the 90 k to buy another part of S’s house. Again S could put the cash in the
bank. With the banks reserve ratio climbing back to 53 % it has enough reserves to make
another loan of 81 thousand dollars to X. X could again use the money to buy yet another
part of the house and S would yet again deposit the cash with the bank, increasing his checking
account to a balance of 271 thousand dollars. Finally the bank has enough reserves to satisfy
X’s desire for another loan of 29 k to pay the last part of the house. After S has taken
his last payment to the bank we have reached exactly the same picture as before. X has
the house and the loan, S has a checking account for 300 k and the bank has 100 k in cash and
the loan to X. So there is fundumentally no difference between both scenarios – one simply
required a few additional transactions, but the actual outcome is identical in both cases,
so why bother and go through the trouble at all? Finally one last way to look at fractional
reserve banking becomes apparent when looking at the last example. What did the commercial
bank do? It took S’s deposit – which is in essence a very short term credit that is being
renewed every day – and relent the money to X for a much longer term. But S is not aware
of this duration mismatch and thinks he really can withdraw all the money he deposited at
the bank at any time. As soon as the bank extends the credit of 90 thousand dollars
to X the assumption in S’s head is no longer true – he could only withdraw the 10 thousand
dollars the bank kept in reserve and not 100 thousand dollars as he assumes. Then, as X pays S for the second time using
the money he received through his loan, S does not realize that he just re-received
his own cash. Instead he thinks it’s new money, deposits it in the bank again and now thinks
he can claim even more cash from the bank than before – in our example 190 thousand
dollars – 90 thousand more dollars than there are actually in existence. S would not have this wrong assumption if
the bank actually told him that it lent his money to X for a certain amount of time and
that he could only withdraw it again once X has repaid his loan. So the final way to
look at banking is that banks borrow short term, lend long term and keep their depositors
in the dark about it. We now have a basic understanding of the banking
system as it exists today. Of course there are still a lot of missing details but we
know enough to answer the first questions from the beginning. “Where does money come from?” We now know
that before we can answer this question, we should probably ask “What kind of money are
you asking about?”. If it is simply paper currency, then the answer is: “It is created
by the central bank and spent into the economy by buying interest bearing assets or through
repurchase agreements.” If one is asking about book money then the answer is: “Commercial
banks simply increase the balance in an account when extending a loan and act as if they actually
have the paper currency to back it. But since people are usually able to convert the number
in their checking- or savings-account into paper currency, people understandably assume
that commercial banks could do that for all of their deposits and thus these account balances
are being treated as money also.” Perhaps a shorter, more general answer would
be “Nowadays money is practically solely created out of debt, debt that carries interest”. This leads to a very crucial observation:
Since money is lent into existence in exchange for a promise to repay more money later, the
available amount of money is always smaller than the amount of outstanding debt. So how can debt with the outstanding interest
ever be repaid? A common thinking error is that due to this
fact it is simply impossible for all loans to be repaid without anybody having to default
or take on a new loan to pay the old one. But this is – at least in theory – not necessarily
true. Let’s first illustrate the example of an impossible
loan and then see how the situation could be mended. Imagine a small economy of three people: A
creditor – perhaps a banker, a debtor – perhaps an entrepreneur and a consumer. In this system
we assume that in the beginning the creditor has all the money – two dollars. The debtor
has an idea for a business. He owns a garden with an apple tree that grows one apple per
day and he knows that the consumer would be willing to buy apples for one dollar each.
His only problem: He lacks the necessary tools to pick the apple. Luckily for him, the consumer
sells a gardening device that allows him to cut the apple from the tree for two dollars. So let’s image in this first scenario, that
the debtor takes out a loan of two dollars from the creditor and agrees to pay back three
dollars in three days time. So he receives the two dollars from the creditor and uses
it to buy the gardening device from the consumer. He then starts working and uses his gardening
device so that at the end of the first day he has successfully produced his first apple,
which he then sells to the consumer for one dollar – just as predicted. The same thing
is repeated on the second day. The apple tree grows a new apple which is again harvested
by the debtor and sold to the consumer for one dollar. On the third day another apple is grown and
harvested but now, with the looming deadline for his loan, the entrepreneur faces a big
problem. While the consumer would still gladly pay a dollar for an apple he has run out of
dollars with which to pay, after all only two dollars entered circulation through the
original loan. In fact in this scenario, the entrepreneur has no chance to avoid default
– because he has agreed to repay three dollars even if there are only two dollars in existence
– an impossibility. I think it is important to stress that the
entrepreneur did not do anything wrong per se, except perhaps agreeing to the unsatisfiable
loan contract. But as soon as he had agreed to it, his fate was sealed. Even if he had
been able to invent cold fusion or some other miraculous product or service, short of counterfeiting
the missing dollar he would have been unable to repay. But there is actually a way to repay a loan
of two dollars and the additional dollar of interest if there are only two dollars in
existence. All that is needed is a slight change in the loan contract, so let’s look
at the second scenario. Again we have the same creditor, debtor and consumer but this
time the terms of the loan are a repayment of one dollar every day for three days for
an initial loan of two dollars. So similar to the first time around, the creditor lends
the debtor or entrepreneur two dollars so he can in turn buy the gardening device from
the consumer. He then proceeds to cut the apple from the tree and sells the apple for
one dollar to the consumer. Now it is the end of the first day so he gives a dollar
back to the creditor. On the second day, the same transactions take place – he sells his
apple to the consumer and receives the dollar which he in turn hands over to the creditor. Now the fateful third day arrives, but this
time the situation is different. Last time around he already possessed all the money
in the system so there was no one left to sell his apple to, but this time his creditor
actually has the money to buy an apple from him. If he does then the entrepreneur is able
to pay back the last dollar at the end of the day, without having to default on his
promise. But notice the two critical prerequisites
it took for the loan to be repayable: The creditor had to spend at least the interest
– in the previous case one dollar – back in the economy. If he hadn’t the debtor couldn’t
have earned the interest simply because it was not in the system. Also, the consumer
was not allowed to hoard any money but had to spend it again after he got hold of it.
It would have still worked, if he had only spent one dollar on an apple and kept the
other dollar to himself, but then the creditor would have had to buy two apples and would
have ended up with only one dollar, after all transactions had taken place. So we find that for loans to be truly repayable
– that is without having to take out additional, bigger loans or defaults – money has to keep
circulating and creditors have to consume at least their earned interest. If even a
single participant does not play by those rules but keeps accumulating money eventually
all funds will flow to him leaving the debtors unable to repay their debts because he has
sucked all the money out of the system. We don’t even have to look at complex institutions
like commercial or central banks to realize that these prerequisites are obviously not
fulfilled in reality, because there are normal, private individuals who managed to accumulate
enough money to easily cover their living expenses with only a fraction of the interest
they receive, thus accumulating more and more money over time. It therefore follows that the only way to
deal with loans other than defaulting is to take out new and bigger loans. This generates
a cycle that feeds on itself – and since the interest paid on a loan is a percentage of
the principal the size of new loans has to grow exponentially. If you are not familiar with exponential growth
and its ramifications there are several great videos on this topic on YouTube such as the
ones I put up here and I urge you to watch them to get a real grasp of what exponential
growth really means and entails. I will only present the topic briefly and highlight a
few important facts. Let’s begin with the definition: Something
– like a population, an amount of money or an economy – is growing exponentially if it
grows perpetually by some percentage of its current size whenever a fixed span of time
passes. For example, loans with compounding interest grow exponentially. But another,
equivalent definition of exponential growth that is much easier to grasp is that something
grows exponentially whenever it doubles in a fixed span of time. There is a simple formula that is pretty accurate
to get to the doubling time from the typical percentages of growth per unit of time. It
goes as follows: If something grows by x percent per unit of time then it takes about seventy
divided by x units of time for the entity in question to double in size. For example
if you have a savings account that pays one percent of interest a year, it will take about
seventy years for your savings to double. If it pays two percent it only takes thirty-five
years. If it pays ten percent it only takes seven years to double your money. Another useful rule of thumb is that when
something has doubled its original size ten times it is approximately one thousand times
its original size. Accordingly if it has doubled its size twenty times it is approximately
one million times its original size. If you draw a graph of the amount of the quantity
in question over time if it grows exponentially you will get a “hockey stick”-chart – that
is a chart that looks pretty flat in the beginning and seems to accelerate greatly towards the
end. This is one of the main problems with exponential growth – if you have a fixed supply
of something and your consumption grows exponentially practically until the very end it looks as
if you still have a lot of reserves left – until they are gone practically in the blink of
an eye. But enough with the theory for now – based
on the analysis of money creation and the mechanics of loan repayment, I made some very
bold claims saying that in our current system debt grows exponentially and that because
of fractional reserve lending there are actually more forms of money than just the paper in
our wallets. So let me show you that the data actually supports these hypotheses and that
I haven’t just made all of that up.

Tagged : # # # # # #

15 thoughts on “Economics Deconstructed – Infinite Growth Paradigm – Part 6/9”

  1. Everything you explained in your videos up to & including this one I've been trying to explain to morons (what most people are) for years.

    Including that, ultimately, it does not matter functionally if credited accounts must have an integral reserve ratio or both debited (depositors') accounts (account with the bank) and credited accounts (borrowers' accounts with the bank) may only be covered fractionally in actual/real/earned money.

  2. The only 2 differences are 1st:

    That in one case the real money needs to be spent and deposited again before it can create more imaginary money.

    And in the other case it needn't.

    Newly created imaginary money may be instead credited directly to the borrower's account. Without someone having to have deposited it with the bank beforehand.

    And 2nd:

    The size of credits that may still be extended is not limited by the amount of reserves in excess of the mandated minimum that are still available.

  3. If the bank only has $1.000 of real money still available as excess reserves it can't, at once, extend a credit of $5.000 fractionally backed by the $1.000 in excess reserves.

    It can, at once, only extend a credit of $1.000 and must wait for that money to cycle back to it before it can, again, loan $800 of it out.

    In such a system imaginary money is only introduced into circulation on the intake side of the bank, to depositors' accounts, in exchange for real money usurped from depositors.

  4. Under false pretences. Which are that their monies are there (redeemable at demand or within a short term in exchange for better interest) and, yet, also paying dividends.

    For nothing. I mean, how could money that, allegedly, just sits there accrue interest if not for nothing?

    That is to say, the banks promise a supposed free lunch.

    Lying through their teeth, of course. The money on the account statement are just the afterglow of the money you deposited. Not the actual money, that's gone.

  5. And yet you can spend this afterglow, this empty promises to pay that money, in lieu of the promised money.

    Such that, to a naive and uninformed observer, the same money is present in two different places at the same time. Being spent by two different people on different things at the same time without the other's account balance shrinking by the amount the other one spent.

    And yet people fail to see how this is inflationary (when new physical money is first introduced to the economy)

  6. when newly printed physical money loaned into the economy has yet to have passed through the system enough times to produce the maximum possible amount of fractional claim upon it.

    & people also fail to see how this is naked serfdom to the banking/financial system then.

    When no more new imaginary money can be issued as claims to the once new physical money and the monetary mass is again fixed and only shuffles back and forth.

    Now people have to pay the banks back fake loans, with interest.

  7. When the cost of the loans has already long been beared out by the real, productive economy (the only real creditor and the only source of real capital) through inflation, dilution of purchasing power, and prices have stabilized for the new monetary mass.

    This entire fraud is possible because prices, by themselves, are misleading. Without knowledge of the total money supply in circulation, accurate to second.

    Knowledge of the increase in the money supply lags behind the actual increase

  8. This fools people into accepting less than they ought or, indeed, they are entitled to charge for what they are selling (goods, property, resources or labour).

    It doesn't help that it is expensive and time consuming (lagging) to convert money to gold or some other real store of wealth, safe from theft through inflation, and back again just-in-time for spending or saving without incurring inflation losses or fees.

    Or that they also sell imaginary gold & silver so they can steal from you anyway.

  9. It is not the form of money employed that matters.

    The reason gold money (and all money with high intrinsic value) has been and is used to settle debts or mediate exchange is that it is hard to counterfeit.

    That's all that matters about gold money. Its scarcity and intrinsic value make both work to make it hard to counterfeit.

    No money without intrinsic value is as resistant to legal counterfeiting.

  10. You basically have to trust the issuer of the currency not to issue any more after the initial public issuance. Which he will eventually always, always do.

    So instead of fighting this, you embrace it.

    The alternative to money with intrinsic value and money with no intrinsic value is money issued by essential (like the energy or chemical) industry that is backed by the realised but as yet unsold production of that industry or its short~medium term expected production.

  11. The money issued by industry would be redeemable in units of that industry's production.

    By having an essential industry issue the money you insure that all money in circulation will be redeemed within a few weeks to, at the outside, a year or so. People won't sit on the money as they do with current, non redeemable fiat currency.

    And you insure that no more money is issued than production there is to redeem it.

    Because if that is the case, the culprits are found out within, at most, a year.

  12. As people, if they want to consume any of the production of the essential industry(ies) issuing the money for the entire economy, will be forced to periodically redeem their monies issued by that industry and thus expose the issuers as the crooks they are if they issue more money than they can redeem with their industrial production.

    Naturally, the cost and value of everything in would be monetized in units of industrial production of the essential industry issuing the money.

  13. So if the energy industry would be the one issuing the money, every price and income in the economy would be expressed in kilowatts-hours. And everything would be reported to the cost or value of energy.

    A Ford 250 would cost 1 megawatt-hours, for example.

  14. the more economies need to grow in order to service mounting debt, the more wealth is transferred to the FED system via the petrodollar – economies need more and more energy to continue

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