LanceH:In short, it has to mimic what you, too, had to do when you had to decide how large a cash-reserve to keep, before you got a credit card. You, too, would have maintained a larger cash float, and you might have dipped into your savings to make a large purchase or to do your Xmas shopping.The company does not, of course, maintain a 100% reserve up to everyone's credit limit, but only enough on hand to meet all the expected payments for a day. Your cash reserve has effectively been transplanted.
No it doesn't and that's the whole point. If I replace a $5,000 cash reserve in my checking account with a cc with a $5,000 limit, the cc company doesn't need to have $5,000 standing by at all times to cover my "just in case" payments. In fact, if I rarely use my card, it will hardly need any float at all, and by pooling millions of people, the "risk" is spread.
Juan:You don't have 8,000 in reserve.
Maybe you do.
I think the issuing bank creates fiat money in the full amount of the account limit at the time a credit card account is opened, and then just holds the money until charges are made. Am I wrong about that?
leonidia:No it doesn't and that's the whole point. If I replace a $5,000 cash reserve in my checking account with a cc with a $5,000 limit, the cc company doesn't need to have $5,000 standing by at all times to cover my "just in case" payments. In fact, if I rarely use my card, it will hardly need any float at all, and by pooling millions of people, the "risk" is spread.
That is exactly the definition of fractional reserve banking.
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Well, it's kind of like fractional reserve banking, but not exactly, because the bank is making a line of credit avaialble without you actually drawing on it. But yes it's similar and I take your point..
In any event, the fact that you no longer have to maintain an actual cash balance to act as your reserve fund, means that the process is inflationary.
DBratton:I think the issuing bank creates fiat money in the full amount of the account limit at the time a credit card account is opened, and then just holds the money until charges are made. Am I wrong about that?
This is a really interesting point. But I think the issuing bank only "creates" money (as it affects the economy) equivalent to the amount of reserve cash you used to hold in your checking account, even if your credit limit is higher. What do you think?
leonidia:This is a really interesting point. But I think the issuing bank only "creates" money (as it affects the economy) equivalent to the amount of reserve cash you used to hold in your checking account, even if your credit limit is higher. What do you think?
I don't see a firm link between all checking accounts and all cc accounts. Maybe some vary their checking balances as a result of credit but I don't think it's a rule. What does seem inflationary to me is the creation of money to cover the CC credit limit. If my limit is 10,000 and I only charge 500, what happens to the other 9500? I doubt the bank leaves it just sitting there. My guess is this money gets counted into the bank's reserves for purposes of making other loans. That's probably why they bump your limit up every so often without being asked to do so.
DBratton:I don't see a firm link between all checking accounts and all cc accounts. Maybe some vary their checking balances as a result of credit but I don't think it's a rule.
I don't think one can say it's a definite rule, no. What's interesting, though, is that banks have no qualms about using the cash balance in your checking account if you don't. Most banks now have very sophisticated software to analyse each account holder's average balance, and they sweep unused balances overnight and at weekends into money market deposit accounts MMDAs. MMDAs have similar rules to savings accounts. The average account holder has no idea this goes on. The purpose is not to earn interest on the money per se, but because MMDAs have 0% reserve, whereas checking accounts have a 10% reserve minimum. Thus if a bank is able to sweep half of its customer's cash balances into MMDAs they can effectively lower their minimum reserve requirement to 5%. By some estimates, as much as 75% of cash balances are swept this way, which would imply an effective reserve ratio of 2.5%. This is undoubtedly inflationary. The catch, for the banks, is that they are only allowed to move the cash back and forth in a single account up to six times per month; hence the sophisticated software.
"Well, it's kind of like fractional reserve banking ... by pooling millions of people, the "risk" is spread"
You are assuming that fractional reserve banking works because of the pooling of funds. It does not. It works because money is redeposited in the bank by other banks. if, for example, everyone stopped redepositing their money in banks, and simply kept it in currency at home instead, then money would steadily drain out of the banking system, and fractional reserves would not be feasible. Indeed, fractional reserve banking took off in England before Europe precisely because people in Europe initially mistrusted banks and tended to cash in their checks rather than deposit them.
leonidia:If I replace a $5,000 cash reserve in my checking account with a cc with a $5,000 limit, the cc company doesn't need to have $5,000 standing by at all times to cover my "just in case" payments
The $5000 limit has not replaced a $5000 cash reserve. My card has a $12000 limit (and each year I ignore their offer to increase it), but that in no way replaces $12000 in a non-interest-bearing demand deposit account. Very few demands for payment come out of the blue and are required to be paid on the spot. I do not need to meet them out of a cash reserve; I have time to sell liquid investmets or to dip into my savings instead.In short, the credit card has not so much reduced my demand for cash, as reduced my demand for what Mises calls "secondary media of exchange", i.e. liquid investments that can be sold wihout inconvenience and at short notice to pay known bills. And the cash that it has reduced my demand for has just been translated to the float of my card company.
leonidia: DBratton:I think the issuing bank creates fiat money in the full amount of the account limit at the time a credit card account is opened, and then just holds the money until charges are made. Am I wrong about that? This is a really interesting point. But I think the issuing bank only "creates" money (as it affects the economy) equivalent to the amount of reserve cash you used to hold in your checking account, even if your credit limit is higher. What do you think?
My understanding is that the bank creates the money on demand, i.e. when the card is used. The credit limit itself is an off-balance-sheet item.
Even if the card company is not a bank, it maintains a line of credit with the bank.That is why the analysis changes if FRB is taken into account.
LanceH: "Well, it's kind of like fractional reserve banking ... by pooling millions of people, the "risk" is spread" You are assuming that fractional reserve banking works because of the pooling of funds. It does not.
You are assuming that fractional reserve banking works because of the pooling of funds. It does not.
No I'm not and I know how fractional reserve banking works. You took two of my statements out of context, stictched them together and made It look line I was sayng something else.
leonidia:No I'm not and I know how fractional reserve banking works. You took two of my statements out of context, stictched them together and made It look line I was sayng something else.
OK, my apologies. But if it's not like fractional reserve banking, then how will the pooling of balances cut any corners from what would originally have been separate reserves?
leonidia: Everyone seems to be missing the point; I'm not taliking about fractional reserve banking, nor am I talking about defaulting on the loan, nor on whether or not merchants deposit the cc slip right away. I'm talking about something more subtle, so follow closely here. Most people who have only a checking account never let their balance get close to zero. They keep a certain amount in reserve. That money just sits there, but it serves a very importatnt function. It's there because people need a reserve "just in case". It's what Rothbard calls the reservation demand for money. Now the total demand for money is made up of this "reservation demand" and the "exchange demand". (I'm ignoring any non-monetary uses) When the reservation demand decreases, that necessarily increases the exchange demand, and this casues prices to rise. Put another way, previously idle cash is being used to buy goods, so prices go up. That's pretty starightforward stuff. OK, now suppose you didn't need this reserve cash any longer because you could use the unused balance on you credit card as the back-up instead. You'll probably never have to use this back-up, just as you wouldn't have if it were cash lying around in your checking account. But it's available if you need it and it serves exactly the same function as if it were reserve cash....except there's no actual cash there! And the reserve cash that was in your checking account has been set free. Make sense?
Everyone seems to be missing the point;
I'm not taliking about fractional reserve banking, nor am I talking about defaulting on the loan, nor on whether or not merchants deposit the cc slip right away.
I'm talking about something more subtle, so follow closely here.
Most people who have only a checking account never let their balance get close to zero. They keep a certain amount in reserve. That money just sits there, but it serves a very importatnt function. It's there because people need a reserve "just in case". It's what Rothbard calls the reservation demand for money. Now the total demand for money is made up of this "reservation demand" and the "exchange demand". (I'm ignoring any non-monetary uses) When the reservation demand decreases, that necessarily increases the exchange demand, and this casues prices to rise. Put another way, previously idle cash is being used to buy goods, so prices go up. That's pretty starightforward stuff.
OK, now suppose you didn't need this reserve cash any longer because you could use the unused balance on you credit card as the back-up instead. You'll probably never have to use this back-up, just as you wouldn't have if it were cash lying around in your checking account. But it's available if you need it and it serves exactly the same function as if it were reserve cash....except there's no actual cash there!
And the reserve cash that was in your checking account has been set free. Make sense?
Leonidia,
I follow what you're saying and agree completely. Credit cards are an alternate source of liquidity so reduce the demand for cash. Therefore, the value of cash falls; ie, prices rise. That's not what I would call "inflation" since the quantity of money has not changed (yet).
I think Rothbard mentions other factors that have a similar effect, such as changing pay schedules, for example.
A-R
A-R: I follow what you're saying and agree completely. Credit cards are an alternate source of liquidity so reduce the demand for cash. Therefore, the value of cash falls; ie, prices rise. That's not what I would call "inflation" since the quantity of money has not changed (yet). I think Rothbard mentions other factors that have a similar effect, such as changing pay schedules, for example.
Thank you A-R. Finally somenody gets it!
And I agree, it's not inflation, but it does cause prices to rise.
As regards Rothbard, are you referring to his argument that people who get paid weekly, for example, can keep a lower average balance than people who are paid monthly? If I remember right, he talked about how there was a period in his life when he was paid every six months!
LanceH:how will the pooling of balances cut any corners from what would originally have been separate reserves?
If you accept the premise that a credit card issuer can provide the liquidity to replace (or partially replace) its customer's reservation demands for cash, then the cash on hand required by the issuer for this purpose (and this purpose only) will obviously be much less than the aggregate reservation demand it provides.
leonidia:Why has it been captured? Explain that process. The reserve cash that was in my checking account has been spent. It doesn't have anything to do with the cc company. I'm now "using" my cc as my "reserve" fund, but I haven't used my cc for that purpose yet.
It is simple. The merchant will still get paid regardless of if you use your reserves or your credit card. The money have to come from somewhere.
The extra supply of money you create when you set loose your reserves will be meet by an equal increased demand for reserve money by your credit card company. They cancel out, it's just the same as if you where to withdraw your reserve and spend it, but deposit an equal reserve in a different bank.
However if the credit card company does not keep your entire credit balance in cash reserves you are right. If they only promise you credit if funds are availiable they can go invest a portion of the reserves in higly liquid assets (or not so liquid assets and rely on there ability to get credit).
This would be similar to say if you and your neighbours decided to have a common pool of emergency funds. It would not need to be as high as your individual pools added up, simply because the chance of all of you needing the max amount at the same time is much smaller then the chance that you do. Or more realistic scenario would be youth that keeps no own reserves because they can borrow from there parents if they get into sudden money trouble.
So it would set more money "loose" and decrease the price of money. Still neither of this actually increases the money supply.It only shifts the balance between money held in reserves and money used.
The money supply is only increased when more money is printed or when currency substitues are traded with no discount at the same time as the currency they are substituting. Well at least I think, I am not quite sure of the exact border for FRB operations and why myself.
Zeddicus: So it would set more money "loose" and decrease the price of money. Still neither of this actually increases the money supply.It only shifts the balance between money held in reserves and money used. The money supply is only increased when more money is printed or when currency substitues are traded with no discount at the same time as the currency they are substituting. Well at least I think, I am not quite sure of the exact border for FRB operations and why myself.
You are absolutely correct. There is no actual money creation, but by shifting money from reservation use to exchange use, it has the same effect as creating money.
It's interesting that the supply of money is usually portrayed as a vertical line (the money stock), and the demand for money, consisting of reservation and exchange demand combined, as a downward sloping curve to the right. But you could, if you wanted to, portray it a different way. You could define the total money supply as total money stock less reservation demand, which would be an upward sloping curve to the right, and the demand for money would then just consist of exchange demand. This picture of the relation between supply and demand would of course yield exactly the same price of money, but it's just a different way of looking at it. Under this defintion of the money supply, as reservation demand switched to exchange demand, the supply curve would become more vertical and shift to the right.
This is really hard to explain without a chart!
leonidia:If you accept the premise that a credit card issuer can provide the liquidity to replace (or partially replace) its customer's reservation demands for cash, then the cash on hand required by the issuer for this purpose (and this purpose only) will obviously be much less than the aggregate reservation demand it provides.
I don't think that this is obvious, no (under a 100% gold reserve standard).But, let's suppose that it is true. Forget about credit cards for the moment.Suppose Bank A offers cash warehouse facilities, 100% cash on demand.
Bank B also offers 100% cash on demand (under normal conditions), but it invests that part of its reserve which, according to your aggregation principle, is surplus to practical requirements. As a result, it is able to pay a small amount of interest on its deposits, or at least to waive storage costs. We'll suppose that it is up-front about what it is doing, that it iinvests only in highly liquid AAA+ investments, that it is audited frequently, and that it guarantees that, even if there were a bank run, it would be able to liquidate its investments within a few days, and everyone would be paid in full.I'm not sure if I would deposit money at Bank B. Would you?
I only skimmed through the replies and I had not seen this mentioned yet, however if it has already then I apologize.
If I have a $10,000 total credit limit on a credit card and have used half of it, my balance on that card is $5,000. I have borrowed $5,000.
But what happened to that $5,000? I either withdrew it as cash, or transferred it into an account of my own, or into the possession of someone else in exchange for goods and services. In any of these scenarios the $5000 has been accounted for in a properly counted money supply and to count it would constitute double counting of the same $5000.
see http://nimamahdjour.blogspot.com/2008/03/money-supply-watch.html
LanceH:I'm not sure if I would deposit money at Bank B. Would you?
Maybe, maybe not, but I'm not quite sure where you're going with this. Are you attempting to equate bank B with the credit card issuer? I don't see the similarity. I haven't deposited any money with my card issuer, or are we talking about something else here?
dsimo04:But what happened to that $5,000? I either withdrew it as cash, or transferred it into an account of my own, or into the possession of someone else in exchange for goods and services. In any of these scenarios the $5000 has been accounted for in a properly counted money supply and to count it would constitute double counting of the same $5000.
We're not talking about money spent on purchases, or cash withdrawals, or cash transfers to another account, all of which nvolve debits on you card . Ans as you rightly point out, these kinds of transactions are paid by the card issuer and to count this as any kind of money creation would indeed be double counting. But this is not what we're talking about.
We're talking about the fact that having a card allows one to reduce one's reservation demand for cash (in other accounts or physical cash) because your credit card can provide you the liquidity instead. The term "reseravtion demand for cash" has a very specific meaning. It's money that you would NOT normally spend, but which you keep in your account to provide yourself with needed liquidity. If your credit card can do this for you, then you no longer need to hold this cash.
When the reservation demand for cash falls, the purchasing power of money falls and prices rise.
I wish money supply was defined as "total money stock minus reservation demand" and money demand were defined as "exchange demand only" . This is how supply and demand for goods that have a reservation demand are usually defined.
Unfortunately, money supply is usually defined as "total money stock" and money demand is defined as "exchange demand plus reservation demand". Defining it this way makes it harder to see what's going on.
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