HOW CAN A BANK NCRESE ITS ASSETS

I AM QUITE NEW TO THIS KNOWLEDGE OF BANKS CREATING MONEY.  i HAVE READ EXTENSIVElY ON FRACTIONAL RESERVE BANKING AND OTHER ARTICLES, BUT HAVE A QUESTION

If a bank has $1,000,000 in assets (cash) and wants to increase its assets. It buys governments bonds worth say £25,000,000.

and it buys the bonds by a simple method. IT JUST TYPES IN THE FIQURE IN THE ACCOUNT AND TRANSFERS THAT FIQURE TO THE GOVERNMNET.

IS THAT HOW BANKS CAN BUY BONDS? AND REDEEM IT LATER SAY 3 MONTHS LATER. AND THE GOVERNMENT THEN PAYS BACK £25,000,000 WITH INTEREST SO THE BANK HAS ACTUALLY £26,000,000 IN PHYSICAL CASH AT THE CENTRAL BANK.

would some one please enlighten me.

zeb187

Is your question "How can commercial banks increase their assets?".  Or do you want to know how central banks and commercial banks work in lock step to increase the money supply?

My understanding on "How can commercial banks increase their assets?" is this.  First of all commercial banks can effectively create assets themselves by gaining deposits and then lending out a multiple of what they have received in deposits.  This is fractional reserve banking.  So, if a bank receives $1,000,000 in deposits and decides to keep a 10% reserve, it would hold $1,000,000 and lend out $9,000,000.  This $9m are new assets for the bank, created out of nothing.  That is why banks compete so fiercely for deposits. 

Historically, and I mean going back to Greek and Roman times, this has been regarded as an illegal practice.  Why?  Because two people believe they have the immediate use of the same money: the depositor believes he has full and immediate access to the $1m, and the person receiving the $9m loan believes he has full access to those monies.  Money cannot be in two places at one time.  (However, if someone loaned the bank $1m and the bank lent out the $1m at a higher rate of interest, this would be legitimate entrepreneural activity.)

Banks have always been tempted to lend out monies on deposit and have done so secretly, knowing it to be misappropriation of funds.  In Spain in the middle ages, bankers were publicly executed for this fractional reserve banking.  Also, historically, banks have not been able to carry this practice out in the long run because as soon as word got out, there would be a run on the bank and it would fail.  And this is an example where one could not insure against bank failure because of the moral hazard involved.

To explain how commercial and central banks work in lock step to increase the money supply this is my understanding.  To make fractional reserve banking work governments are needed, first to legalise a fraudulent activity and second to provide a central bank to act a lender of last resort.  The big beneficiaries of this were the banks themselves for whom this is a very profitable process and governments who greatly benefit from the increased ability to borrow.

When a government wants to create money they do not do anything as crude as printing more notes.  The central bank writes a cheque on itself.  It has nothing to back this up, of course, but governments have given central banks the power to do this.  The central bank then goes into the open market and purchases something.  It could be anything, but normally it is their own debt, government bonds.  The people who have sold the assets to the central bank then deposit their cheques with a commercial bank.  Hey presto, new money has been created!  The commercial banks then places their cheques on the central bank. 

The government has now created something out of thin air, but it is this ability to create money out of nothing plus the multiplier effect of fractional reserve banking that turns this into a truely awesome process of credit expansion. 

As soon as the commercial banks have received the cheques from whomever the government has purchased assets, the capital base of the banks is increased.  The commercial banks can now lend out against this capital base on the assumption that not everyone will want their money at the same time.  This is fractional reserve banking.  Let us say that the banks require a capital base of 2%.  This means that the banks can then lend out 50 times the money that the government had created out of nothing initially.

So, that is my understanding as to how the banks create money; and it is banks in the plural: commercial banks and central banks.  

On the process of credit expansion I recommend Murray Rothbard's "The case against the Fed".  And on the historical distinction between deposits for safekeeping and deposits for loans I recommend Jesus Huerta de Soto's "Money, Bank Credit and Economic Cycles".

My question was  "How can commercial banks increase their assets?".

P.s thanks for your reply. I see what you will have to say. Thanks

Hmm, I don't think that is really how it works.

Banks dont operate in that manner for each indvidual bank there balance sheet will add up.

The assets (money lent out) does not exceed the liablities (deposits) in there balance sheets, it would be impossible for a bank to operate in the manner you present. Since they simply dont have 9 million to lend out after only receving 1 million in deposits....

Having a 10% reserve would rather mean that for each 1 million in deposits 900 000 are lent out and 100 000 are held in the bank.

It's (Deposits = Money lent out + reserves) and nothing else.

The money created by commercial banks are created when you do this process multiple times, re-depositing the loan each time.

1 million cycled 3 times with 10% reserves:

1st deposit: 1m deposited, 900k lent out, 100k reserves

2nd deposit: 900k deposited, 810k lent out, 90k reserves

3rd deposit: 810k deposited, 729k lent out, 81k reserves

there are several more effective cycles on this but you can add them yourself if you want.

We can however already se that for only 1 million real money that whent into the system there is now a total of 2.71M in bank deposits, 2.439M in loans and 271k in reserves. That is over 5 million in readily avaliable currency for only 1 million actual money deposited in just 3 cycles.

These cycles can happen in the same bank or a different one.

When someone takes out a loan they usually do it to go buy something. The person that sells to them will get the money and deposit into there bank. That is 1 cycle completed. Banks also lend money directly between eachother and the central bank which also add cycles.

This process is also the reason why the centralbank can manipulate the money supply so well just by adjusting the interest rate.
When the interest rate goes up there are less loans and the cycle starts happening in reverse as loans are repaid and the money supply goes down.

 The bank could ofcourse just cycle the money internally and do give out a 9 million loan for a 1 million deposit. But i think this simplifcation of the procedure is a bit messleading since this in not the way it actually looks in the banks balance sheet.
Also for a single bank that does that it would crash as soon there clients try to spen more then 1 million outside the bank at the same time.
It works a lot better if all the banks are involved under a single currency. If people try to remove more then the inital deposit from the system at once the system will collapse. But if every bank is involved it becomes pretty hard to remove the money from the system at all and it could go on forever. As long as the demand for cash transactions or to have cash stockpiled in other places then bankaccounts don't spike...

I would be glad to hear some thoughs on how Savings & Loans bank could be prevented from operating in this fashion and how and who exactly are violating the peoperty rights of other in the economony by cycling money like this.

Remnant you seem to be confusing things. Commercial banks are not able to multiply money, as Zeddicus has said, they can at most lend out less than was deposited. However, as this money works through other (or the same) banks, the 1,000 eventually becomes 10,000, with a 10% reserve, because with each new cycle, more and more people end up with claims on the original 1,000.

The central bank, on the other hand, can directly create 9,000 out of nowhere, without any cycles. This is because money held by the central bank is called "High-powered money". Only central banks can write a check on themselves for money they don't have, essentially creating it ex nihilo using book entries.

What I am having problems with is how this is considered fraudelent if the bank tells everyone what they are doing.

I am having trouble explaining causing inflations as doing harm on some elses property. What is so fundamentally different about it then the value of there money being changed by a change in the demand or real supply of money really...

It might be inheretly fraudulent though. As it requires the bank to treat the money that it gets back the second time as what it is not.
This is not actual money it is at best a right too use a certain amout of the banks pooled resources. The fact that banks have to disregard this and treat it as actual money might make it fraudulent?

Zeddicus and Fred

Thanks for your input and I agree that there cycles and that the picture I painted was very simplistic.  However, I think I am right in saying that it is possible for credit expansion to occur even without the central bank.  Banks practising fractional reserve banking are doing just this.  They are lending out more than they have been lent.  In practice, banks have not been able to do this for very long before runs occured. 

The reason fractual reserve banking is fraudulent, even though laws have been passed making it legal, is that the banks say that the depositor has all of his money available on demand which is not the case.  At the same time other people think they have the full use of the same money.  Not everyone may be aware of what happens with fractional reserve banking, and banks go to some lengths to obscure what bank deposits actually are. 

I agree that central banks can create money out of nothing, but it is that ability plus the multiplier effect of fractional reserve banking that makes it the potent weapon that it is. 

With kind regards

Remnant

Remnant, you're right in that banks conflate the two radically different concepts of time deposits, and demand deposits, whereby the former transfers both ownership and availability, while the latter only ownership (for convenience's sake as money is a fungible good).

Zedd, the banks don't tell people what they are doing. By and large, most people I've talked to didn't have the slightest idea that their current accounts, which are supposed to have 100% availability, are actually treated as time deposits. People think that their current accounts are a real safeguard of wealth, and that banks are just elaborate vaults. It's incredible how short a memory people have with regards to bank runs, or their causes. Btw, with the introduction of, and gradual augmentation of the powers of central banks, these cycles of expansion will be able to last for longer than before (central banks print money as a last resort).

I have been debating this in another forum starting from the notion that banks could lend more then they borrow, this created a great deal of confusion which was finally cleared up when i found this lending cycle. Best to say that they by re-borrowing money they lent out can cause this credit expension...

Yes I know banks today don't tell people, the current system is illiegitimate in a whole bunch of ways. But what about the practice in a free system where they do tell people what they do. I would prefer it outlawed but I have problems justifying this position...

Fred

You are hitting the nail right on the head about the distinction between availability and ownership.  It has taken me a long time to get to this point in my understanding and I am impressed that a young person like you has got there straight away (I hope that doesn't sound condescending because it is not meant to be). 

I have only just started to understand this principle and the symbiotic relationship between the central and commercial banks after reading Rothbard "The case against the Fed" and Jesus Huerta de Soto's "Money, Bank Credit and Economic Cycles".  (Incidentally, I think that de Soto's book is well translated from Spanish and I have found the style easy to read and flowing.)

By the way, are you aware of the Rothbard Instituut in Belgium?  I have just seen something on the Mises.com blog - set up at the end of last year.  http://rothbard.be/english

With kind regards

Remnant.

Zedd, the solution does not require any laws at all, merely more free market than you're probably considering. It's not even so much a matter of banks telling people. Most people can feel the effects of inflation without realising where it comes from. What I think should work well, is that anybody can print their own currency. Let's say there are a dozen commercial banks, all of which can print their own currency. Businesses can then choose which of these currencies to accept. Over time, those banks that practice fractional reserve banking will devalue their currencies, while those that practice either full reserve banking, or less fractional reserve banking, will have a stronger currency. With free association, and no government coercion with regards to national currencies, as soon as one currency begins to lose its value, businesses and consumers are likely to switch to another, in order to preserve their savings and make sure their purchasing power is not eroded. Once again I think free competition solves these problems, without any coercive laws required.

Thanks Remnant, I got my understanding of ownership and availability from Huerto de Soto. I especially love the historical examples he uses, it really puts things into perspective.

I wasn't aware of this institute, so thanks very much for the link. I'm actually very surprised that such a place would exist in Belgium.

Murder and theft for instance are things that ought to be illegal in a stateless society as well. The state isn't really a part of the issue.

Question I am interested in is if you have the right to shut down someones bank if its subjects you to inflation.
Issuers of currency do however have a pretty clear right to regulate banking in there currency.

It may however be impossible to inflate someone else currency or a commodity itself without someone using deception. Which might solve this problem. If some issuer of 100% gold backed currency doesnt care what savings and loads bank do with there currency. FRBs start to operate in there currency and they dont adjust the statement that it is 100% backed by gold they will be lying.

You, as a consumer, don't have the right to shut down any bank. However, if the bank cannot provide you with your demand deposit, you can of course sue them for fraud. If they have high reserves, for example 50%, and therefore don't run into liquidity problems for a long time, yet still inflate the currency, you can just switch to another currency with another bank (freedom of competition).

The only people who can stop a bank from inflating currency are those that have issuance rights on that currency. So let's say I found the Fred Dollar, and then give banks the right to hold my currency. If I want this currency to have a 100% gold backing, I would explicitly state so in my contract with them. If they then violate that contract, I can retract their right to safekeep my money (and probably sue them for damages due to devaluation). I think though that by and large banks themselves will be the issuers of their own currencies, and may use their ability to issue currency as a tool to attract customer loyalty. I would certainly patronise a bank that keeps 100% gold reserves and doesn't devalue my savings.

Freedom of association can do what no laws can (since laws can be corrupted, as we can see with relation to fractional reserve banking laws).

Yes, you can inflate your own private fiat currency as much as you want I see no problem with that.

Banks could however also inflate the price on any commodity.
Question is if this itself allows owners of said commodity to use force against the bank to defend there property from inflation.

Maybe not. But it should be impossible to do unless the bank somehow makes the market think that there reciepts are 100% backed. Otherwise the price for the reciepts will drop but not the commodity itself. And that would make it appropriate to use force in self-defense against the bank as against any scammer.

That is authoritarian law. Removing authoritarian law doesnt mean there will be no law, just voluntary law produced by the market.