How does money supply contraction take place?

Reply

jimaustri123 Posted: Wed, Aug 22 2012 12:49 PM

rated by 0 users

Over the last couple of years I've heard much about how the government and special interests create money out of nothing i.e. the treasury goes to the fed and says I need some money... don't worry I'm good for it - just add it plus interest to the national debt for the taxpayer to worry about. The Fed then prints up(paper or digits) the money for the treasury and charges interest on it. I think that's how it works, anyway.

I'd like to know how a contraction of the money supply takes place. I'm not sure but it seems once you create it it becomes tradeable like a promisory note, and it doesn't dissappear. It just gets passed around on the assumption it came into existence through the creation of something tangible of value.

So how does the supply ever decrease?

Reply

Kelvin Silva replied on Wed, Aug 22 2012 12:57 PM

rated by 0 users

They contract it by selling those assets.

Reply

Neodoxy replied on Wed, Aug 22 2012 1:00 PM

rated by 0 users

On the side of the market it comes from hoarding/destruction of money (although this is better described as a change in the effective money supply) or banks terminating unbacked checks they issued.

On a government level it comes from the fed selling assets which they bought with their own fake credit in exchange for credit, so now they have the money and don't spend it.

Reply

Kelvin Silva replied on Wed, Aug 22 2012 1:02 PM

rated by 0 users

Mention too, the government can always raise taxes to counter inflation. They tax the money out of you and lock it up in a vault. or burn it. or dig ditches.

Reply

Bogart replied on Wed, Aug 22 2012 1:57 PM

rated by 0 users

Money is destroyed in exactly the opposite mechanism the Fed used to create it.  That is the Fed will sell the assets it "owns" trading the asset for electronic money issues from Bank Reserves.  Understand the impact of this process.  This money purchased for an asset by the Fed is no longer available for the member banks to engage in Fractional Reserve Lending.  So if the reserve rate is 10% for the bank or $1 in reserves for $10 in loans, the banks must now either get the money on loan from another bank or sell their assets to maintain this ratio.  A lot of selling of assets by the Fed could easily make the banks insolvent.

Keep in mind that most assets held by the Fed are interest bearing US Gov Bonds.  So if the Fed offers to sell these then the price of the bond will drop meaning the yield of the bond will jump.  Since interest rates are the inverse of yield the interest rates will rise forcing the Government to pay more for its debt.

Reply

John James replied on Wed, Aug 22 2012 4:31 PM

rated by 0 users

But keep in mind, inflation of the money supply doesn't only occur through fractional reserve banking. There is still new money created out of nothing that doesn't get destroyed as loans are paid back.  (And of course, government loans are never paid back anyway.)