[wulfgar]

Turkey, on 21 November 2011 - 12:30 PM, said:

One veryimportant thing to remember: money supply e.g. M3 is not netted(otherwise we have this clearly absurd situation of a zero moneysupply), that is an accounting function.

e.g. US M1 = Currency in circulation + sight deposits + travellers cheques + NOW deposits.

Euro M3 = M1 + time deposits + money market funds + bills and bonds with less than 2 years residual maturity.

It is a purely additive function.

Anotherway of looking at it - why would central banks get so worried aboutdeflation if it was merely a function of cranking the mechanicalprinting press a little harder?

Otherwise, Mr Medved and Tom, you are agreeing with me without realising it

Asyou have pointed out, credit is created by banks, can be spent justlike physical money (therefore is for all intents and purposes money -and is included as such because it finds itself in deposits), adds toGDP by bringing forward demand, but is fundamentally more unstable andcan end in tears in debt deflation.

Ok yes. Let's say Bank A attempts to "pay" Bank B with an IOU for $1,000,000 rather than the million legal tender cash.

Essentially it is only the legal tender cash which constitutes payment. It wouldn't matter if Bank B is owned by Wulfgar who thinks only gold coin money because he cannot refuse.

However if Bank A offers merely an IOU as payment then Bank B can refuse. Because in reality and IOU is deferment of payment rather than payment itself. The interest for Bank B is that the IOU pays interest. But in the long run what Bank B is after is more real cash.

If Bank A's IOU's were the same as real money it wouldn't matter what fantastic sums Bank A owed in principle and interest, because Bank A can write any set of figures on its IOU's........one million $..........one billion $.........on trillion $.......and so one. As long as Bank B accepted my IOU's I'd never have to part with real cash.

But ultimately it doesn't work and comes to a grinding halt as it did in 2008.

The Central Banks acted quickly and began "guaranteeing" the interbank loans by using the central bank as an intermediary. The central banks created "reserve balances". The Banks might not trust each others credit but they will trust the Central Bank.

The relationship between "reserve balances" and real cash is another issue.

But this is the problem, one can argue that bank credit can be used as a medium of exchange. However it is never "final payment" something which only real money can do!

[tom]

I guess the fundamental to understanding credit creation or retracement is understanding the parties involved.

For credit to expand you need;

A depositor (in the broadest sense of the word)

A borrower

Normally necessary a facilitator of some kind (the bank)

The first two are the only essential ingredients the third is really only necessary because we don't all trust each other like we trust banks...

There is nothing special banks can do that anyone else cannot. They require a depositor and then act as a facilitator to lend this to someone else. Sure a banking system which is reckless will see more credit created but they need equally reckless depositors (or governments) to engage in this behavior.

[wulfgar]

tom, on 22 November 2011 - 04:24 AM, said:

For credit to expand you need;

A depositor (in the broadest sense of the word)

Sometimes they term it "deposit money". It is simply what the banks owe the saver. People get carried away with the idea that deposit money can be transferred between banks.
Basically the depositor has used his bank iou a spending money and transferred as payment to another bank creditor. The one weakness in using iou's as money is that it is not final payment and simply deferral of payment. Another weakness is debt used as money is more volatile than ordinary money.

But you don't need a bank for this to occur, you simply need a third party.

This post has been edited by wulfgar: 22 November 2011 - 05:09 AM

[Turkey]

tom, on 22 November 2011 - 04:24 AM, said:

I guess the fundamental to understanding credit creation or retracement is understanding the parties involved.

For credit to expand you need;

A depositor (in the broadest sense of the word)

A borrower

Normally necessary a facilitator of some kind (the bank)

The first two are the only essential ingredients the third is really only necessary because we don't all trust each other like we trust banks...

There is nothing special banks can do that anyone else cannot. They require a depositor and then act as a facilitator to lend this to someone else. Sure a banking system which is reckless will see more credit created but they need equally reckless depositors (or governments) to engage in this behavior.

The counter-argument is in your post i.e. that you need a facilitator of some kind and that it is completely impractical to get paid in IOU's from some random people that you do not know and/or trust (even if the banking system merely abstracts that little detail away )

Using your logic, there is nothing special that central banks do that anyone else cannot.

We can all agree that salt or sea-shells or beads or gold or anything else is the money that we are going to use to trade, and then the central bank is irrelevant.

I'm not sure what the point is though, because that is as impractical as not using the commercial banking system. I think it's another variation of "if my auntie had balls she'd be my uncle"... (if we didn't take [fractionally backed] loans from banks then they would not create money).

[tom]

Turkey, on 22 November 2011 - 05:20 AM, said:

I'm not sure what the point is though, because that is as impractical as not using the commercial banking system. I think it's another variation of "if my auntie had balls she'd be my uncle"... (if we didn't take [fractionally backed] loans from banks then they would not create money).

I can agree with all of that.

The reason I am trying to bring the whole box and dice into it, is that it is really very simple the mechanics around M3 creation. It can happen in many different ways but each time it takes at least two and normally 3 to tango.

People start to talk about things around; "what if the vendor uses the same bank as I did for my loan" or "if the vendor does not withdraw the funds at another bank" etc then they can create money etc. It all still has that necessary ingredient of a depositor at the end of the day except in that special case of central banks, they are the depositor and the lender wrapped up as one.

It is for that reason I don't like the turn of phrase; "banks can create money". Sure they can create money like I can create fine works of art. They are part of the M3 creation process but cannot do it on their own.

Anyway it seems basically we agree.

To the theory then if we all now understand the mechanics of M3 creation...

I should start by saying Australias regulation around banking while not having a set percentage around cash reserves has instead capital reserve requirements. Why this is ridiculous is that it allows the banks to deposit their own capital with another bank and for that capital to then circulate again as deposits. We end up with the absolute bear minimum of cash v M3 in our economy with nothing in reserve for a liquidity crunch. It baffles me how we have lasted this long? I suppose the bank guarantee in Australia where from our supposedly strongest position we were going first and going hardest might have something to do with this regulation?

[Mr Medved]

tom, on 22 November 2011 - 05:49 AM, said:

I should start by saying Australias regulation around banking while not having a set percentage around cash reserves has instead capital reserve requirements. Why this is ridiculous is that it allows the banks to deposit their own capital with another bank and for that capital to then circulate again as deposits. We end up with the absolute bear minimum of cash v M3 in our economy with nothing in reserve for a liquidity crunch. It baffles me how we have lasted this long? I suppose the bank guarantee in Australia where from our supposedly strongest position we were going first and going hardest might have something to do with this regulation?

Something to consider... capital reserve requirements are just accounting rules. Reflect on the "mark to fantasy" accounting rules implemented in the US to hide the true nature of bank balance sheets. You can hide a whole lot of bullsh*t until something blows up as everything is treated as a ledger entry.

One example Max Keiser gives is during the dotcom boom - company A would create "web page views", say 1M hits with a book value of $1M and sell them to company B, while at the same time company B would do the same to company A. Instantly on a balance sheet the company has expanded its balance sheet but there really isn't $1M in assets/revenue. It all looks great... until it unravels.

My guess is if liquidity becomes an issue then the RBA will step in to assist. So far (since the Panic of 2008) they have not gone down the same road as the Fed, ECB or BoE but they haven't needed to.

[wulfgar]

tom, on 22 November 2011 - 05:49 AM, said:

It baffles me how we have lasted this long? I suppose the bankguarantee in Australia where from our supposedly strongest position wewere going first and going hardest might have something to do with thisregulation?

With the widespread use of computing a generation ago the banks use a more sophisticated mathematics. It does seem to be the case that most of the time they can function without the reserves they used to have.

[wulfgar]

tom, on 22 November 2011 - 06:42 AM, said:

Quantitative easing can swell M1 and this will to a degree followthrough to M3 initally just as M1 but later as it gets levered up atwhatever the new M1 / M3 ratio is it will increase M3 by more than justthe total M1 printed.

Tom you seem utterly confused about what the M1 and M3 are. Maybe you should forget about it and just concentrate on the M3, the whole lot is retail deposits in any case.

Retail deposits are only created when somebody deposits.

[tom]

wulfgar, on 22 November 2011 - 10:26 AM, said:

Tom you seem utterly confused about what the M1 and M3 are. Maybe you should forget about it and just concentrate on the M3, the whole lot is retail deposits in any case.

Retail deposits are only created when somebody deposits.

Indeed I was confused forget M1. Base currency to M3 ratio is what I meant.

Substitute M0 everywhere I have just said M1. Who starts a series with a 0 anyway.

[wulfgar]

tom, on 22 November 2011 - 10:38 AM, said:

Indeed I was confused forget M1. Base currency to M3 ratio is what I meant.

Substitute M0 everywhere I have just said M1. Who starts a series with a 0 anyway.

The M3 includes all the savings. The M1 which is included in the M3 total is the transaction accounts.

This post has been edited by wulfgar: 22 November 2011 - 11:48 AM

[tom]

wulfgar, on 22 November 2011 - 11:45 AM, said:

The M3 includes all the savings. The M1 which is included in the M3 total is the transaction accounts.

I know I was starting at M1 for base currency and working from there as they increase in scope. Trouble with that is the series starts at base currency at M0...

[wulfgar]

tom, on 22 November 2011 - 11:10 PM, said:

I know I was starting at M1 for base currency and working from there as they increase in scope. Trouble with that is the series starts at base currency at M0...

Well the M1 extends to the transaction accounts. Beyond that are nominal savings as you extend the net into the M2 and M3.

The transaction accounts are not called savings, it instead refers to what used to be called "checking" accounts.

This is a special kind of account for making payments from and normally attracts zero or little interest.

The deal with transaction accounts is the bank has to cash your payments or your payments fail. So the transaction must go through!

Where as there is a different rule with your savings account like netbank which does pay interest, payments from this can be knocked back if the bank is out of money. So even if your savings account claims to be instantly accessible, the bank can knock that back.

Although I personally don't find much need for amounts in the transaction accont. It is easier to use CC and only have the required amount in the transaction on the CC payment date. This seems to be the practice in the US where they don't have much in the M1, where as Europe that doesn't use CC very much has a large M1.

So before you conclude there is some magic at work, it all depends how much account holders are keeping in their transaction account.