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> This is just completely wrong - banks only loan out money they have. If you go to a bank and get a loan the bank didn't just edit a database entry - they had that money. Banks loaning out money they don't have is extremely illegal.

I'm afraid to say that this is completely wrong. Commercial banks do in fact create money via lending! The 101 textbook explanation offered here is at best outdated and at worst misleadingly perpetuates a myth that simply must die.

The Bank of England's note on money creation in the modern economy [0] is the place to start - and more or less reflects the explanation in the article.

[0] https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/m...

Page 19 seems to show that the newly generated money has to be backed by somebody's deposit and not just minted though. Like for any situation that doesn't involve you taking a loan from a bank to use that money at the bank the BoE paper calls out that the bank needs to get deposits from where you're sending the loan.

So, you buy a house using say Chase and the seller has Wells Fargo then Chase "mints" say 1M the money for your loan but then solicits 1M of deposits from Wells Fargo. like why does it matter if the 1m for your loan came from Chase depositors or Wells Fargo depositors? The point is that it's backed 1:1 by cash that came from a person which BoE example shows.

> the newly generated money has to be backed by somebody's deposit

Ok. Suppose I am a bank, and pg deposits $10. Then I lend to you, lesourac $9. This $9 is "backed" by pg's deposit. But I, the bank, only hold $1, and you, lesourac, hold $9.

In your head, you hold $9. In pg's head, he has $10 of assets. There are $19 of imagined assets running around, even though the "real" assets are only $10.

It's all good until pg pulls his $10 sooner than I expected, or if you, lesourac declare bankruptcy and default on your loan, and unable to pay back those $9. This is why bankruptcies are deflationary.

We could have a safer banking system if loans were from individual to individual, possibly mediated by a bank, and the lender fully accepted the risk of default.

I think you've missed the argument.

Nobody is arguing that the Money Multiplier [1] doesn't exist. Nobody is arguing that a bank run won't cause loss of deposit (ignoring FDIC).

The argument is whether a bank takes in say $10 of deposits to then loan out $10 OR if a bank "generates" $10 at-will to make a loan of $10.

[1]: https://en.wikipedia.org/wiki/Money_multiplier

> The argument is whether a bank takes in say $10 of deposits to then loan out $10 OR if a bank "generates" $10 at-will to make a loan of $10.

In some sense, the loans are real and backed by real money, but it's your balance that is generated from thin air when the loan is issued.

Oh interesting. That seems academic given the reserve requirements by the Fed under Regulation D which basically says every bank must have $x dollars in reserve for every $10 loaned out. Thus, the bank already has to have that $10 deposit before it's able to make the loan, but as long as those reserve requirements are met, they can make all the loans they want. Given the size of a commercial bank with deposits and withdrawals going on constantly across many customers, they run with some amount of margin, but basically they'll be able to make a good number of loans before they're anywhere close to their reserve limit. So to answer your question... sorta?

https://www.federalreserve.gov/monetarypolicy/reservereq.htm

This link sure does do the rounds! It's practically a meme in itself these days.

But it's only part of the picture, for instance, large banks have capital requirements - https://www.federalreserve.gov/supervisionreg/large-bank-cap...

I think you've also missed the argument.

So, the side I don't particularly like goes like this. Alice deposits $10 into Bob's Bank. Bob's bank now has $10 of liabilities (Alice's account) and $10 of assets (Alice's ex-Money). Charlie _wants_ a loan of $10. Bob records an increase of assets by $10 so now the bank has $20 in assets and records a corresponding increase in liabilities (to balance out the minted money) of $10 so now the bank has $20 in liabilities. Then the bank gives Charlie this _new_ money. In essence, the bank is not giving out depositor's money for loan but instead new money. (See the Bank of England (BOE) paper for details showing this [1]).

My argument is that (1) the same BOE paper shows that whenever that minted money needs to leave the minting bank's computer systems an equal amount of money from somewhere (either that bank or the receiving bank) will be destroyed. (2) That money will commonly move between banks. Therefore the fact that money is minted is irreverent because it's subsequently quickly destroyed.

Side note, it makes total sense to me that a bank would rather mint money in a lump sum exactly equal to the amount needed for a loan than figure out what fractions of the loan should come from what depositor. Its just practical.

[1]: https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/m...

Do you consider the value in your yield bearing savings account to "not be money" in the sense that your stocks "aren't money"? If the median American does, then your argument holds water. I don't think this is the case, though.

The BoE considers savings accounts to be part of the 97% of money in an economy. Although I'm still not too sure if you're on the side of a bank using a depositor's money or minted money for a loan.

> Of the two types of broad money, bank deposits make up the vast majority — 97% of the amount currently in circulation.

I don't mean to be rude. I really like Hacker news. It's a great place to get a wide range of interesting posts with a technology focus, and great talking points from people who have specialization within these areas. It reminds me of the early days of slashdot and even digg. However, it frequently falls short when it moves into areas outside of this. Especially when it's finance or fintech related fields. I think too many people here are well regarded in their tech field and think whatever thoughts they have on areas outside their lane is wisdom, even if they haven't spent much thinking of or gaining much knowledge in said field.

The maximum money supply is infinite, and the marginal value of dollars approaching an infinite number is zero, and every levered loan, derivative contract, and rehypothecated asset creates new hot money out of risk.

Banks pre-2008 were loaning out 30x the cash they had on hand. That is what creates the money. The loan creates it. This is not loaning out money they in fact have at all, it's pure risk compensated for by the rate of interest. The rest about fractional reserve is mostly accurate, but that fraction of reserve they keep and lever up 10-50x, and then charge fees, interest and commissions back on - together these make the bank a dynamical system whose failure mode requires exogenous recapitalization. Banks are just government backed hedge funds with airs.

The challenge with the article is that if you stop believing in the integrity and base reality of fiat (layer 1 capital), apprehending the consequences of what else has (or doesn't have) meaning is a bit much to ask of most people who work really hard just to align to their norms and are very personally invested in them. Cryptocurrencies were a forcing function on a critical theory of money, and that's more radical than mere 20th century radicals were willing to go, imo.

Loan creation doesn’t work like that for many many years. These days banks don’t even have a reserve requirement. They just create the money and balance the books later.

Edit: to make my point clearer, banks don’t need your deposits to create new money. They just do.

> Loan creation doesn’t work like that for many many years. These days banks don’t even have a reserve requirement. They just create the money and balance the books later.

I glossed over it because it isn't really relevant to my point, but yes, the reserve requirement in the US is currently zero: https://www.federalreserve.gov/monetarypolicy/reservereq.htm

> Edit: to make my point clearer, banks don’t need your deposits to create new money. They just do.

This is not true. Like I said, banks only lend out money they have. The only way banks "create" money is because the same money can be lent out multiple times (Bank lends out Person A's money to Person B; Person B deposits their money at a bank; Bank lends out Person B's money to Person C; etc)

and what would then happen if a bank were -- somehow -- induced to make more of those loans, which, as you describe "duplicate" or "create" money a number of times up to the number of loans made?

and how would the world look if that same bank then decided to stop making so many loans?

would there be a difference in the total money "created"/"duplicated" between those two worlds?

you can quibble with language ("Many people get ensnared in a series of linguistic traps when they talk about bank accounts." - quoting the article) but I think you'll find the OP and other commenters here have a sufficiently reasonable model of what is happening under the hood in the modern banking system. I suspect if you view the OP charitably and accept that he does understand what's going on and is describing the relative difference between these two hypothetical scenarios I gave above as "more or less money creation"...the essay becomes less "bad".

You are wrong. Banks don’t need deposits to create loans/money. They crate the money, out of thin air, as the conspiracy theorists like to say it, and they pay the central bank interest on it. That’s it.

Start with this paper from the BoE if you want to learn more: https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...

I'm presenting an outdated and simplified version of the process, because yes, you're correct in the short term. The process happens asynchronously where the bank gets to loan out the money now and sort out the backing money later.

But it has the same _effect_: the government controls the maximum money supply and the creation of money.

> Bank lends out Person A's money to Person B; Person B deposits their money at a bank

You describe this as a two-step process, but it's actually one step, with no actual cash involved. If Person B gets a personal line of credit, it is issued as a deposit in their account at Bank, not paid as cash which is then deposited.

Even if Person B immediately spends that money (on e.g. a house), it is transferred to Person C (former homeowner) directly as a bank deposit, either at the same bank or a different one. There's never any direct cash involved - only bank deposits are moving back and forth.

I work at a bank in the US, your statement is false for almost all non-federal banks. There’s some complexity to it, but in general banks are required to have roughly 5% of deposits liquid at the close of every businesss day. There’s some wiggle room, but banks are never allowed to go below 0%. If it looks like they’re going to risk going below 0% they can borrow money from other banks with too much cash through the repo market, but this is expensive and regulators don’t like it so banks will strictly avoid this. This actually explains why different banks will have different loan/share rates from each other. You’d expect in an efficient market they’d all be the same, but banks deliberately make their offerings less competitive if it’ll leave them with too much cash/debt. In short, banks do not just create money in the US. They are heavily regulated, and any bank that started cooking the books and lending more than they have would be swiftly taken under management by its regulatory body.

One point that might make this clearer - the government serves as the lender of last resort for a bunch of banks. Lending more than you have would be incredibly risky - why would the institution that has to eat the potential loss allow you to do so?

How does this square with the fact that the reserve rate is now zero?

https://www.investopedia.com/terms/r/requiredreserves.asp

Most banks are regulated by either the FDIC or NCUA, not the Fed. So the fed setting reserve rates doesn’t change anything for banks that, like, normal people use. Additionally, I think you’re viewing reserve rates as the only way banks measure liquidity, which is not the case.

But, even if reserve requirements are zero, and banks are allowed to loan out every penny… they’re still not allowed to just make up money, that’s not how it works.

Reserve requirements are not the whole picture, there are also capitalisation requirements.

The reserve rate is now zero because it's no longer the favoured mechanism.

https://www.federalreserve.gov/supervisionreg/large-bank-cap...

At 5%, banks can create 20 times more new money then they hold deposits.

Obviously they don't have to go below 0%, as at 0% they are already at inifinity.

Also, they don't have to have the reserves when they are lending, they can just borrow the reserves later, which is a huge difference, as just as we've discovered - lending creates money, so you can stuck it up structurally and keep expanding.

That’s not at all how that works. At 95%, they can lend 95 cents for every dollar on deposit.

Bank A has $100 deposits, Bank B $0.

Bank A creates $95 worth of loans, which get deposited to Bank B. Now Bank A has $100 deposits, $5 reserves, $95 loans. Bank B has $95 deposits.

Bank B creates $90.25 worth of loans. These loans gets deposited to bank A. Now Bank B has ... $195.25 deposits and is ready to make $85.7375 in loans again...

> banks don’t need your deposits to create new money. They just do.

Yes, exactly. The key phrase here is

loans create deposits

When you take out a loan, the bank conjures the casino chips from thin air and increases the numbers in your bank account.

Eventually the bank's reserves at the central bank need to be a percentage of their liabilities

> You don't have to go through a bank to see this in action: Alice loans Bob $20 and then Bob goes and loans $20 to Charlie. The world now has $40 "more" in it, and remains that way until the loan is settled.

The world now has $40 debt in it, it still only has $20 of spending power. Suppose both Alice and Bob sell their debt to Donna, sight unseen (ie only the amount is known). Bob still owes $20, but now to Donna, effectively canceling out the $20 he received for Charlie's note.

In your example, there is still $20 in the economy after Bob lends Charlie $20. Alice has $20. She loans it to Bob. Alice has $20 in assets (the loan), Bob has $20 in assets (the money) and $20 in liabilities (the loan). The net amount is still $20. If Bob loans Charlie his $20, the net is still $20.

Banks do create money via lending, but the money creation comes from the interest charged. For example, if Bob lends Charlie $20 for a year and charges 10% interest to Charlie, he'll have $22 after one year. Where did the $2 come from?

> Where did the $2 come from?

Charlie

Yes, the money came from Charlie. But at the beginning, there was only $20 in circulation. After the loan is repaid, there is $22. Money was created from the loan.

The bank didn't create anything, though. It got the money from Charlie. If it wasn't in circulation before, Charlie must have created it. Off to prison with him.

The bank did create the money. There is an element of cash flow to all of this. Charlie takes the loan, uses it to start a business, perhaps by buying something from Bob. Bob uses the money to pay back Alice. Alice then buys something from Charlie, allowing Charlie to repay his loan. The economy is basically a big flywheel.

> the money creation comes from the interest charged

This bit. This is the bit that's wrong. There is no money being created when interest is charged. The bank is certainly not creating it in this transaction: it is charging interest - that is, it is asking someone else to give it that money.

Ok, then where did the extra $2 come from in the example? Yes, ultimately Charlie pays Bob $22, but there is only $20 in circulation when Charlie takes out the loan. There are a bunch of moving pieces here that are all tied together.

1) There needs to be liquidity in the market place. Money needs to be flowing to and from Charlie for him to be able to service his loan.

2) Charlie needs to be engaged in an economically productive activity so that he can bring in cash flow to service the loan.

There's definitely some other prerequisites to bootstrap the system as well. But the loan is what increased the money supply. The interest has to come from somewhere. Which is also why banks can't create a limitless supply of money. The interest has to come from somewhere. There is a certain amount of money that can be put to genuine economic use. If banks lend more than can be put to economic use, you have bubbles like we saw in 2008, or you have inflation like we have now.

What you appear to be saying is that if I lend you $20 at 10% interest, the fact that you have to either eventually pay me back $22 or default on our agreement means that I have somehow created that $2.

Can you please clarify either how that is different from what you are saying, or if that is what you are saying, how it makes any sense at all?

> Alice loans Bob $20 and then Bob goes and loans $20 to Charlie. The world now has $40 "more" in it, and remains that way until the loan is settled.

Alice has $30 to spend. Bob and Charlie each have $10. After the loans you described Alice and Bob have $10 and Charlie has $30. That’s the same.

There's only $50 physical dollars sure.

But if they take all of their money out of the bank then Alice has $30, Charlie has $30 and Bob has $30 which adds up to $90 (aka $40 more). Charlie and Bob still owe $40 combined but the point is not the net amount of dollars change its that the assets/liabilities increased by $40.

There is no bank in his description.

w/e, `sed 's/banks/Bob and Charlie/'`.

Do you not get what he was getting at with the extra $40?

https://en.wikipedia.org/wiki/Money_multiplier

I understand how debits and credits work in fractional reserve banking and how money is created in such a system. I don’t understand whatever OP was describing.

Now that I have more time…

Alice has: $10 and Bob’s IOUs for $20

Bob has: $10 and Charlie’s IOUs for $20

Charlie has: $30

Will Alice take Charlie’s IOUs for $20 from Bob to settle?

Will Target take Charlie’s IOUs for $20 from Bob in exchange for socks and underwear?

The answer is no. Charlie’s IOUs and Bob’s IOUs are like Lloyd’s Samsonite briefcase filled with scraps of paper in Dumb and Dumber. Worthless.

However, if Alice deposited $20 in a bank and is issued a debit card for that bank, and then if Bob went to another bank and was loaned $20 and issued a debit card for that other bank, and then Charlie went to yet a third bank and did the same…

Alice, Bob and Charlie have: $10 cash and $20 on their debit cards.

Bob and Charlie also owe the bank money… but in the meantime all three can go to Target and buy $20 worth of socks and underwear and still have $10 in cash. If Alice, Bob and Charlie have a positive balance in their checking accounts, ACH will ultimately (via hand waving) handle settlement between Target’s bank and Alice, Bob and Charlie’s banks.

When Alice deposited $20 at the bank one real and two accounting things happened: the bank put the $20 bill in their safe and debited $20 to their cash assets and credited $20 to Alice’s checking account, a liability on the banks books.

This is called double-entry accounting. The same double-entry happens with a loan: Bob’s IOUs are a kinda risky asset but they are still balanced with $20 credited to Bob’s checking account.

The system works for a few reasons, but mainly because everyone trusts each other’s banks and our banks trust each other. The Federal government instills a lot of trust and stability to the whole system. Banks can trade in cash, bank IOUs, and Target, Alice, Bob and Charlie IOUs and that enables quite a bit of commercial activity.

It’s not a closed system or a zero sum game. The average loan has positive expected value in terms of new, real goods and services being created – so it can be accompanied with an increase in nominal amount of money. The casino analogy falters here, because gambling is associated with, at best, only intangible entertainment value creation, and at worst, value destruction. Banks are somewhat free to create money, because they enable making new real value, and carry much of the risk for bad calls.

Boy do I hate that BoE paper.

What exactly is wrong with it? Is it really unequivocally dead wrong, or is there some subtle point of contention I'm missing? I'm having a hard time trusting MrPatan and cmeacham98 over the Bank of England.

Not really.

The bank has money, it lends it to you, and then shortly after it bundles that loan up into an MBS and sells it to the Fed (for a profit).

Repeat step 1.

The Fed - for the last 15 years - usually "expanded its balance sheet" to buy MBSes.