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Comment by nazgulnarsil | Hacker News Reader

while it is good to raise awareness about the federal reserve this video draws fallacious conclusions based on a stupid premise: that when you make an agreement to pay back a loan you aren't creating value. If i give you a piece of paper that says I will pay you $x over the next 10 years that paper has value and can be used as money to the extent that you are legally obligated to make said payments. A loan is transplanting future productivity on your part into value today, which can then be traded for a house a car what have you.

I'd suggest the free literature from the Mises institute if you want to understand banking.

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I watched this video a while ago, so I don't remember it exactly, but there is clearly something dubious behind the money-creating power governments give to banks.

As a society, we do want to grant promissory notes to encourage growth. However, banks, as commercial entities, quickly run away from simple, society-uplifting investments to derivatives and subprime credit.

As rational businesses they are motivated to grow, so the value/paper ratio goes steadily down as they expand.

There is clearly something missing in the equation, and I think the video hints at it nicely. Something is wrong when the rules of the business encourage banks to make increasingly lower value loans over time.

And bailouts make them even less likely to be prudent with the power we give them.

I feel very uncomfortable with all the financial derivatives - and derivatives of derivatives and so on. It becomes so abstract that it loses connection with what is going on in the real world processes. It seems counter-productive to me.

I feel that way as well, and I assumed I was ignorant or stupid because I couldn't make sense of it... then October hit and it became obvious that a large number of companies that made their fortunes on this system also did not or could not understand the whole thing either. It was kind of reassuring in a "you're smarter than you let yourself think, but not smart enough that your house isn't underwater" way.

The last time I felt this way was in the mid-late 90s sitting on the porch with my dad in rural Nebraska. We couldn't figure out why so many tech companies were darlings of the stock market. And sure enough, while there was some (read: substantial) lasting value in the internet business, there were a lot of really stupid dot coms that didn't bring anything to the table.

I believe that there's a large amount of capital seeking returns right now. That is to say, I think at this stage of the world's economic evolution many organizations have obligations to invest large amounts of money, and that there's some ratio of money to real work that is off kilter possibly. For this reason I think tech and the financial bubbles represent a class of problem that we're going to see repeat itself (irregularly) going forward. It would sure be nice to be able to capitalize on it, somehow. :)

Something like this, from the Financial Times' chief economist, Martin Wolf, might be a better treatment of what's wrong and how to fix it:

http://en.wikipedia.org/wiki/Fixing_Global_Finance

The Economist has been dedicating a lot of space to the topic as well. Neither one of them advocates throwing the baby, bathtub, and one's self out of the window.

> I'd suggest the free literature from the Mises institute if you want to understand banking.

Those guys have an Agenda with a capital A themselves. I'd suggest reading a broad variety of sources, including some (mostly, actually) mainstream ones. With economics, there is an unfortunate tendency for "free on the internet" to mean "extremist", which is quite different from all the free programming docs we are used to hoovering up. Imagine if the documentation to color forth were the only thing you could get for free on the internet...

BTW, this is one notable exception:

http://www.introecon.com/

I have to second this point. Mises.org is a propaganda site, an echo chamber for people with a rather extreme political philosophy. It is not a source of balanced information on any topic.

One of the main take aways I had, was the fact that banks can lend more than they have on deposit. Then that money can be deposited with another bank, and again multiplied indefinitely.

  So for example,
  I deposit $10 at bank A
  Bank A can now lend 10x ($100) to you
  You deposit that at Bank B, who can again lend 10x ($1000)

Can you explain what value has been created there? To me, it seems like the bank has been given a license to create money indefinitely, which seems like a very bad idea.

For me, that is the scam. Why can't we exist only allowing banks to lend out what they actually have instead of creating money out of thin air?

Banks don't create money indefinitely. If you deposit a $10 banknote at a bank, then the whole money supply can only increase by $100 (when the reserve is 10%). Your example is wrong, because you mixed up deposits(which exists only on the balance sheet of the individual banks) and reserve (which is basically the paper money + balances of all banks at the central bank).

But of course you're right, that banks still lend out more than they have, which I agree is scam.

If I have only $100 and I lend out $60, then I have loaned more money than I have, because I now only have $40 dollars.

Banks are not doing anything different to this. They are just loaning the cash deposited with them. Although the original $10 loan will eventually lead to $100 being created, it has also lead to $100 dollars worth of loans to banks. There's no scam here, it's just the way that debt works. It's no different to people loaning money to each other.

Banks loan out money on checking accounts, but the basic idea of a checking account is to have access to the money anytime. So if I put $100 in my checking account, and the bank lends out $90 of it, the bank has liabilities of $190, backed by only $100 in cash. In other words, the bank has created $90 out of thin air.

This is still no different to normal lending. If I loan you $100, then you have created a $100 bond "out of thin air." It's true that we use "bank bonds" (checking accounts) as money, and it's true that we do this because they can be redeemed on demand, but that's our decision, not the bank's. We could use bonds issued by you instead if we wanted to. The bank is still not lending more money than has been deposited with it, or doing anything else nefarious. It's just making loans.

The bank IS lending more money than it has been deposited with. If banks were sane, they wouldn't lend out any money out of checking accounts. They would only lend out money on savings accounts, where I would agree to give up my right on immediate redemption in exchange for payment of interest.

Not it's not. The bank only ever loans a fraction of the money deposited with (or borrowed by) it. The rest goes in the reserve. The total amount of cash loaned is always strictly less than the cash borrowed. Bank's just can't create base money from nothing. They can create checking accounts, but these are neither loaned nor borrowed. They are financial instruments representing a loan that has been made.

Did you watch the video at all?

  * You deposit $10 at a bank
  * The bank is allowed, to lend a *multiple* of that $10.

So it can now lend say $60 out. Even though it hasn't got $60 to lend. It's created the extra $50 from thin air.

This is not how normal lending works. It's like if you lend me your bike, and I have magical powers that allow me to then summon 4 more bikes out of thin air, so that I can lend out 5 bikes.

No, and if the video says that then it's wrong.

Please explain to me how a bank can create base money, which is exclusively issued by the central bank.

* The bank is allowed, to lend a multiple of that $10.

False! The bank can lend only a fraction of that $10. However, if the borrower deposits that money back in the bank (i.e. makes a loan) then the bank can lend the money again, just like with normal borrowing.

http://en.wikipedia.org/wiki/Fractional-reserve_banking

You should at least watch the video so you can see what we're discussing...

Banks cannot create base money. That link doesn't say that they do. Creating base money is forgery and is illegal.

Nope. Look more carefully at the video (it gets most things wrong but not this). If you look in the second part, for any deposit, the bank can lend 90% of it.

But then how do you explain bank runs? If banks practice normal lending, then bank runs shouldn't be harmful, because the bank would always have enough money to redeem all deposits.

The bank can't pay because it has loaned the money out.

OK, but as I already said, the point of a checking account is to always have access to the money. You wouldn't call this a scam?

I wouldn't, because borrowers are compensated for the risk through the payment of interest (or other services, such as free transactions). A deposit at a bank is just like any other kind of investment: you get a reward because you took a risk.

It's also worth pointing out that bank runs are incredibly rare events. In a correctly functioning market, a bank can always pay its depositors by securitizing its loans. In a dysfunctional market (such as now) there are usually government guarantees that help smooth the process. The big problem with banks at the moment is that they have been keeping insufficient capital to cover their losses. Insufficient reserves has not been a problem.

Now I get your point. So basically we have different understandings of checking accounts. I'm not a lawyer, but in my opinion money in a checking account should always be redeemable. But you're kind of right that by depositing money there, people are agreeing to their money being lent out in exchange for interest.

They're creating new "money of zero maturity". If I have a CD I can't withdraw for one year, and that's used to create a loan due in one year, that's one thing. The problem is when money in my checking account that I can withdraw at any time, is used to make loans that can't be called in at any time. This is what creates the possibility of a run on the bank. Banks borrow short and lend long, which is profitable, but can with some justice be called fraud.

Fraud involves deception. When was the last time you saw a bank advertise that it didn't lend out your money?

OK, thanks for clarifying. Still, the main point stands.

What's you're saying is actually not true. Unfortunately, it seems that almost everyone on the internet gets this wrong. The correct calculation goes as follows:

If you deposit $10 then, assuming a 10% reserve rate, the bank will keep $1 and loan $9. In return, you get a $10 bank balance, so the money supply has increased by 10$.

However, the money that was created cannot be loaned again. You can't loan your bank balance to someone else, and neither can the bank. However, the remaining $9 cash can be re-deposited by someone else. Again, the bank keeps 10% and lends the remaining $8.10, creating a $9 account in the process. Then the $8.10 can be re-deposited and so on. The total amount of money that can be created is therefore given by the equation

  m = d/r

where d is the initial deposit, r is the reserve requirement percentage and m is the amount of money created. So for my example, the maximum money created is $100.

http://en.wikipedia.org/wiki/Fractional-reserve_banking#Mone...

What confuses everyone is that in normal circumstances, banks don't give cash-in-hand loans. Instead, they open an account for the borrower, who has the option of withdrawing that cash, but will probably leave it there. In effect, the $9 has been immediately deposited back at the bank, where it can be reloaned. This doesn't really change anything though. It just means that the same bank is reloaning the money rather than a different bank. The total money loaned to the bank is effectively $19 (the original $10 plus the borrower who has loaned their borrowed money back again). If the borrower transfers the money to another account, then a different bank will hold the money, but it makes no overall difference to the system.

OK, thanks for clarifying. I don't see it making a big change to the main point though - banks being allowed to lend more money than they have on deposit.

Stupid doesn't quite do it justice.

The first fallacy is the Malthusian fallacy: namely that humans cannot grow indefinitely. If anything, history has shown as that we can. People have been predicting the coming scarcity apocalypse every few decades and they have always been wrong (the most recent predicted famines in 1985. Then people came up with artificial nitrates...).

The second fallacy is that a certain number of borrowers must default: The money can go in a circle reflecting the value created by the borrowers in excess of interest.

Fallacy 3: It assumes that if nobody had any debt, then there would be no money. The fallacy is that the original money issue (~$2 trillion for the US) is unaccounted for. If there are absolutely no debt, we would still have that amount. (Which can go on ...)

The replacement ideas suggested are idiotic beyond words. This video starts well and quickly degenerates into loony-ville.

> the Malthusian fallacy: namely that humans cannot grow indefinitely

Nothing grows geometrically forever.

Malthus's discovery was that any increase in food supply was matched by an increase in population until food per person was pretty much the same. He didn't actually say anything about limits to growth. But guess what? He perfectly described all human societies all over the world for over 50K years. The data clearly show that Victorians and cavemen and modern day residents of Ghana had basically the same quality of diet on average.

The Malthusian equation has only "stopped" being clearly applicable in a select few industrialized countries and since different points in time after about 1820. For most of humanity the equation actually still works. That's a pretty flimsy set of evidence to start talking about the "Malthusian fallacy" with its huge pile of evidence.

"Nothing grows geometrically forever."

No, not in the empirical sense but the universe is large and, as far as we know, ours for the taking.

By "'stopped' being clearly applicable", you mean completely irrelevant and flat out wrong.

Also, >200 years of data is flimsy? In a scientific sense maybe, but economics isn't a science -- you can't really perform controlled experiments on the entire economy. Also, if some of the third-world countries do indeed start to grow in economic terms, I am certain that their food production capabilities will catch up. India can feed its 1 billion population and I am pretty sure that 50 years ago, that would have been considered impossible.

The point isn't that India can't feed its 1 billion. The point is Indians have close to the same standard of living and quality of diet as when they were feeding half that. They're running in place. That's the malthusian trap.

If you want to grow faster than cubic in the long run, you need some different physics than the ones we currently believe.

No problem. Physics goes through a major revision every ~100 years. Last revision brought us relativity and QM the latter of which may result in computers which are exponentially faster than the ones we currently have. The next one is around the corner and I am sure that will open up even more opportunities for progress.

Malthus didn't go wrong we he observed that humans can't grow geometrically forever. That's totally correct.

He went wrong in a much more subtle way, and one that I can't really blame him for. He went wrong in the assumption that humans would continue to grow geometrically until all resources were expended, then be forced back down by resource starvation.

Instead, human growth has been tapering off in industrialized countries, and long-term forecasts of human population in the year 2100 has been dropping for a long time now. Many, many, many people have all the food they need and the continued realistic prospect of all the food they need, yet choose not to have children.

That is Malthus' fallacy, even though he was reasonable to believe it. Now, as it turns out, he was also wrong about where the resources would run out because he grossly failed to account for human ingenuity, but that just moves the "end-of-resource" date around if humans still grow geometrically, it doesn't actually ruin his argument. Voluntary, pervasive non-geometric growth does, especially when combined with continuing human ingenuity.

(This is very poorly understood on the internets.)

> He went wrong in a much more subtle way, and one that I can't really blame him for. He went wrong in the assumption that humans would continue to grow geometrically until all resources were expended, then be forced back down by resource starvation.

You are badly misrepresenting his theory.

A brief review of Wikipedia leaves my opinion unchanged.

Care to detail?

(I mean, yeah, there's a lot of fairly uninteresting stuff about how selfish people are and such, but whether or not he realized that, that also just fiddles around with "when" the catastrophes happen, not "whether". My summary rather gives him the benefit of the doubt.)

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