Saturday, February 5, 2011

Fractional Reserve Lending, etc.

In reply to a comment at:

@Ingo Bischoff

I find several aspects of your post confusing.

“You must understand that the Federal Reserve cannot just willy-nilly create "Federal Reserve Notes" out of thin air…The New York Federal Reserve started to violate these provisions in Section 14 of the FRA by monetizing Treasury debt in the 1920s.”

I am not an expert in the Federal Reserve Act. I will take your word on what it allows. However, given that individuals at the New York Fed “violated” these provisions without personal or institutional consequence, I would say they certainly CAN create FRNs willy-nilly out of thin air.

“(The claim that fractional reserve lending creates additional currency is bogus. A little bit of math applied to the claim blows it out of the water.)”

I am quite aware you have in mind precise definitions of currency and money, so perhaps my confusion here is definitional. On 60 Minutes, when Ben Bernanke was asked about the Fed printing money (which I believe in your definition, really refers to currency), he honestly replied no. The Treasury prints the money. However, he was being quite precise as well.

Of course, the technically honest reply wasn’t the honest reply. Ben knew this.

So, in this same light, I can understand the fractional reserve lending does not create additional currency units: neither the banks nor the Fed have a printing press.

However, fractional reserve lending does produce additional units of digits that can compete for and purchase materials, goods, labor, and assets. These digits are currency units in my definition. Perhaps not in yours. Thus my confusion.

I can understand your statement in the “Ben Bernanke” literal sense. However, I do not understand it in the real world sense. I also understand why you believe it, as you defend Real Bills from the same charge. Real Bills also enable fractional reserve lending in exactly the same manner, and for Real Bills you also appear to claim it does not create additional currency (or in my terms, digital or paper purchasing units), as you are quite insistent Real Bills are not inflationary. As you know, I disagree in the case of Real Bills, just as I disagree with you as regards fractional reserve lending. The root of your belief is the same in both, and it is helpful to me (and perhaps others) that you have stated the equivalency of the two so clearly.

“After 2008, FRNs were created with two different kinds of quality, those which represented taxpayer productivity and those which represented private debt. The problem is that you cannot distinguish between them.”

The distinction is unimportant. That digits are created out of thin air is the key. The Fed buys securities with digits it created just as easily as the digits I am creating in typing these words. The difference is, my digits don’t trade in the market for billions (or trillions) of “dollars”. That the securities come with different risk profiles is important around the edges, but the crux of the crime is in the creation of digits from nothing.

“The FED is now running out of defaulted mortgages and defaulted credit card debt to monetize. The only solution left is to print "money" out of "thin air" with which to pay the interest and debt payments due.”

The Fed need not run out of things to purchase. There is no limit on what they can buy. Can they not buy municipal bonds? There is no shortage of these in want of buyers. To say nothing of a couple trillion dollars of treasuries annually. Why not corporate bonds?

All of the Feds purchases, of any security of any quality are made by printing “money” out of “thin air”. No one at the Fed is producing product by which they can earn real money in the marketplace. It is ALL funny money. What is purchased is less important that the fact that digits from nothing are created to purchase the assets.

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