Banks do not make up money any more than companies issue bonds make up money. In the bonds case the company does not hold onto the money you lend it, so it has 0% reserve ratio, but that does not mean the bond is not backed by anything, it is backed by the assets of the company. The same is true of banks, ignoring legal tender laws, except the banks "bonds" (notes) currency is backed by assets from a number of different lenders.

When you peel away the rhetoric and the newspeak in this article, it really just appears that Iceland is being persuaded (it would be interesting to know where it is coming from) to create a a variation of federal reserve. The US Fed, as we know, was a scheme hatched in secret at Jekyll Island, GA by international bankers and corrupt US politicians in the lead up to the 1912 election cycle. They finally got their national bank established and empowered it as an entity outside of the US government ("independent committee"). After 100+ years the US Dollar has lost 90+ % of its buying power.

For a good resource on the history of banking, fractional reserve banking and of the Fed try G Edward Griffin's book on the Fed if you haven't already. It was an eye opener for me, when it came out about 20 years ago.

http://www.amazon.com/The-Creature-Jekyl...

I think you're correct in that the author doesn't reall understand the system...he would have been correct had he said, "Unfettered fractional reserve lending allow banks to lend out a nearly infinite amount of credit with essentially no backing."

Banks started running into serious problems because of the Community Redevelopment Act, a well meaning but thoroughly misguided attempt to help people get into a home of their own. You know...the American Dream. Unfortunately, as usual, the pols writing this piece of garbage hadn't considered the law of unintended consequences. As the CRA was expanded over the years (most notably under the Clinton Administration) banks realized that the government was effectively guaranteeing bad loans. Happy Days Are Here Again! When it was realized what was happening, the Congress allowed banking institutions to change the way the books were kept. Now a mortgaged home was carried as an asset no matter what was owed. And with real estate prices skyrocketing, the "assets" we're getting more valuable by the hour. Banks were rolling in cash! At least on paper. Now the Greater Fool Principle would ask, "What makes your widget worth $1?" The answer is that I can find some fool to give me $1.01 for it. And so on, and so on. The metal meets the meat when you get to the last fool. Then the whole house of cards collapses. Now government's solution to this was the Troubled Asset Relief Progam, or TARP. I for one believe that all they've done is put in another quarter, reset the game, and are doing the same thing all over again, the difference being that they're now playing with tens of TRILLIONS of dollars, not just billions. And the presses keep on rolling.

Interesting discussion. I am learning a lot about banking. The most startling thing to me about the article was that the term, "centrist Progressive" was used as a label for a conservative financial plan.

My only input, based on scojohnson's comment, is that if one puts to good use the loan for your farm, then the end result is an improvement to your farm that exceeds the interest on the loan. If you get hit by a meteor before you pay off the loan, then the bank gets more in worth from the farm collateral than the loan would have paid. (If you do not get struck by a meteor, then it is 'win-win'.). This means that good business = good insurance.

Jan

For the most part... the larger (real insurance) companies have their own re-insurance. Lloyds of London, FEMA, etc.. with really deep pockets.

The paper http://www.forsaetisraduneyti.is/media/S... makes the claim that with reserve lending that effectively the banks make up the money that they loan. That, reserve requirements aside, they simply enter the amount into a customer account. The reserve requirement only comes into play if the money is actually taken out of the customer account, or any customer account in the bank. The borrower can pay the money to another customer of the bank and the assets on hand remain the same.

Since in Iceland, the banking system is almost completely dominated by three large banks, that effectively the creative money simply gets moved from bank to bank and never triggers a reserve requirement. In those cases where it does, the central bank must make up the difference or trigger a national liquidity crisis.

I don’t see this as creating money, per se, but as monetizing assets. The risk, of course, is that if the asset valuation changes the underlying support for the money evaporates (2008).

Their goal is to centralize the creation of money so as to keep the money supply in balance with the goods and services available so as to maintain a balance between money and goods, preventing inflation and deflation.

Of course a side effect is that they effectively seize any growth in GDP for the government by issuing cash to the government equivalent to the GDP growth that the government can spend as ‘free money’.

In "The Black Swan" Taleb makes the point that supposedly conservative banking rules are actually quite risky when there is an unexpected event. And sooner or later one of them always comes along.

As you point out, insurance is only really effective in the case where you have a statistical universe with a predictable percentage of events. A premium can be levied on each insured sufficient to pay the events that actually take place. You cannot effectively use insurance to cover very low risk events with massive impact. This is one of the reasons insurance doesn't work well for things like nuclear power disasters. How much reserve do you need to actually cover the worst case scenario -- even if it is a 1 in a billion chance, you still need reserves to effectively cover it.

I observed an interesting example of this in the small town where I grew up. The local insurance agent stopped sending in premiums to the insurance company and pocketed the money. When someone had a claim, he was very helpful, giving them the money “out of his own pocket” and “taking care of the paperwork for them”. This worked for years, all of his customers were very happy, they had their claims settled quickly, generously and no one ever had cause to complain. Then came the big hail storm with hailstones golf ball size and larger. The claims overwhelmed his pocket and he was slow to pay. Someone called the insurance company to complain and he went to jail.

He was breaking the law, but in the end all insurance is just like him, paying the claims “out of their own pocket”.

Volume-wise - most lending is done by re-selling the loan to other institutions and either selling it completely, or holding onto the servicing (statement & collecting the payment) for a fee - a couple of points off the loan interest rate. Credit cards, etc., are all funded by selling bonds - you can buy CapitalOne or Citibank $1000 cc bonds all day long as an individual investor). Actually, for the most part, the deposits capitalize the access to greater volumes of money.

Would depend on the business cycle. In 2008, there definitely wasn't much for deposits (but not much lending going on either). Deposits spiked after the recession hit with people hoarding cash... so right now, I'm sure it mostly is borrowed from cash in deposits.

Years ago - in the 90's for example, that probably wasn't the case. Cash was flowing into the stock market, not the banks and businesses were borrowing for expansion like never before.

The reason banks can really do that though is because of the secondary mortgage market. If they had to hold (rather than just service) real estate loans, they wouldn't have anything for anything else -and probably wouldn't make many loans at all. Very few people have enough on deposit to cover the mortgages going out, and certainly not in small towns, etc. Mortgages are flipped to Fannie Mae / Freddie Mac / Insurance companies, etc., within hours or days. (I used to be in that secondary market business at one time.)

Correct.

Insurance on deposits is a different animal... a 'run at the bank', etc., can't be predicted, and can collapse the institution(s). Its the only place I support some limited governmental involvement in banking.

Most lending is done against deposit (CDs, saving accounts, and checking accounts) not by borrowing from the Fed.

Unfortunately... the 'outside insurance agency' was something like AIG. They gave out insurance policies for a fee with a maximum exposure thousands of times more than their ability to pay. "Nothing bad will ever happen, we'll just keep collecting premiums and banks will just pay us and feel better".

They even sold insurance policies (credit default swaps) to entities that had no interest in whether a loss occurred or not - such as a neutral 3rd party wanting to make a bet on how the US housing market might be going, with nothing actually at stake other than the wager they are placing in the form of a premium. In any other form of insurance, that is not allowed (I can't take out an insurance policy on my neighbor's house because the guy is a clown and plays with matches & gasoline in the garage).

The only reason I support government-provided or subsidized forms of depositor insurance, calamity risk - such as natural catastrophes, and other things like that (or at least re-insure the insurers), is because of the amount of unpredictable risk:

1.) The bank depositor has no idea what the bank is doing with their money, or how solvent the bank's insurance company is - marketing can do a heck of a spin on the solvency (or lack thereof). The average consumer just wants a checking account at a convenient location, not worried about or understanding the banking business. I understand it a little, but I also doubt the bankers (or more than 1 out of 100,000 people) can write consistently-winning 300 page professional services proposals to US & foreign governments. That's my specialty.. not many in that field. Just like there isn't that many people in the insurance actuarial business. People specialize, the economy is better for it than having some jack-of-all-trades & barter system.

2.) Always comes to the ability of the insurer to pay. If the potential loss is something like Hurricane Sandy, how does an insurer develop adequate risk tables for that? Or how does new competition with say "trillions of reserves" lying around enter a market? Does that stifle competition?

The problem is, something like Hurricane Sandy can happen again this year, and the year after, or not for 10 years, or 3 times in the same year in the same place. Kind of like living in Moore, Oklahoma... I personally wouldn't want to bet that there would never be another F4 or F5 tornado there, but they could easily go 4 years, or 10 years, then have 3 in the same year. (although maybe the loss from #2 & #3 might not be much after the first one flattened the town anyway).

My point is, in some cases, the unlimited resources & borrowing power of the government/economy kind of have to be in play for something as complex as the US with so many threats and the size of the economy itself.

In the case of Iceland, I don't know, although they have hundreds or thousands of volcanoes... their risk to their economy, large swaths of populated areas destroyed, etc., are always a possibility. Hurricanes & tornadoes like we have that can destroy a city are not a threat to them, but I'm sure they have other things.

If you have an engineering background, what the bank does with cash on hand is sort of like a multiplexer. Not everyone needs or uses their telephone line all the time, so telephone companies build fewer lines than the total number of people having phones and banks do not need to have enough cash on hand to pay out every depositor at once.

The best answer would be for the government to not be in the money business. People can decide what they want to use as money and banks can decide, at their own risk and disclosure, what reserve ratio they want to maintain.

That is true. The collateral pledged for a loan - say a farm in exchange for the farm loan, is always added as an asset by the bank for future lending purposes, just like deposits in accounts. "Good Banking" would dictate that they always have a little more asset in collateral than the loan held against - the buyer's/owner's downpayment or equity for example. Every time they place a loan, the assets actually grow in relation to money out on loan, then you do some smart assumptions on how many loans would typically fail out of every billion dollars worth, etc.

I think your view is correct. Presently, I would imagine a lot of the money lent by banks in the US right now is borrowed from the federal reserve & marked up, because the rates there are so cheap (almost zero), but if they were more 'normal' - say 5% for the lending window, you would see the banks add 4-6% to that, and you would be looking at market rates of say - 11%, just for a mortgage, at least, with perfect credit history / excellent cash reserves/etc.. Add risk premiums on top of that - .

Iceland took a killing though during the recession, their banks had been buying subprime debt from he US like there was no tomorrow. It was a favorite place to dump the worst of the sh*t.

Some knee-jerk reactions, even if 7 years later... are probably still kind of expected. Their economy will suffer as a result, and we'll see what they do after.

Of course, it's all easy to do stuff like this if you are the world's reserve currency and you can just print enough money to re-inflate the world. Iceland doesn't have that luxury.

completely deregulate the banks. Let the stockholders be the losers if they make bad loans. Banks with the best ratings will garner deposits. They will pay lower interest rate cd's. Banks that loan money to less qualified people will get higher rates and if an individual wants to get a higher return he/she must take on more risk. The more conservative banks will be more stable and the opposite for the other banks. Banks could also buy their own FDIC insurance from an outside insurance agency. The insurance company will see to it that the bank complies with good banking standards. The bottom line is that the banks should be exposed to pure, unfettered capitalism and you would see a healthier banking system.

After the collapse of Iceland due to its outright reckless money management and staking everything on derivatives, they're trying to be more conservative. Unfortunately, they still don't "get it." Trying to build a conservative banking system around a fiat currency, with the money supply arbitrarily determined by committee, is unlikely to succeed in doing anything but strangling investment.

There have been 100% reserve ratio banks in history and they did not make loans. And as you point out they had to charge for bank accounts and checks etc.

I'm guessing this is in the early stages. I'll have to see if I can find a follow up with more details.

I know I don't fully understand it. From what I have read it can get out of control and ultimately over time ruins the currency.

Not real familiar with Iceland. Not sure if they can pull it off.

An interesting article that addresses many of my concerns about money supply, economic growth and attempts to control, and boom/bust cycles.
Txs for posting.

This seems like it has a number of downsides. The first thing that occurs to me is that without marginal lending, your deposits are a liability. The bank can do nothing with them to generate revenue, they are simply a more secure mattress. I would expect consumer banking charges to go up to cover the full cost of managing the accounts plus some profit with no offsetting loan revenue.

Loans would then be similar to a manufacturer making a product, the banks would be distributors, buying the money at some markup from the central bank and then lending it at an additional markup to business and consumers. the markup would be a form of taxation and a control of the money.

Of course there could be private lending outside of the banking system so bonds would still be an option.

Am I understanding this?

This is a highly confused article that includes some minor good points and many falsehoods. For instance it states:
"Fractional reserve lending allows banks to lend out a near infinite amount of credit with essentially no backing."

This is not true and shows a complete ignorance of how fractional reserve banking works. Lending is always based on the underlying assets backing the loan, which may include gold and silver or cash and hard assets such as farms and buildings.
This article is written by an Austrian and once again shows their basic ignorance of finance. If banks cannot make fractional reserve loans then logically you should not be able to issue a bond. If Iceland does this it will cripple their economy unless they free up their capital markets to take up the slack.