earlgrey Posted April 9, 2016 Report Share Posted April 9, 2016 I have to imagine this topic has a thread somewhere, but searching yielded little... I'm thinking through how lending affects inflation. Clearly it creates money, but few people are willing to address just how that happens, so I want to pitch an example to see what I'm missing. Example: $100,000usd home purchased with a 100% ltv loan from Seller, who owns the home outright. Please accept the over-simplification with only mild irritation. Bank's value is N, currency in circulation is C. I've put current values at the end of the bullet point. Bank writes a $100,000 note (a liability for Buyer and an asset to Bank) N+100,000, C Bank writes a $100,000 deposit into an account used by Bank N+200,000, C+100,000 Bank sends (via check, ach, etc.) $100,000 to Seller N+100,000, C+100,000 $100,000 note subject to capital requirements less than 5%, so Bank needs to get $5000 more in deposits So in that example, 100,000 "dollars" came in to existence. What am I missing in that process? Can a bank use a loan to cover capital requirements? In the example above, a $5000 loan wouldn't change Bank's value, but it would have $5000 more in cash on hand. Maybe I'm still getting hung up on "reserves" there. Thanks for any insight. Quote Link to comment Share on other sites More sharing options...
softwareNerd Posted April 9, 2016 Report Share Posted April 9, 2016 (edited) A transaction like this does create an asset of $100,000 in the form of a bank deposit owned by the seller, but it also creates a liability of the same amount on the books of the borrower. That much is not controversial. "Pure credit-creation" is the implicit transaction where the bank creates a deposit in exchange for its faith in the borrower's credit and the lien on the house. In other words, the bank looks at the future earning potential of the borrower and looks at the value of the house and "monetizes" this (maybe monetizes 80% of it) in the form of a bank deposit. I think a typical objection to this would be that it gets the micro picture right, but misses the macro. In most schools, people are taught the idea of a "money multiplier". Classical, Monetarist and Keynesian economists seem pretty comfortable with the idea that bank deposits are primarily driven by the underlying "core money" or "high power money". Once, this was gold. Today, the proxy is the Federal Reserve deposits plus the vault cash held by banks. In the establishment view, should look at the macro picture: the volume of core money and the reserve ratio, taken together, determine the volume of bank deposits across the economy. In this view your scenario is correct, but it does not imply banks can create deposits at will. Rather, the macro factors set the level of possible deposits, and your scenario describes how those macro goals can be reached. In fact, even under a gold standard, there is no fixed multiplier. Today, a "multiplier" is largely a fiction. The Government's power to create an unlimited amount of (fiat) money implies that a bank can create as much of new deposits as it likes, constrained mainly by the government's guarantees and by its own capital-reserves (to cover non-guaranteed losses). Edited April 9, 2016 by softwareNerd Quote Link to comment Share on other sites More sharing options...
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