How Money is Created and Destroyed

A description of the process by which money is created and destroyed in the United States.

Category:

Education

Tags:

• money
• banks
• federal
• reserve
• loans
• national
• debt
• treasury
• bonds
• taxes
• interest
• production
• wealth
• economics
• credit
• economy

[johnnibarger]

This video is WRONG WRONG WRONG - INACCURATE INACCURATE INACCURATE. The bank cannot "create" 9 times its deposits, it can loan 90% of its deposits! The way new money is created is that original deposit remains "booked" and is money. The loaned money when redeposited by the borrower into a their account is booked and thus there is the original deposit, plus the new deposit of lent funds. This process continues (90% or the amount after reserve) which replicates out creating roughly 9-10x money

[spectator59]

@johnnibarger As I said in the video, to keep the model simple, I am using one bank to represent the entire banking system, and one transaction to represent many. The *net result* is the same, as you said yourself -- reserves can be multiplied by up to 9x, given a 10% reserve requirement.

[johnnibarger]

@spectator59 I watched the video 3x and it does not provide adequate explanation to make this distinction. It appears to say that a $1000 deposit creates an ability to loan 9x. 9x may be the net effect, and this may actually be referred to as the "money multiplier" but it is important that you explain that a bank does not loan more money that it books, it can only loan it's deposits minus reserves and that the lent funds being redeposited creates the effect of new money, not leverage

[spectator59]

@johnnibarger "Modern Money Mechanics," written by the Fed, says, "Carried through to theoretical limits, the initial $10,000 of reserves distributed within the banking system gives rise to an expansion of $90,000 in bank credit (loans and investments) and supports a total of $100,000 in new deposits under a 10 percent reserve requirement." The video illustrates that fact. The issue you raise concerns "excess reserves" and the associated incrementalism, and is secondary, IMO.

[GerhardSchroeder]

The government has to pay interest for bonds. Where does this interest go? I mean the FED receives this interest but what does it do with it?

[spectator59]

@GerhardSchroeder The Fed receives interest only on the bonds it holds. The received interest is considered income for the Fed, and is first used to pay their expenses (salaries, equipment, etc). From the remaining profits, they pay 6% out as a dividend to all member banks. At the end of the year, everything that's left over after that is rebated back to the US Treasury.

[bammbamm12]

The reason this is hard to understand is because every tutorial runs into the easy part (loans, fractional reserves, debt) and doesn't explain thoroughly the first few stages. What does the Fed do with the bonds? How does the govt. pay the interest on the notes? What interest rate does the govt pay? What are the factors in determining the interest rate? You guys must be amusing yourselves because you're not teaching anyone anything.

[TheAwesomeMoments]

Wroooooooong!!!!!!!!!!

[PleaseReadSomething]

What if I, as the employee, am a gold miner. I dig up, and smelt $1,000.00 worth of gold, ship it to the government and they send me my check. Now we are on a gold standard - since the government has in its reserves an amount equal to the dollars it created. What if the economy needed more than gold; items like oil, timber, and food. Now our currency is backed by all the production that the workers created. Fiat money is never worthless - it is backed by production.

[johnnibarger]

@ehertzog - I never used the term "90% effect." I referred to multiplier. 90% was the "example" lendable amount of funds if a reserve were set at 10%.

[ehertzog]

@johnnibarger It is called a "multiplier effect" and not a "90% effect" for a reason.

[johnnibarger]

@johnnibarger One more issue that would be interesting is that it is IMPOSSIBLE for all debt to be paid in full. Because all currency is issued through debt, and debt incurs interest charges, the initial $1000 lent requires more than $1000 to be repaid. Therefore there is not enough money in existence to repay all debt with interest. This creates the necessity for a continual increase in money otherwise the interest eventually over time would consume all money supply.