 If you want to look at the slides, because I'm going to present PowerPoint slides, they're at this URL right here, okay? So you could pull them up on your on your various electronic devices So notice the title of my talk. It's economics of fractional reserve banking So that means I'm not going to talk about whether or not fractional reserve banking is fraudulent. Okay. I'm an economist Not a legal expert. That's not my area of expertise though. I do have I have ideas on it so we're going to stick to the positive analysis of the Consequences of the economic consequences of fractional reserve banking All right, let me just they would all be like that. Let me just mention that fraction reserve banking is inherently inflationary and Generates the business cycle that is a cycle of inflation followed by recession. Okay. That's the conclusion of economics not ethics I'm not going to go into that too much today because that will be Roger garrison's topic tomorrow or the next day But also keep in mind that it's a hybrid of two forms of banking Each of which in their pure form are perfectly fine on the free market did not cause Business cycles or inflation one is loan banking Which I'll talk a little bit about at the end of the lecture and the other is deposit banking So in their pure forms These types of bankings banking are benign or welfare improving do not cause inflation When they're mixed together It's it's like mixing, you know sodium and you know, so which can't hurt you and and chlorine together and getting sodium chloride Or rather taking them apart and and and you know eating chlorine alone consuming chlorine alone, which will kill you Okay, so we're going to talk a little bit about Some of the basic concepts are going to have to do with Financial assets and liabilities. So just when we talk about assets It's a claim to a present or future sum of money or stream of money payments A present sum of money is the ownership of the money itself Okay, so if you have a claim to a sum of money a present claim to some of money that I'm holding That means that that some is yours. I'm only holding it As a result of a contract in which I'm storing it for you or moving in some place like an arm and car company You are still the owner. You have not loaned that to me. You have a present claim Okay, if you loan it to me for three months or 30 years That's a that's a Credit claim that's a claim to a future of some of money or a future stream of payments A liability is an obligation to make money payments either now right away when the person comes in with the claim or in the future according to financial contract Like a bond contract. Now. Let's just talk a little bit about the bank T account It's a simplified accounting statement. All right that shows and those of you that had economics who have had economics Will recognize it it basically shows the bank's assets and liabilities simplified Balance sheet of a bank's assets and liabilities So let's just take an example the first national bank. Let's say it has deposits of a hundred dollars. Those are liabilities because That's an obligation to pay on-demand Acclaim held by a depositor And let's say it has reserves of ten dollars. That's a present sum of money that it owns and keeps on hand either in its own vaults But or ATM machines, but in the modern world today Most of those reserves are really just computer entries at the regional Federal Reserve Bank and loans Okay, those are assets because that is that that is the title to a future stream of payments from the borrowers That they have the bank is loaned to So the banks liabilities include deposits and the assets includes loans and reserves Include there are much many more assets and liabilities on on a real banks balance sheet, but this is for simplicity So in this example notice that are the reserves Represent about ten represent exactly ten percent of deposits. Okay, the rest of that deposit money is loaned out But let's take an example Suppose there's a hundred dollars of currency and circulation in this economy And we want to determine the bank's impact on the money supply And we're going to posit three different suppose three different cases One where there's no banking system Two with a with there's a what's called a 100% reserve banking system where the bank holds 100% of The customer's deposits. Okay, and makes no loans and the third is the fractional reserve banking system So case number one no banking system. There's this currency or if it's a gold standard gold and circulation There are no banks the total money supplies equal to one hundred dollars. That's simple Let me go back for a second now. No matter what anyone does If one person makes a loan to someone else or if one person Buys someone else's mortgage. Okay makes a mortgage loan to someone else There's no change in the money supply. There's a change in who owns Cash balances. Okay, so if I loan you ten dollars, I no longer have that ten dollars to spend Now you have the ten dollars that does not increase the money supply. Okay, no matter how many How many loans are made in this economy? It doesn't affect the money supply doesn't affect the quantity at any given moment of Gold or if this is government dollars fiat dollars in the economy Now let's introduce banks a hundred percent reserve banking system. This type of a banking system did exist in the 17th century the 1600s Gold goldsmith bankers initially held 100% reserves So if the public deposits the hundred dollars at the first national bank Well, what it's done is really replaced its gold or its its dollars with checking account dollars The bank doesn't make any loans. It holds the full one hundred dollars in let's say notes in reserve And in exchange it establishes liabilities of one hundred dollars in checking account money that it owes to the customer Or to whoever the depositor names on a check So the money supply is always equal to currency plus deposits in the economy. That's a simple definition of the money supply M1 In this case, there's no more currency in circulation It's all held in the banks and it's all backing the one hundred dollars in deposits But note the sum doesn't change the composition of the money supply changes Now there's more deposits in the economy and less Currency So in a 100% reserve banking system banks do not affect the size of the money supply And now let's talk a little bit about bank reserves In a fractured reserve banking system banks keep a fraction of deposits as reserves That's what it means. It doesn't hold the full amount of the deposit. It holds some fraction 80% 20% In today's economy the legal minimum is 10% At least behind checking accounts For savings of deposits the legal minimum is now zero Okay, it used to be 3% The Fed establishes reserve requirements. That's the legal minimum amount of reserves That must be held against a given amount of deposits. That is the legal ratio of reserves to deposits Banks may indeed hold more than the minimum amount. In fact today they do For a number of reasons one of the uncertainty of the future the fact that no one really knows the full effects and costs of Obamacare no one knows what's going to happen to the system of taxation in the face of the huge debt that the US government has piled up So banks are not loaning for that reason. They're holding money. They're holding excess reserves We call them more more reserves than they need to hold and because the the Fed is paying them One quarter of one percent per year on their deposits Okay, so that's a completely safe investment allowing the Fed to just hold These computer entries which are your deposit which are your reserve deposits Okay, the Fed is The bankers bank it holds the bankers deposits those deposits in addition to the money in the ATMs that the banks have the currency and The very little that they have in their vaults Those all together are its reserves Okay So banks are probably holding nearly a hundred percent Reserves today that that will change the reserve ratio. We symbolize by R It's the fraction of deposits that banks hold as reserves. Okay, the legal reserve ratio in the US today as I said is 10% Because of certain things, it's actually much less than that There's there's these sweep accounts in which the banks are allowed after banking hours to take people's deposits and to put them into Interest-bearing a money market deposit accounts and other things. Okay, so they can actually earn Interest on them or another way of putting it is the reserve ratio is the total reserves as a percentage of total deposits Okay, so that's about a you know that let's say it's a hundred percent today The actual reserve ratio the legal reserve ratio again is only 10% according to to the Fed regulation Okay, so now let's look at how the fractional reserve banking system affects the money supply So we have the simplified t-account people deposit a hundred dollars and for the time being Banks are holding the hundred dollars in reserves In a normal situation, they're not going to be doing that because they're forgoing something very important. They're forgoing interest So if we suppose that the reserve ratio is equal to 10% in the first national bank here Wants to be fully loaned up you want to loan as much as you can legally in order to earn the maximum interest They'll loan all but 10% so they'll loan out $90 and they'll retain in reserves the minimum legal Requirement of $10 so now we have 10% reserves or fractional reserves But notice the depositor still has his hundred dollars. That's part of the money supply But then now the currency and the banks don't actually lend currency But it's a little bit simpler to put it this way, but $90 that it's loaned out to someone That's in addition to the money supply So the banks through fractional reserve banking have created an additional $90 Okay, the positive still have a hundred dollars in deposits the borrowers now have $90 in currency Together that equals $190 Prior to that transaction prior to someone putting a hundred dollars into this fraction reserve bank a bank There was only a hundred dollars in the economy now. There's a hundred ninety So when banks make loans, they create money. That's a key insight all economists Keynesians to Austrians All of them except except this The borrower gets the $90 in currency an asset that's counted in the money supply But also gets $90 in debt so There's no new financial wealth Right, you have 90 more dollars, but you owe the bank $90. However, there is an increase to the money supply Fractional reserve banking system creates money, but not wealth So now let's take this a step further. This is the money supply process okay The the guy who borrowed the $90 He doesn't want to just keep it there. I mean he's paying interest for that He's borrowed it because he wants to either spend on consumption or because he wants to let's assume invest it at interest in either Adding to a small business or investing in stocks or bonds So in doing that he pays someone else the $90 that person Okay, let's say you hired someone to Help extend his cleaning Help build on to his cleaning a dry cleaning establishment That person then then takes the $90 the 90 thousand currency deposits it at the second national bank That is his or her own national own bank and that bank now has an additional $90 in reserves but if as Is the case the reserve ratio is 10% This bank is going to want to earn interest on the $81 it can loan out It only needs to hold $9 to back up the deposits of 90 So that's what it's it's it's assets look like now now we have $9 in reserves which is required and $81 more in loans. That's 81 plus the hundred and ninety So now the money supplies increase even more this money is being spent as we go along by the way And that's beginning to raise prices and that's why fractional reserve banking is inherently inflationary All right, so we could take it one or two more steps All right, so the second national banks borrower because bars the $81 Doesn't want to keep it in hordes or you know keep it under his pillow and fondle it unless he's some kind of a weird miser Any case I'm sure there's none of you here like that They they now deposited at their bank the third national bank So now the third national banks reserves go up by $81 and they have an additional $81 in deposits and liabilities But they only have to back that by 10% or $8 and 10 cents So you get the idea down, okay It will loan all but 10% of the deposit again in a normal situation in a non-recessionary non-crisis situation It will keep fully loaned up Okay, and there it will make a loan of $72.90 and keep $8.10 in reserves that loan is now additional currency That inflates the money supply or expands the money supply even further So here's what we get The original deposit the original deposit doesn't change the money supply initially, okay a hundred dollars in currency is exchanged for a hundred dollars in deposits But what's the money's loaned out you get 90 new dollars in the next round 81 new dollars in the third round 72 dollars and 90 cents and it's going to continue. This is an infinite geometric series Okay, the total money supply will be equal to one thousand dollars Okay, that is a total amount of deposits the original deposit plus all of the Created deposits that the banking system has created Now you can see something here that the banks themselves They don't understand when the economy say you create money because this guy said look somebody deposited that money I didn't create any money. I just loaned part of it out at each at each step They're going to say oh, I didn't create that money. I just loaned out What was what was deposited but the system as a whole creates the new money? The fraction reserve banking system creates the new money okay, this analysis was first really elaborated in 1915 by an American economist and sort of an Austrian named Herbert Davenport, but then really brought out in the 1920s By CA Phillips who also wrote a very Austrian oriented book explaining the Great Depression so the Austrians were instrumental in developing this a very important analysis and Actually in his book in 1912 Mises speaks as if this is what the case is he doesn't analyze it But he speaks as if well, you know, this is obviously what what's happening So in this in this example a hundred dollars of reserves Generates a thousand dollars of money So when you or I Let's say you let's say you get you have you graduate from college and your generous ant gives you a thousand dollars as a Present and you put a thousand dollars into your checking account. That's going to ultimately create ten thousand dollars in the economy That's not ten thousand new dollars. That's ten thousand deposit dollars You have to subtract from that the one thousand dollars of currency that you put in because you no longer have the currency You have the the deposit so it creates nine thousand new dollars Okay, that is the ten thousand dollars in deposits minus the one thousand dollars in currency that you took out of circulation and put in the bank Okay, and this is known as the money multiplier I don't have to mathematically prove it to you, but the amount of money in the banking system That generates with each the amount of money that the banking system generates with each new dollar of reserves That's equal to one over the reserve ratio So in the old days when the feds started the reserve ratio used to be 25 percent Which if you take this formula the money multiplier One divided by point two five gives you four the money multiplier was four each new dollar That was deposited. Can you each new dollar of currency could create ultimately at a maximum four new dollars of of Bank deposit money now it's 10 percent the Fed has continually lowered it used to be 13 percent up until 1980 And it was lowered to 10 percent. So now that it's it's 10 percent One over point one gives you ten the money multiplier Which is the maximum amount of new money that can be created by each dollar of reserves is now ten So in our example r equals 10 percent the money multiplied was one over r Point one equals ten. Okay. Now does each dollar that we actually put in again before the crisis situation? Actually create did it actually create ten new dollars? No, it was probably about two dollars and fifty cents There's a couple of reasons banks did hold excess reserves to some extent even even in normal times But also when you when people get paid they don't put all of their new all of the money They get paid into a checking account. They hold some in currency So if you at each stage of each person hold some as currency that reduces the money multiplier Okay, the key is though that there is a money multiplier now This is how you or I would increase the money supply But but at the same time people are depositing currency others are taking it out so overall If you didn't have a central bank and you just had people you had fraction reserve banking But you just had you know people going and taking Depositing money or taking currency out you wouldn't get much of an inflation at all. Okay Because The reason the reserves that are being put in by you and I for currency are being taken out Let me give you an example during Christmas people like to walk around with They make many small purchases. So during the Christmas holidays. They like to pull out cash, okay during the shopping holidays from You know the end of November right at the Thanksgiving or even now it's actually moved up to after Halloween at least in the Northeast All the Christmas lights go up if Halloween and people start shopping So people want to walk around with more currency. They withdraw it from the bank. Let's say that people withdraw a total of Let's say 20 billion dollars from the bank throughout the United States Okay, and currency that would decrease the money supply because this works in reverse You if you take reserves out if you take 20 billion of reserves out that 20 billions backing up a hundred billion of Deposits so banks would have to shrink their deposits by a hundred billion dollars Okay, the Fed does not let that happen. I'm jumping ahead of the story What would the Fed do at the same time that you and I are Withdrawing currency to pay merchants storing the shopping season the Fed is injecting and the 20 mil Billion dollars by simply printing it up out of thin air, which we're going to get to in a moment Okay, at the end when the merchants deposit all the cash that they've Earned during the shopping days at that point Reserves begin to go up and the Fed drains money out Okay, so you and I have a strong control of the money supply. That's where a bank run is if we all if we all left today and With drew money from the from the from the banks The whole system would collapse because really they can only pay out about 10% Okay, of what they all all all all the positors I guess the mortar I'll tell you an interesting story When I was a student at Boston College during the heyday of the anti-Vietnam War Protests there was an underground newspaper. I think it's called the Phoenix That used to report it was for college students and there was about 250,000 college students in the Boston area, so it was a great place to go to go to college In any case they would report on you know various events that students would be interested in concerts and so on and so forth Well, I won one come out every Friday So on one Friday there was a full-page ad taken out by some radical Marxist economists from local Boston They're actually learning the PhD students graduate students from MIT from Harvard and and Puffs and all these other Boston colleges and they urge all the students in Boston, you know 250,000 students in Boston the following Friday Okay, and we didn't really have many credit cards back then. I mean, you know our parents civil We didn't we just had checking accounts to take all the money out of your checking account Every student should take go to the bank take all the money out of your checking account. What would that do? That would create real havoc with the Boston banks They would have to they would have to stop paying for a while until they ordered more currency from the Federal Reserve banks So they thought this would be a great way to protest against the war and you know, we all thought it was great We all talked about it is great. You know, I was an economics. I sort of knew that was true I wasn't a Marxist or anything. I was still a libertarian, but I thought this is great But you know, but then after a few days of partying and so on we all forgot about it by the next Friday So the whole so so the whole thing was a dud. I mean, so it never came off, but it would have worked It would have worked. It could work today Now you're not allowed to add that's against the law to advocate that people withdraw money from banks Because the banks run stable or something you can't really do that. So I'm not advocating that I see it I see a drone sitting in small and right outside the window there Yeah, so um Okay, so now all right now we're going to get into the Fed I'll only take questions if it's a point of information In other words, is there something you didn't understand Yeah, we'll get to that. Okay. Well, that's loan banking. I'll get that at the end. Don't raise your hand again Only kidding Okay Okay, so central banks and monetary policy. Okay now now now here here. Here's you know, the Mordor of Our system the central bank an institution that oversees the banking system and regulates the money supply Sounds very innocuous and not at all evil like it really is And I mean evil evil is as evil evil does I mean has evil effects For the point of view of consumers. So the monetary policy is the setting of the money supply by policymakers in the central bank Remember monetary policy is not the setting of interest rates They cannot set interest rates what they can do is they can beat them down by creating reserves That the banks get and then loan out. Okay, so they owe to keep reserves down You have to keep creating new money Okay, or new reserves for the banks and the banks are and and the Fed is doing that every month It's creating 85 billion new dollars in reserves for the banks So the federal reserve or the Fed is the central bank of the US. You all know that which we didn't The reserve system consists of the Board of Governors You know which are located to seven members pointed by the president for 14 year terms Located in Washington DC. There's 12 regional Fed banks used to have more power in the old days They don't have much today located around I actually think that's from the drone So anyway 12 regional but the federal open market committee has the real power that's all seven of the Board of Governors including You know who and the president of five of the regional reserve banks and the New York president is always on that committee The other four are on of the other banks are on a rotating basis And they decide monetary policy and they meet every six weeks for two days and then they give you a completely incomprehensible two-line press release and They issue reissue the minutes the months later But yet don't tell you who says what so as this old left-wing Democratic Represented from Texas Henry Gonzalez Proposed and I'm all for this every minute of those meetings should be videotaped and release the next day or the next week All right, so the open market operations is a number of different ways to control the amount of reserves in the banking system Open market operations are the kinds that they use on a daily basis. Okay every single day At 1015 or so there are open market operations I Okay, all right now This is how the I mean this is a funny exact. I'll give you a couple of other pictures But so notice the money the dollars go out from from the Fed from the FOMC You know Bernanke Bernanke has really the biggest influence on that committee So the green dollars are going out. They go to the commercial banks and it buys their bonds Or it goes to the public doesn't usually buy bonds directly from the public It really buys bonds from around 30 primary dealers privileged Wall Street banks That get a high price for the bonds that they sell to the to the Fed where the green things come from Just print it up not even print it up. It's just a keystroke in cyberspace Simply adding to the bank's reserves This comes out of out of its ex knee. Hello come from nothing from latin from nothing So So, yeah, they want to control recession they create reset, but anyway, forget that I got this online the central bank Creates the dollars on the left side, right? The banks have purchased in the past government bonds So the dollars go to the banks the bonds go to the central bank and it becomes part of their balance sheet Not only are they buying bonds, but we know they're buying mortgage-backed securities They're buying long long-term government bonds. They only used to buy short-term securities T bills But now that the banks have reserves they have to loan them out The only way they can loan more money out at a given interest rate is to make it more attractive to the borrowers They have to lower the interest rate. That's how the Fed lowers the interest rate. It first creates more reserves So the Fed does control the money supply not perfectly, but it controls the money supply That's monetary policy not setting interest rate, and it can only really set one interest rate that can really peg By continually popping money in and that's the overnight rate called the Fed funds rate Your own information. That's the overnight rate at which banks will loan money excess reserves to one another The and the right side you forget because the central bank almost never decreases the money supply That just shows you that when they sell bonds back to the banks the banks pay them and They don't act banks don't actually pay them. They just write down the bank's reserves Okay in their reserve deposits. It's just it's just all done in cyberspace Speaking of which I went I found the names of these people that actually do it per the permanent open market operations group every day they get together about 1015 and I Have it here. There's some Oh, yeah, here it is So mr. So so he's since retired Brian sack or he was sacked, okay, there's this controversy on it Pun intended so he has a PhD in economics for MIT 40 years old supervisor is this mysterious guy Josh Frost Who has a mathematics degree and a degree from NYU and then this there were three traders as of 2011 Tiffany Wilding a 26 year old NYU student Blake Griffin and James white 20. They're just traders regular guys hanging out There they are the picture you rarely see that that's that's the federal that's the open market trading desk That's where they actually do it three blocks from my office in Pace University. I'm three blocks from the Federal Reserve's Bank the New York Fed. It's all done to New York Fed. That is the most powerful regional bank, okay? Notice there's not even any Bloomberg Terminals there. You can't see any anything. I mean, they're just you know hanging out now They're not just just hanging out not Okay on a recent Thursday morning What mr. Frost and his five young colleagues did over a 45 minute period might have unsettled even a seasoned Wall Street hand They bought in a 45 minute period 7.8 billion dollars of treasuries 45 minutes now that means that if that if banks are going to be fully loaned out Which are not that could increase to that would increase the money supply by 77 billion dollars in 45 minutes Okay It would take a few weeks as it went from bank to bank, but that's what they would do So how do they do it? Okay? Well Let's delve deeper as offers to sell so what happens is at 1015 One of them pushes a button on a computer and across Wall Street three musical notes an F and E and a D Fed sound on training terminals. That's Fed time. I mean, that's okay. The Fed's in the market. That's what it means Feds ready to buy and Alerting traders the Fed is in the market. So in a fact that there's only 30 of these banks You're setting yourself up to have to pay high prices Right, you're setting yourself up for these banks to collude these primary dealers Wall Street banks So as offers to sell treasuries, so then the banks start making offers to sell these securities in exchange for these reserves that are created thin air There's a the Fed has a computer algorithm that somebody developed which determines which ones to accept Okay, the computer compares the offers from the wall from Wall Street Against market prices. So the prices that were paid what Wall Street's offering and the Fed's own Calculation of what constitutes a fair market that price Which is interesting. I mean that's distinct from what Wall Street's offering and what's and what what what the? Market prices have been for these things that can be sold You know are being sold not to the Fed but to others in the market Okay, so, you know, what what does that? What does that mean? Okay? Are they subsidizing which they probably are these these large Wall Street banks through this process and no doubt they are That is instead of opening it up to everybody to allow Everyone to you know offer offer securities at different prices. It's just these 30 primary dealers The real work is done by the three traders Tiffany Wilding isn't there. I was hoping to see her given her name I want to see what you look like But so who are referred to during the operation as trader one trader two and trader three They sit at a long table against the wall tapping at several screens While she reviewed she reviewed the stream of offers and then the price is finally accepted by the algorithm trader to Blake Blake win double-checked her decisions. So Tiffany was doing it make the accepting of the offers or at least Monitoring the offers that were being accepted by the computer algorithm Blake Griffin 29 double-checked her decisions and James White made a duplicate of everything in case the computers crashed I mean, it gives you real confidence right in the Fed Fed system Okay, it's a bunch of kids and making sure the computer doesn't crash and stuff Sounds like Briggs in the tech room We could probably do it from here. I mean Okay, so That's how it actually happens Okay, the Fed just simply writes a check on itself in the old days it wrote a paper check on itself Okay, and just sent it to the bank Actually, let me clarify this a little bit more if you have a used car that you want to sell for $5,000 The Fed now has the power to buy anything at once, right? You can buy GM. I mean you can buy anything at once So if the Fed wanted to buy your car, it would send you a check for $5,000 you would deposit that check in in the bank the title would go to the Fed for your car and You when you deposit that $5,000 suddenly out of nowhere There's five thousand new dollars of reserves in the bank and the bank would then lend it out and through this multiplier expansion process You would get eventually ten times out of five hundred. I'm sorry fifty thousand dollars of new money So no matter what the Fed buys, you know your bottle of water your laptop It does so by printing money Okay, and and giving you a check just writing a check on itself and And that then kick starts the whole process of money that's increased in the money supply This is what fraction reserve banking is So I don't know if you can actually see this but I just want to show you a few a few Steps in this so when you're so if the Fed buys US Treasury bond for a hundred thousand dollars if that's the bank there the first national bank look on the left side The bank gives up some assets a hundred thousand dollars in securities and in exchange it gets a hundred thousand dollars in reserves Okay, you go to be the banks not going to keep the hundred thousand dollars in reserves. In fact, that was created not by a deposit So it doesn't have to hold any of it to back up the deposit was created by the Fed So it would just loan out the full one hundred thousand dollars So we just simply create a checking deposit of a hundred thousand dollars for some borrower and That bar would then take the money spend it and it would go It'd be withdrawn by that borrower. Okay, so the checkable deposit would go to zero but it would be spent on something else and That would then go to So I'll show you the steps. So we start the following assumptions the banks don't want to hold excess reserves Again in today's world. It's unrealistic the reserve requirement ratio is 10% Currency holding does not change when deposits and loans change Meaning people don't take some of that new money and hold it in currency Which again is unrealistic people do do that you may take half the amount and hold it in currency and put the other half in the checking account And when a borrower writes a check none of the recipients of the funds deposit them back in the bank that initially made the loan In other words, everybody uses a different bank. Okay Those are just some assumptions, but basically we can look at it this way. Let's say there's an offer offer office building company that Borrowed that a hundred thousand dollars that was created by the Fed from the first national bank and it paid it to American steel for steel inputs American the steel then has a hundred thousand dollars. Okay in the check It writes. So it takes that check at deposits it in its bank the second national bank and The Fed is credit and therefore the the second national banks Account after the check clears at the Fed is credit with a hundred thousand dollars Now they have to hold 10% of that to back up their checking account of a new checking account of a hundred thousand So they loan out 90,000 okay, and whoever borrows it deposits it and Spends it and the recipients deposits it in the third national bank Okay, and these are the the accounts. We don't really have to go through that but Just by the third round notice that a hundred thousand dollars in open market purchases has created a hundred thousand new dollars When the first bank loan the whole thing out When the second bank loan 90,000 of it out 90,000 new dollars then 81,000 so in the first three rounds the Fed is already created out of thin air 271 thousand dollars in new money. Okay So There's a federal reserve creating a hundred thousand dollars in reserves by buying securities the first bank loans out a hundred thousand office builders Inc Makes a payment to American Steel Company of a hundred thousand they deposit in their in their bank. They keep 10,000 in reserve and Loan 90,000 third bank It's eventually deposited in a third national bank Which keeps the 9,000 reserves loans out 81,000 so on and so forth on and on okay So this is basically what you get When it goes through all of its stages the maximum that that that Increased deposit is ten times the initial hundred thousand dollars one million new dollars is created Okay, which goes along with the one million dollars in new loans that have been created and All of that is backed by a hundred thousand dollars, which is ten percent Okay, so each bank holding deposits holds ten percent That's all gonna add up to the reserves that the that were created. All right Okay, there's another way that the Fed can increase the money supply suppose The Fed has a discount rate or discount window It charges an interest rate for banks that want to borrow money now these banks tend to be ones that are that might be in trouble Okay But in any case what happens is The bank calls up the Fed Talks to the Fed loan officer, you know whether it's in Philadelphia They'll talk to the Philadelphia Fed or if they're in San Francisco in that area the San Francisco Fed and they'll say we need Ten billion dollars or let's say a hundred million dollars make it more realistic. We need a hundred million dollars Okay, because we have insufficient reserves So few hours go by the Fed loan officer comes back calls back and says you have it Where do they have it? Well the Fed went to the computer and just added to the bank's deposit a hundred million dollars So that bank now has a hundred million dollars that it can use for loans and so on Okay, it was just done by a telephone call and a key and a couple keystrokes. That's how the new money was created And so when so the Fed can lower the discount rate. They don't generally do that anymore When they lower the discount rate, it's cheaper to borrow so there'll be more Reserves borrowed and therefore the money supply will increase but as I mentioned, this is not a tool That's used on an everyday basis. It's used to signal that the Fed may want to eventually increase the money supply The Fed can also change the reserve ratio So for example, if you change the reserve ratio, let's say it was 20 percent to 10 percent suddenly banks, let's say there was a Hundred a hundred billion dollars of total reserves in the banking system, which means that there would be $1 trillion in checking account money I know let's say if it's 20 percent would be five times that so if there's a hundred billion dollars There'd be 500 billion dollars in checking account money if suddenly the Fed reduced the reserve requirement overnight to 10 percent from 20 percent That means that all banks would have double the amount of reserves. They need it. They would have 50 billion extra dollars They would all go out and loan it loan that money out and that would would would circulate and increase the money supply And the money supply would double from 500 billion to 1 trillion dollars So even small percentage changes in the reserve ratio can heavily influence the money supply So my point is they don't change the reserve ratio much at all anymore Okay, the last time they did it as I mentioned it went from 13 percent down to 10 percent But they haven't reduced it the legal ratio since then, okay, and then they've done something else Beginning in 2008 the Fed has paid interest on reserve which I reserves That banks keep in the accounts of the Fed Okay, so when the so they're paying point two five percent if they start worrying that the banks are gonna loan out a lot of these excess Reserves which are now holding and cause the money supply to explode. What would they do? They'd raise the interest rate payment to point five percent or point seven five percent So it would keep the banks from making risky loans if I can get point seven five percent without risk Well, maybe I'll just keep money there So that's one of the tools the Fed might have to use once the economy picks up Once banks have more confidence once borrowers have more confidence that they can make good investments The Fed is going to have a problem Trying to unwind its position. It can also bring about open market sales It can sell some of these all these bad mortgages that it's accumulated But if it does that that will collapse the mortgage market. Okay, it's gonna be very interesting to see how the Fed gets out of it or stops Any attempt of the banks to to loan out these excess reserves? So the Fed does have some problems controlling the money supply as I said when you arrive take our money out of the banks That reduces the banks reserves at the power that can that can be a powerful influence As I said during Christmas when people pull out pick cash for shopping you're going to find that Bank reserves fall and the Fed offsets that by injecting new reserves at the beginning of the shopping season after Thanksgiving and Then sucking them out at the end of the shopping season in January When banks have to hold more reserves than required they make fewer loans and the money supply falls Okay, so in other words If banks were suddenly to be afraid and call in some of their loans as their loans came in they didn't re-loan them out The money supply would fall So there are two things that can counteract what the Fed is doing one is you and I pulling money out of the banks That reduces reserves to Banks deciding they're not going to renew loans and they're going to hold these things as reserves That will also decrease the money supply But the Fed can continually pump in money through open market operations So they still can exercise control of the money supply Now let's talk about money bank runs. Okay, it's like one of my favorite things And the money supply so a run-on banks is when people suspect Their banks are in trouble. They may run to the bank to withdraw their funds holding more currency and less deposits and once for every dollar that you take out in currency the bank then Has no backing for ten that ten dollars of checking account money They have to shrink their checking account money by ten times the dollar you take out and that's what the bank run is So if we all run on banks, they can only they can only pay ten percent of their liabilities the deposit liabilities The rest just disappears into thin air before we had a Fed or before we had an FDIC Which guaranteed deposits, that's what happened if you saw the the movie It's a wonderful life that every it's not a million times a Christmas You know and you see poor George. I forget what Jimmy Jimmy Stewart's name is in that in that movie But he's supposed to be the good guy, you know He stands up on on the counter in the bank and tells everyone well, you know You put the money in here, but it went to your neighbor. We loaned it here and there and the other thing Yeah, George, but the neighbors aren't paying it back So people can't get the deposits out, right? So he's not really the good guy, right? I mean he's um He's he you know, he's duping everybody Okay, whether or not you consider it fraud. I mean he can't he can't pay back and That's a second thing about banks banks. Not only are there are they inherently inflationary They're inherently unstable because of what we call the mismatch of maturities The maturities of their deposits are very short, right? They're instantaneous checking account Checking accounts and saving accounts can be withdrawn They're called site site bills as soon as you were the inside of the bank. You have those You can command Your all your checking account money to be given back to you all your saving account money be given back to you Okay, but on the other hand that money's loaned out for three months six months 30 years on mortgages okay, so The bank basically borrows short and lends long that's another that's a very innocuous way of putting it But what they're what is really the case? They have deliberately mismatched the maturity profiles of their assets and their liabilities Their assets are primarily short-term or even instantaneous If it's a claim like a deposit claim on the bank while their That's their liabilities while their assets are all long-term mortgages and and so on home equity loans So under fractured reserve bankings banks don't have enough reserves to pay off all depositors Hence banks may have to close unless they're bailed out So you need a central bank to keep My position is that to keep central to keep fractured reserve banking going on a free market. That's totally free Where there's no central bank where there's no federal deposit insurance Would be impossible. It wouldn't it wouldn't be able to last very long Okay, so whether it's fraud or not is a separate question. We can argue about that But what I think the conclusion of economics is that in fact you can't Have fractured reserve banking on a free market. Okay that it will very quickly collapse and let me give you an example Okay, very impressive right that's the Washington Mutual Tower Let me say a few words about Washington Mutual Washington Mutual which was abbreviated to a WAMU WAMU was a savings bank actually and it was the The owner of Washington Mutual Bank. Okay, so it was a holding company their own Washington Mutual Bank Which is the main thing that it did It was it was the United States largest savings bank Savings and loan association savings and loan association makes primary their their loans are primarily for mortgage loans It was also the sixth largest bank in the United States It was a darling of Wall Street Let me give you some figures here it Is two sets of thousand seven sec filing it held assets of three hundred and twenty seven billion dollars Okay more than half of those were were single-family home mortgages. Okay about 180 billion it had 2200 branch retail branch offices operating in 15 states It had 4900 about 5000 ATMs had 43,000 employees Okay As I said, it had 327 billion dollars in assets the sixth largest bank in the US Then something strange happened or something upsetting happened On September 2015th Lehman Brothers the Wall Street Bank collapsed Sending shivers throughout the the system that very day credit agency Downgraded the credit rating of WAMU Within nine days WAMU lost 17 billion dollars in deposits it was an online bank run. Okay people just pulling pulling their money out That's That's almost 10% of their of their assets. That's 10. That's 10 percent of their deposits They lost all the The reserves, I mean they lost most of the reserves. I'm sure they had some excess reserves Two weeks later the mighty WAMU was no more it's disappeared Once people lose confidence in a fraction reserve bank it disappears I mean it literally disappears overnight people no longer want to accept or hold this deposits and And the thing disappears no matter what it looks like no matter how high its stock price was Does that happen to any other business on the free market? Not any other business on the free market Where it will disappear overnight When I gave testimony before Congress, I use the following example and that was of Johnson and Johnson that owned the Tylenol brand during the 1980s there were 21 murders and no maybe seven murders in Chicago where someone had adulterated Tylenol the product on the shelves and I think seven people died There were a lot of serious consequences for Johnson and Johnson People that the brand lost I think it had 35 percent of the market and it went down to like, you know 5% or 9% but Johnson and Johnson Followed up in a very open and transparent way. It showed that had nothing to do with it that it was a criminal Its stock price took a small hit But but within a year it had 30% of the market back again. Okay of the pain reliever market So even even even murders of people even when firms are implicated with murder, they don't disappear overnight So I'm getting at but the brand name wama. I mean that's that just disappeared. It just went away Okay, as soon as people lost faith and confidence and So it was the darling of Wall Street noticed that its stock price started at five dollars five dollars in 1992 and it shot up to over $40 by late 2007 and then look how it plummeted it went to zero Okay One bankrupt just went to zero so Mighty wama would just just simply disappeared and that's what happens the fraction reserve banks when common people lose faith in them the depositors and That's why I do not think that it would exist on on the market Now somebody asked me and I have a few minutes about If banks don't make any loans Yeah, I don't care about any of this. Okay If banks don't make any loans, then what what what happens, you know, who would make loans? Well, there is so there's deposit banking which I said is not doesn't create new money is not inflationary Doesn't have the ability to bring about crises or anything like that You would so if you if you want to deposit your money and always have it available so that you write checks on it Or or withdraw it at will then you would pay the bank to hold your money Okay, you pay them a small fee every year every month whatever it is to store your cash balances That bank couldn't loan any that money out, but on the other hand there is something called loan banking Which is completely legitimate in which banks could make loans and Let me just quickly show you one or two slides here This is from actually rock one of Rothbard's books Okay, so If you started a bank you could do that a loan bank, okay? You put your own equity in you put your own money in you'd loan the $10,000 out Okay, you'd have cash of 10,000 you then make a loan Okay You would make a loan at 10% let's say so that you keep some cash And if you look on the left side there the IOU from the person you made a loan to will be $9,900 You would now no longer have the $9,000 that person would There's no deposits involved. There's no increasing the money supply at the end of the loan when the loan is paid back The cash is transferred back. Let's say it was a one-year loan Transferred back to the owner of the loan bank The borrower no longer has the cash The owner in this case Rothbard has his cash back. There's no new money created in that Another quick quick example I have two minutes Let's say he wanted to expand the equity of the bank. Well, then he'd bring his brother-in-law in really be the same thing Okay, so if you want to go public and have have Others shareholders and so on Let's say not only your brother-in-law, but others those would be shareholders They don't have the right to demand money All they have ownership of they don't have ownership of bank accounts all they have ownership of is the IOUs The loans if those loans go bad bad, they're the ones that suffer There's no effect on the money supply. They just don't get their loans back in one year time or two years time Okay, and finally There's other ways that banks could in a non-inflationary way make loans Which Rothbard points out and that is for example now you could not only have people shareholders right there So you don't only have a hundred thousand dollars in capital from shareholders But you could issue a long-term bond to someone that you pay interest on let's say five years You'll pay back after five years and you could issue a three month or a six month or a one-year certificate of deposit These people can't withdraw their money at will Okay, they're bound by contract to leave it in the bank all of that money can be loaned out and not cause inflation Because they no longer have money. They no longer can write a check on any of that stuff and And finally When when the the banks Lends the borrowed funds. Okay, so it then transferred the borrowers they have it these people don't have it Okay, so loan banking is inherently non-inflationary. There's nothing wrong with loan banking To the extent that banks do issue bonds or do issue certificates of deposit They do not cause an increase in the money supply. They are not inflationary the key in a free society What I think would develop where there was no central bank no deposit insurance would be a separation of Deposits from lending. Okay, and I'll stop here. Thank you mark