2. How Banks and Thrifts Create Money 14 C H A P T E R

3. How Banks Create Money [ MS ] M1=Currency+DD of Public Banks [thru loans] C reate M ore DD Give me a loan so there will be more DD in the system.

4. “Wow, you mean we can create money out of thin air.?” gold-smithy Once upon a time there was a gold-smithy who offered to store people’s gold in his vault. He issued paper receipts for the gold, and it was not long before the townsfolk used the paper to purchase eggs and beer. The smithy’s “good as gold.” paper receipts became as “good as gold.” not stupid“I have 2000 ounces of gold Our Smithy was not stupid. He said to himself. “I have 2000 ounces of gold stored in my vault, but in the last year I was never called upon to pay out 100 ounces more than 100 ounces in a single day. What harm could it do if I lent out say, half the gold half the gold I now have? I’ll still have more than enough to pay off any depositors that come in for a withdrawal. No one will know the difference. I earn 30 additional ounces of gold could earn 30 additional ounces of gold each week. I think I’ll do it.” “The smithy has invented the Fractional Reserve Banking System.” Advantages of Lending Advantages of Lending [One disadvantage was the possibility of “bank runs”] 1. Depositors haven’t lost money [ Goldsmiths paid them instead of other way ] 2. With the interest you earned you could give some to depositors. 3. The loans benefited the economy The Very Early Days Of Banking The fractional banking system began when someone issued claims for gold that already belonged to someone else. Greatestinventionsince sliced bread

5. BALANCE SHEET OF A COMMERCIAL BANK ASSETS = LIABILITIES + NET WORTH The Goldsmiths Fractional Reserve Banking System

6. FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES (OWN) (OWE)

7. FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH TRANSACTION 1 Creating a bank $250,000 Cash for Capital Stock

8. Cash $250,000Capital Stock $250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH Deposit Added to Vault Cash

9. Property 250,000Capital Stock $250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH

10. History of Deposit Insurance In 1934, federal deposit insurance made its debut at $2,500 $2,500 to protect the average family’s savings and end the bank runs bank runs that had shut down businesses and contributed to the Great Depression Great Depression. Through the years the coverage rose $5,000 increments in $5,000 increments until the 70s until the 70s when it jumped to $40,000. 1980 In 1980, it was raised $100,000 to $100,000.

11. Property 250,000Capital Stock $250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH TRANSACTION 2 Accepting Deposits $100,000 Cash

12. Cash $100,000 Property 250,000 Checkable Deposits $100,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH

13. Cash $110,000 Property 240,000 Checkable Deposits $100,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH NOTES: Bank deposits are subject to a reserve requirement. Reserve ratio

14. Cash $100,000 Property 250,000 Checkable Deposits $100,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH Actual Reserves $ 100,000 Required Reserves - $ 20,000 Excess Reserves $ 80,000

15. Cash $100,000 Property 250,000 Checkable Deposits $100,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH Important Issue... 1 - Excess Reserves = Actual Reserves - Required Reserves (assume 20% reserve requirement) $100,000 - 20,000 = $80,000

16. Cash $100,000 Property 240,000 Checkable Deposits $100,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH TRANSACTION 3 Deposits at the FED $100,000 Cash

17. Cash $ 0 Reserves 100,000 Property 250,000 Checkable Deposits $100,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH

18. Cash $ 0 Reserves 110,000 Property 240,000 Checkable Deposits $100,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH TRANSACTION 4 A check is drawn against the bank $50,000

19. Cash $ 0 Reserves 50,000 Property 250,000 Checkable Deposits $ 50,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH

20. And What Happens If A Turtle Doesn’t Keep Up with His Mortgage Payments

21. Cash $ 0 Reserves 50,000 Property 240,000 Checkable Deposits $ 50,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH NOTES: Banks create money by lending excess reserves and destroy it by loan repayment. Purchasing bonds from the public also creates money.

22. Reserves $ 50,000 Property 250,000 Checkable Deposits $ 50,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH TRANSACTION 5 Make a loan from excess reserves $40,000

23. Reserves $ 50,000 Loans 40,000 Property 250,000 Checkable Deposits $90,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH Making the loan created money!

24. Reserves $ 10,000 Loans 40,000 Property 250,000 Checkable Deposits $ 50,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH After a check for the $40,000 is drawn against the bank

25. Reserves $ 50,000 Securities 50,000 Property 250,000 Checkable Deposits $100,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH TRANSACTION 6 (Assume previous balance sheet) Buy Government Securities $50,000

26. Reserves $ 50,000 Securities 50,000 Property 250,000 Checkable Deposits $100,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH

27. MULTIPLE DEPOSIT EXPANSION PROCESS Bank Acquired reserves and deposits Required reserves Excess reserves Amount bank can lend - New money created A B C D E F G H I J K L M N Other banks $100.00 80.00 64.00 51.20 40.96 32.77 26.21 20.97 16.78 13.42 10.74 8.59 6.87 5.50 21.99 $20.00 16.00 12.80 10.24 8.19 6.55 5.24 4.20 3.36 2.68 2.15 1.72 1.37 1.10 4.40 $80.00 64.00 51.20 40.96 32.77 26.21 20.97 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.59 $80.00 64.00 51.20 40.96 32.77 26.21 20.97 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.59 $400.00 Total amount of money created by the banking system

28. RR Excess Reserves Total(Actual) Reserves Dennis Rodman deposits $1 with A 10% RR 10 cents. 10 cents 90 cents One Dollar One bank’s loan becomes another bank’s DD. Rodman’s

29. MULTIPLE DEPOSIT EXPANSION PROCESS Bank Acquired reserves and deposits Required reserves Excess reserves Amount bank can lend - New money created A B C D E F G H I J K L M N Other banks $100.00 80.00 64.00 51.20 40.96 32.77 26.21 20.97 16.78 13.42 10.74 8.59 6.87 5.50 21.99 $20.00 16.00 12.80 10.24 8.19 6.55 5.24 4.20 3.36 2.68 2.15 1.72 1.37 1.10 4.40 $80.00 64.00 51.20 40.96 32.77 26.21 20.97 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.59 $80.00 64.00 51.20 40.96 32.77 26.21 20.97 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.59 $400.00 Total amount of money created by the banking system Money destruction works in exactly the same multiple way!

30. Maximum checkable- deposit creation = Excess reserves x Monetary Multiplier Monetary Multiplier Required reserve ratio 1 = THE MONETARY MULTIPLIER

31. $20 Required reserves $100 New reserves $100 Initial Deposit $400 Bank system lending Money Created $80 Excess reserves OUTCOME OF MONEY EXPANSION

32. $20 Required reserves $100 New reserves $100 Initial Deposit $400 Bank system lending Money Created $80 Excess reserves OUTCOME OF MONEY EXPANSION Leakages exist... Currency Drains Excess Reserves

33. Coming Soon... Monetary Policy Chapter 15

34. THE END