The Creation of the Federal Reserve System (Part 2)

Cash = reserves. How can you say that the Fed pumping 1.9 trillion more cash into the econmy didn't give anyone any money?

You position is beyond bizarre. You claim that cash that you can spend is not money.

How could they lose their deposits if deposits are money? Nobody loses deposits because banks write off bad loans.

Complete fabrication. Deposits aren't lost. They may be worthless, but they aren't lost.

3rd or 4th time. Please cite a source that say deposits are money like cash is money. Show me a source that says a bank can go and exchange a deposit account for cash.

 

A bank doesn't use deposits to "cross off" deposited loans. Deposits accounts are a bank's liabilities. It can't just use them as it pleases.

 

They didn't pump it in to the economy. They pumped it in to the banking system. This is why your theory is completely flawed. Deposits = Cash for the nonbank public. Reserves = Currency Held By the Banks for the banks. Reserves != Cash head by the nonbank public.

They simply gave the banks tons of reserves which they could convert to cash if tons of people wanted to exchange their deposits. But since there wasn't a rush for people to hold on to cash, the reserves are just sitting on the Fed's/Banks balance sheet not seeing the light of day.

Our deposits were unchanged by this process and our amount of money was unchanged by this process. This is why the monetary base is not included in M1. Because it would be double accounting. If the Fed pumps $1.9 trillion in reserves the nonbank public doesn't have $1.9 trillion more.

When a bank is insolvent because of bad loans/investments their deposits go down with them

Sure they are. When a bank fails your deposits are lost. Just because the FDIC insures them doesn't mean that money in your deposit wasn't lost. The Govt now needs to issue debt to replace the lost loans to back your insured deposits. Of course deposits are lost when a bank makes loans that aren't repaid.

This makes no sense, what do you mean "exchange deposit account for cash". Deposits = Cash for the nonbank public, not for the banks.

And I have showed you the reference to the MMM that states what money is and why deposits are considered money.

Source For the millionth Time: MMM
If money is viewed simply as a tool used to facilitate transactions, only those media that
are readily accepted in exchange for goods, services, and other assets need to be
considered.

Today, in the United States, money used in transactions is
mainly of three kinds - currency (paper money and coins in the pockets and purses of
the public); demand deposits (non-interest bearing checking accounts in banks); and
other checkable deposits, such as negotiable order of withdrawal (NOW) accounts, at
all depository institutions,

 

It doesn't use them it loses them

 

How the public views deposit account is irrelevant to what happens when checks are paid or cash transferred.

The didn't "give" anyone anything. They purchased securities which added to the pool of reserves. The theory being that with more reserves, banks would have more money to lend at lower interest.

Wrong. When someone sells their US treasury to the Fed thru a broker, he is paid for the sale, and that money is reflected in a bigger account balance (as well as more reserves in his bank).

See step 1, MMM.

That is true when a bank becomes insolvent for any reason. Because when that happens it runs out of reserves. It would not be true if deposits were cash. Cash does not "go down".

You positions doesn't make any sense. If deposit accounts are cash, or contain cash, or whatever your version is at the moment, then they wouldn't be lost. Because when a bank becomes insolvent it doesn't lose deposits.

Since when have there been two kinds of cash?

I didn't saw it because you didn't refer to my link.

 

How exactly does it "lose them".

 

By creating loans that defaulted

 

Yes, when checks are paid my deposit account money is deducted and another persons deposit account money is credited. None of us get reserves in this process.

That's not the theory. Banks don't lend reserves. Banks create loans and deposits. More reserves means it's cheaper to borrow, it doesn't mean they can lend more because they have more reserves.

Read these two papers. Maybe this will shed some light in to you

http://www.newyorkfed.org/research/staff_reports/sr380.pdf
http://www.federalreserve.gov/pubs/feds/2010/201041/201041pap.pdf

Yes, when someone in the nonbank public does that is what happens. But that is not what the Fed did.

No, it can't replenish it's reserves, it doesn't run out of reserves. The banking system can't "run" out of reserves.

Deposits don't contain anything just like a dollar bill doesn't contain anything. Deposits are simply electronic forms of cash.

There isn't but there is a difference between reserves and cash held by the public

Well I've linked it 100 times. You have seen the same quote 100 times, you are just refusing to believe it, which is what you're good at.

 

But how does the bank actually lose deposits?

When a loan defaults, the loans receivable of the bank, an asset, decreases.

How exactly does the bank lose deposits? Deposits are obligations to the bank. It can't just lose them. It is what the bank owes. A liability.

 

A | L
Loans $200 | Deposits $100
Write-Offs -$200 | Equity $100

Your theory would equate this to

A | L
Nothing | Deposits $100

So use whatever accounting terminology you want to use, but they created $100 worth of deposits that are no backed by any assets, therefore whoever owns that $100 deposit ends up losing it because the bank is insolvent. So this $100 represents the $100 that the bank lost through it's creation of $200 in loans that were not repaid.

 

Unless the payee cashes the check for cash. But otherwise that is true. The bank holds the cash/reserves. Not the depositor. That is the heart of fractional banking.

See MMM.

The lending banks, however, do not expect to retain the deposits they create through their loan operations. Borrowers write checks that probably will be deposited in other banks. As these checks move through the collection process, the Federal Reserve Banks debit the reserve accounts of the paying banks (Stage 1 banks) and credit those of the receiving banks. See illustration 6.

They talk about how banks have more excess reserves because they aren't lending as much (as well as other factors). So what?

Sure it does it all the time.

A bank certainly can. In the macro sense, it doesn't "run" out of reserves, but the demand for money can cause interest rates to rise if there is a limit on macro level of reserves.

A dollar bill is cash, legal tender, and the equivalent of reserves. All of which has been proven to you be reliable sources.

A deposit account is considered money in broad definitions of money, but it is not the same as cash or reserves.

Reserves can be exchanged for cash and vice versa. You've seen this from day won.

Well I've linked it 100 times. You have seen the same quote 100 times, you are just refusing to believe it, which is what you're good at.[/QUOTE]

Source For the millionth Time: MMM
If money is viewed simply as a tool used to facilitate transactions, only those media that are readily accepted in exchange for goods, services, and other assets need to beconsidered.

Today, in the United States, money used in transactions is mainly of three kinds - currency (paper money and coins in the pockets and purses of the public); demand deposits (non-interest bearing checking accounts in banks); and other checkable deposits, such as negotiable order of withdrawal (NOW) accounts, at all depository institutions,

All that is saying is that deposit accounts are considered money, of which there has been no dispute since day one if you are using a definition of money that includes deposit accounts.

But we know deposit accounts are not the same as cash. If they were cash they'd be an asset for the bank. Instead they are an obligation.

MMM explains what happens in the transactions. "Borrowers write checks that probably will be deposited in other banks. As these checks move through the collection process, the Federal Reserve Banks debit the reserve accounts of the paying banks (Stage 1 banks) and credit those of the receiving banks." See Step 6.

If the bank doesn't have reserves to pay the check, the FDIC steps in.

 

That is exactly it. Bank insolvent. FDIC comes in.

But for the FDIC, that is exactly right.

But if deposits were equal to cash, why would they lose? They would have their cash.

Your illustration shows why they are not cash.

No, the $100 represents a deposit account that is worthless because the bank has no money. That deposit account can't be used to buy withdraw cash because the bank is insolvent.

That deposit account is worthless and the depositor would be S.O.L. but for the FDIC coming in any paying the depositor for the amount of the account.

 

The heart of fractional reserve banking in our system is loans. Banks do not need reserves to make loans. They can acquire the reserves after the loan is made. Your fractional reserve theory is dependent on banks having reserves. That's the difference between your understanding and my understanding. Banks don't need reserves to make transactions, they need reserves to meet requirements by the Fed.

Yes that is what banks do

Yes, then they will lend those excess reserves to a bank that is lending more or they will leverage those excess reserves in to other investments. Banks typically do not sit on excess reserves except not that they are being paid to.

Yes, and if banks starting lending like crazy because of this increase in demand for loans there would be less excess reserves or the Fed would withdraw reserves out of the system causing rates to go up.

It is not equivalent to reserves. The cash you have in your hand is not reserves, it is equivalent to a deposit. To banks cash is equivalent to reserves.

It's not the same as reserves but it's the same as cash.

Yes and deposit accounts can be exchanged for cash and vice versa.

Cash held by the public is not an asset for the bank. It's an asset for the nonbank public just like a deposit.

You made up that last part. If it doesn't have reserves to pay the check they will borrow reserves afterward.

We have come to the conclusion that yes banks do transfer reserves. But where your theory fails is that banks do not need reserves on hand to transfer reserves since they can go in to deficiency.

 

No, the illustration shows that the bank made $100 in deposits that are no longer backed by any assets. That $100 in deposits should not exist. It is still money, it just is money that legally can't exist because there is nothing backing it. This doesn't mean the bank ran out of cash, it means the bank lost it's deposit that it created and has to replace it.

The bank doesn't have any money because it lost money. The $100 represents money that should not exist. It still represents money.

No, the deposit account is not worthless. It is used to write off the loan because the loan was not repaid. It is still money. It is being used to pay off the loan and make things right in the system. No money can exist that isn't an asset to one entity and a liability to another. If banks wrote off loans with out destroying either their capital (which is money that exists) or deposits (which is money that exists) than there would be deposits floating around this country that were not backed by any asset.

 

Well, not it is a bit of semantics. Banks need reserves to fund loan proceeds (when the borrower writes a check or withdraws cash). Banks can borrower reserves on the fed fun market if they need to to meet their reserve requirement -- if other banks will lend to it.

Right. That is what banks do when you pay a check or use a debit card. They transfer reserves to the payees bank. That completes the transaction.

Except when you have many banks making few loans like now, there is less lending, because these are not typical times.

OK, and why? Because reserves are needed to complete loan transactions.


It is not equivalent to reserves. The cash you have in your hand is not reserves, it is equivalent to a deposit. To banks cash is equivalent to reserves.

Back to square one.

That's why these definitions are crucial. I've been using cash and reserves interchangeably for how many pages because they are equivalent.

Currency held in bank vaults may be counted as legal reserves as well as deposits (reserve balances) at the Federal Reserve Banks. Both are equally acceptable in satisfaction of reserve requirements. A bank can always obtain reserve balances by sending currency to its Reserve Bank and can obtain currency by drawing on its reserve balance. Because either can be used to support a much larger volume of deposit liabilities of banks, currency in circulation and reserve balances together are often referred to as "high-powered money" or the "monetary base."

So long as the bank remains solvent and has sufficient reserves (or can borrow them), no problem.

Banks provide many services, but for most people, banking consists of depositing their salaries into checking accounts and writing checks on that account to buy things that cost more money than they want to carry in their wallets. People also commonly have savings accounts in which they deposit money they don't need right away or they are saving for a particular purpose. The bank pays interest, or a price paid for use of the money, on savings accounts and often on checking accounts, too.

Very little of this money is kept in the bank's vault, however. While the Federal Reserve requires banks to keep a specified percentage of customer deposits on hand to meet routine withdrawals, they lend the excess. Banks, like any other business, must make a profit to stay in business. Their profit comes from interest people pay on the money they borrow.

http://dallasfed.org/educate/everyday/ev9.html

That's why the deposit accounts are worthless if the bank goes insolvent. The bank doesn't keep the money (cash/reserves) that folks deposit into their accounts, but lends it out.

Thus, deposit accounts are not "just like cash" because if they were "just like cash" depositors wouldn't have a problem if the bank went insolvent.

And cash/reserves that are transferred out of the bank are not assets of the bank.

What if it can't borrow the reserves?

What if it can't borrow the reserves?

 

If a bank has sufficient capital they can borrow from the Fed Funds market at the rate the Fed dictates. Banks will make as many loans that meet their requirements regardless of their reserve position. If the bank doesn't have the reserves they will go out and borrow reserves.

And they transfer money from my account to your account. That completes the transaction. You are talking about this as if you are the bank.

True and the fact the Fed is paying them interest on the excess reserves doesn't hurt

No, reserves are needed to meet requirements with the Federal Reserve. If a bank doesn't need more reserves they will lend them to the bank that does.

Yes, reserves can be exchanged for vault cash. Reserves can not be exchanged for currency held by the public. Deposits can be exchanged for currency held by the public.

Yes this is what banks do

No, they go insolvent because the deposit represent money that has been created that shouldn't exist.

They are like cash.

It can if it has any capital

It can if it has any capital

The only way a bank can not get reserves is if they do not have any capital because no one will lend to a bank that doesn't have any money.

 

What do you mean they "should not exist"? Of course it exists. Just because the bank ran out of money and went insolvent doesn't mean the deposit account doesn't exist. It is still a liability and obligation of the bank.

How can it be "money" if the account owner cannot withdraw cash from it or use it to write checks?

Again, please explain what you mean by "the bank lost it's deposit" and "has to replace". Give examples of where this happens in real life or cite to a source.

I have never heard of a bank "losing its deposits" unless the depositors withdraw or transfer their funds.

So you are saying when the bank is insolvent, has -0- assets, the account holder can still withdraw the $100 in cash? Where is the cash coming from if the bank has no assets?

What? Please explain how a deposit account "is used to write off the loan because the loan was not repaid".

I've never heard of such a thing. You mean you think if a bank makes a bad loan to Mr. Smith it can just "use" a deposit account belonging to Mr. Jones? Please explain how this works!

If the deposit account is still money, please explain exactly how the deposit account holder would get $100 cash for it or spend it given the bank is insolvent and has no assets.

 

This is why deposits are lost. If a bank has a balance sheet like

A | L
Loans $1000 | Equity $100
Reserves $100 | Deposits $1000

If $500 of these loans defaults then the bank looks like

A | L
Neg Equity $400 | Deposits $1000
Loans $500
Reserves $100

So for the banking system to be right again... they have to

A | L
Loans $500 | Deposits $600
Reserves $100

Notice how they lost $400 in deposits. This is no different than someone using their deposit account to pay off $400 in loans. When this happens banks have to sell their assets which includes their good loans. But the deposits are lost in this process not because the bank "ran out" of cash, they are lost because the bank needs to pay back the money it created that is now someone elses deposit.

The people holding the $400 lost their deposits not because the bank ran out of cash but because someone else out there has $400 in deposits they shouldn't have.

 

What if the bank doesn't have sufficient capital and can't borrow from other banks?

So long as reserves are transferred to the other bank, no problem. MMM step 6.

I'm not sure why the Fed decided to do that.

The lending banks, however, do not expect to retain the deposits they create through their loan operations. Borrowers write checks that probably will be deposited in other banks. As these checks move through the collection process, the Federal Reserve Banks debit the reserve accounts of the paying banks (Stage 1 banks) and credit those of the receiving banks. See illustration 6.

If you aren going to flatly contradict the MMM which we have all referred to and relied upon, you are going to need something more than your own baseless, illogical, and erroneous say-so.

LOL -- back to square one. OK, so please explain what you think is the difference between "vault cash" and "currency."

Sure. As long as the bank has the cash to give you.

Correct. Which is why when a bank goes bust and can't borrow reserves your deposit account is worthless, which is why it is not "just the same" as cash.

Cash doesn't become worthless because the bank goes bust.

What? That doesn't make sense. The represent money the shouldn't exist? How can a deposit account represent money that shouldn't exist?

Except cash doesn't become worthless if your bank goes bust.

What if the bank doesn't have any capital and can't borrow reserves to pay checks or disburse cash to deposit account holders?

The only way a bank can not get reserves is if they do not have any capital because no one will lend to a bank that doesn't have any money.[/QUOTE]

 

Then it is insolvent and will have to sell it's assets or fail

Sure, whatever makes you happy

So banks don't go looking for interest elsewhere

MMM

In the real world, a bank's lending is not normally constrained by how many excess reserves it has at any given moment. Rather, loans are made, or not made, depending on the bank's credit policies and its expectations about its ability to obtain the funds necessary to pay its customers' checks and maintain required reserves in a timely fashion.

Vault cash is an asset to the banks
Currency in the hands of the public is an asset to the nonbank public

It's worthless because it shouldn't exist. Not because the bank ran out of money

If the bank makes a loan for $100k by creating a deposit. And that loan does not get paid off. There is $100k in deposits in the banking system that is not backed by an asset. How hard is this to understand?

Worthless banks don't have cash

Than it will become insolvent and fail

 

So what happens to the folks who had the $400 in deposit accounts?

I notice how you've made that up. It doesn't happen like that in the real world. A bank cannot just "disappear" or lose deposit accounts. The deposit accounts are legal obligations to the bank and the bank cannot just make them disappear.

Feel free to give any example of this ever happening.

Exactly. We've finally arrived.

They have lost their deposits. Their deposits are worthless (unless the FDIC comes in and pays them). They are out the $400 their accounts were worth.

But if the deposit accounts were really "just like cash" they wouldn't have lost a cent. Because if you have cash in your pocket, you don't lose it when the bank goes insolvent. That's why there were all those runs on the banks that led to the creation of the FDIC.

And that is the difference between a deposit account and cash.

If you have cash and your bank becomes insolvent, you don't lose it.

If you have a deposit account, you've lost the value of your account.

Because, as we've said 20 pages ago, a deposit account is not the same as cash, but is a claim on the bank's cash/reserves.

 

Sure it can, why do you think their is the FDIC insurance? When banks fail, deposit accounts go down with it.

Call it whatever you want to call it, there is a reduction of deposits in the system unless the Govt backs them by creating debt. You are the one backed in to the corner.

What does cash have to do with this? Cash in the hands of the public is not an asset or a liability to the banking system. Deposits are still money, if a bank loses $100k by making faulty loans and don't have sufficient capital than there is $100k in deposits that exist that are not backed by assets. Not really rocket science here.

Who cares, what does that have to do with a bank making loans that aren't repaid?

A deposit account is the same as cash. It can be used in transactions exactly like cash and it represents your money. If you have a deposit in a bank that becomes insolvent it just means someone else has a deposit that shouldn't exist in the banking system.


If you need a refresher on accounting 101, let me know!

 

This is simple accounting Iriemon.

If a banking system had no loans it would look like this

A | L
Reserves $1000 | Deposits $1000

If Bank A makes a loan for $100 the system now looks like this

A | L
Reserves $1000 | Deposits $1100
Loans $100

Now if the loan defaults the system looks like

A | L
Reserves $1000 | Deposits $1100
Neg Equity $100

Neg Equity is not an asset, it is something that is owed. So the only way to pay back the $100 to eliminate the neg equity is to take away $100 in deposits. This does not mean deposits are not money, this does not mean deposits are just claims on reserves, this simply means that there is $100 in deposits that exist that are not backed by an asset.

It is as simple as that.

The only way your deposit can "disappear" is if a bank makes a loan or an investment that has not been repaid. This is why deposits are money and they are exactly like cash in the fact they are used to purchase goods and services in America.

 

Right. Sio it cannot be true that "Banks will make as many loans that meet their requirements regardless of their reserve position".

It's not a matter of making me happy. It is what happens.

That doesn't make a lot of sense to me.

Exactly. As long as it can obtain the funds necessary to pay checks and maintain reserves, it's good.

So it's all cash, same thing. One's just in the bank's vault (and is reserves) and the other is in someone's pocket.

Cash can always be converted to reserves and vice versa.

But deposit accounts cannot always be converted to cash. As we've agreed, if the bank is insolvent and doesn't have sufficient cash/reserves, depositors lose their account values (until the FDIC comes in).

What difference does it make? If the bank has money, the deposit account gets paid. If the bank doesn't have money, the deposit account is worthless. It doesn't matter whether it "should" exist or not.

I don't get how that shows that it represents "money the shouldn't exist".

But irrespective, your point is not necessarily accurate. If the banks writes off a $100 loan, and it has sufficent reserves and equity to cover the loss, there is no deposit at risk of loss.

Exactly. But if you have cash, you don't lose it if the bank becomes worthless. On the other hand, if you have a deposit account in that worthless bank, you lose your money (unless the FDIC pays you).

Because a deposit account is not "just like cash".

And the depositors lose their money (unless the FDIC pays them).

Which is why deposit accounts are not just like cash.

People thing of their deposit accounts like cash because they don't think their bank will fail, and today, they know the FDIC will cover their loss. But that wasn't the case before the FDIC. If a bank became insolvent and didn't have reserves/cash, the depositors lost their money.

And that is why we have reserve requirements, and the FDIC. To minimize or eliminate the risk of loss that your deposit accounts become worthless if the bank fails.

 

Or course! But if you had your money in cash, and not in the deposit account, you've lost nothing. That is why there were runs on banks.

That is why a deposit account is not "just like cash." It is a claim on the bank's reserves, but if the bank fails and doesn't have the reserves, the account is worthless.

It's not just like cash.

Cash/reserves are what make the account have value. Because when you write a check or withdraw cash, the bank's reserves are what pays it. No reserves, no cash, no check.

Exactly. The depositors are wiped out. It's not "just like cash". It's a claim on the banks reserves. That's what we said 20 pages ago.

Right. It's not. Cash in the hands of the public is not lost if the bank fails. Deposits in the bank are wiped out.

Not much. It has everything to do with the nature of what money is, whether deposit accounts are "just like cash" and the difference between cash/reserves and deposit accounts.

Who cares what someone else has? The depositors lose their money. That is what a deposit account is not the same as cash. You don't lose your money if you had the money in cash.

I think we've established the point. Deposit accounts are not the same as cash.