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November 12, 2012, 07:25:38 AM |
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I understand that money will circulate and the borrower will sell products indirectly to the loaner thus making somehow the interest payments possible because people don't hoard the currency. And with a few loans, that is going to work. However the more loans are made, the more interest payments will become a bigger part of the whole money supply and for example, at some point in time, all the money in existence will become interest payments. I still think somebody has to default to erase some of that interests payments that are now banks profits.
Yes, this is exactly what we are witnessing in our current system: a debt bubble. Now as to somebody having to default: I don't think this is true. The lender of last resort can just add so many zeros to the money supply and inject the fresh money into the economy (albeit usually at the wrong place, in the financial sector). It's not mathematically impossible. However, this will at some point certainly lead to a confidence crisis of the currencies involved, because at some point the fresh money will trickle down sufficiently into the "real economy" and cause prices to skyrocket. People know the central banks are printing money and they don't see any of that money hitting their wages. It's making it impossible for them to simply "save". They will be starting to wake up to that fact once the price of butter increases by 50% within a year and their income doesn't.
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molecular
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November 12, 2012, 07:36:21 AM |
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And speaking of "the people don't hoard the currency" pre-requisite ... what was the percentage of Bitcoins being hoarded? 78%?
That number is debatable. The paper that arrives at it has flaws. Also: if there was a totally trustable depository, I'm pretty sure people would deposit their savings to earn interest. btw: here's a rather tangible example of how fractional lending might occur in the bitcoin economy: Let's say mtgox decides to open up a bucket shop sister site offering leveraged trading. Let's also say it uses the BTC and USD deposited at the real market accounts to lend out for leverage. This is both pretty safe and very profitable for mtgox: after all in case of a bank run, all the money is really still there and could theoretically be taken from the bucket shop borrowers via a margin call (these borrowers did not withdraw the BTC or USD, they put them into a position in the bucket shop). All the while the BTC and USD are sitting comfortably in mtgox cold storage or traditional bank account untouched, but the "perceived" (and this is all that counts) money supply has increased (sum of account balances at mtgox plus positions on mtgox bucket shop TM). Voila: fractional lending.
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November 12, 2012, 07:39:52 AM |
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At the end, all money will belong to the bank as profits from interest payments. A bank is a business like any other. Its profits are not static. They flow out almost as fast as they flow in. Employees. Building maintenance. Rent. Water and Sewage. Security contracts. Banks are part of the economy they serve, not a drain upon it. The bank will not, and can not, ever own "all the money." They might however, at some point, own all the real assets, like buildings, roads, companies, production plants, resource mines, gold, etc... Money is just something that needs to flow around the economy, they don't want it, they know it's worthless paper and database bits in the end. EDIT: sorry guys for my morning-rants. I kinda desynced, you guys seem to be in a different timezone so I have to do a lot of catching up on this very refreshing troll-free informative thread that has already delivered some insights for me. ;>
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DannyHamilton
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November 12, 2012, 01:49:08 PM |
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If you read the Bobitza, Lisa and Danny example, just imagine Danny's fishing net broke again at the end and he had to buy a new one ... 10 times in a row. At the end, all money will belong to the bank as profits from interest payments. Next time Danny makes a loan, Bobitza will have no money to buy the fish thus Danny will have to default.
My example was only offered as a way to explain how it works with your extremely unlikely and really impossible scenario that that one person owns all the units of currency and is loaning all of them out at once to a single person. You'll notice that in the example I gave, Lisa has no need for currency for a period of 11 weeks. In the real word this is very unlikely. To start with, in a world with only 3 people there really isn't a need for a currency. Assuming there are more than 3 people in the world, the Bank will need to use those profits to continue to exist. They will need to spend them on operating expenses. Bobitza will need to purchase more than fish. At a minimum he will need to cover the operating expenses of his fishing supply business. He will have other people making purchases from his business, so he may not need to use funds from his bank account to pay for Danny's fish. Your problem seems to be that you are looking at currency as a static thing. Bobitza loans Danny 10 units, then Danny hands back 110 units all at once before any time has passed. Money gets reused over and over as time progresses. My example was trying to who you how it was the exact same 10 units of currency that kept moving in a circle between Bobitza, Danny, and Lisa to pay off the 110 units. Once the loan (and purchase) was made, there was no need for there to be 100 units in existence any longer. You are right that if a single person significantly out produces everyone else providing something of significant value to everyone, then they can and will amass a very large some of currency over time. The effect is amplified in an example where there are only 3 people and 10% of the entire economy is being moved around on a single transaction. Yes, if Danny has to repeatedly borrow from Lisa, and Lisa has no need to ever spend the currency (or spends significantly less then she earns in interest), then she will eventually own all the currency. On the other hand, if Danny sells 10 currency units of fish to Lisa once and continues to supply fish to Bobitza for 9 more weeks, then Danny owns all the currency. Of course, if Lisa and Danny both buy fishing equipment from Bobitza and he withdraws all his money from the bank, then Bobitza owns all the currency. In reality, all these "ifs" balance out along with the millions of other people using the currency. The money continues to flow throughout the system, and interest continues to be paid. Here is an analogy that might be poor, but it works for me. Assume a bowl of water with exactly 15 units of water in it. You have a spoon (or ladle) removing 1 unit of water from the edge of the bowl. You scoop this water from as close to your right hand side of the bowl as possible. Then you pour it out into the same bowl as close to your left hand side as possible. How many times will you be able to perform this action before all the water piles up on the left hand side? The problem you have is that the water continues to move over time filling in the area where you scooped it from other nearby areas and moving outward from where you dumped it to other nearby areas. So the right hand side of the bowl can continue to pay the left hand side indefinitely as much interest as needed. Now the economy can be manipulated and individuals can suffer from that manipulation. If all the areas near the right hand side of the bowl decided that they weren't going to give that side of the bowl any more water (essentially building a wall to prevent water flowing into that area), then eventually the right hand side would run out. If the left hand side were to start hoarding and refuse to allow water to flow out (building another wall on the left hand side) then the left hand side would end up with more than most areas that are still participating in the economy. But unless the left hand side is willing to spend some of that water into the economy of the bowl, it isn't going to be very useful to them. An area in a bowl of water doesn't need to participate in the economy of the bowl to survive, but we humans generally need to participate in the economy around us for survival. The way that Bitcoin deals with the situation of removing currency from the economy is to naturally end up using a smaller amount if bitcoin for the same type of transaction (delfation). In the water bowl example, all of the participants end up using spoons that shrink over time getting smaller and smaller, so that they are moving ever smaller amounts of water in any given transaction. This deals with both lost wallets (water spilled out of the bowl), and hoarding.
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molecular
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November 12, 2012, 02:23:53 PM |
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Assume a bowl of water with exactly 15 units of water in it. You have a spoon (or ladle) removing 1 unit of water from the edge of the bowl. You scoop this water from as close to your right hand side of the bowl as possible. Then you pour it out into the same bowl as close to your left hand side as possible. How many times will you be able to perform this action before all the water piles up on the left hand side? The problem you have is that the water continues to move over time filling in the area where you scooped it from other nearby areas and moving outward from where you dumped it to other nearby areas. So the right hand side of the bowl can continue to pay the left hand side indefinitely as much interest as needed.
Now the economy can be manipulated and individuals can suffer from that manipulation. If all the areas near the right hand side of the bowl decided that they weren't going to give that side of the bowl any more water (essentially building a wall to prevent water flowing into that area), then eventually the right hand side would run out. If the left hand side were to start hoarding and refuse to allow water to flow out (building another wall on the left hand side) then the left hand side would end up with more than most areas that are still participating in the economy. But unless the left hand side is willing to spend some of that water into the economy of the bowl, it isn't going to be very useful to them. An area in a bowl of water doesn't need to participate in the economy of the bowl to survive, but we humans generally need to participate in the economy around us for survival.
The way that Bitcoin deals with the situation of removing currency from the economy is to naturally end up using a smaller amount if bitcoin for the same type of transaction (delfation). In the water bowl example, all of the participants end up using spoons that shrink over time getting smaller and smaller, so that they are moving ever smaller amounts of water in any given transaction. This deals with both lost wallets (water spilled out of the bowl), and hoarding.
some would argue that it will be a problematic when the floodgates are being openend.
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DannyHamilton
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November 12, 2012, 02:32:41 PM |
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some would argue that it will be a problematic when the floodgates are being openend.
Certainly, but that is part of an entirely different discussion than the one I am having with Bobitza right now. At the moment we are discussing why interest on loans in a currency with a fixed supply is able to work. The sudden release of previously hoarded currency is an issue that is not limited to fixed supply currency. How the market can adjust and minimize the unpleasant effects on the economy in that scenario should probably be moved to a different thread.
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November 12, 2012, 03:28:10 PM |
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A couple of comments on the IOUs, warehouse receipts, customer deposits and loans in a BTC economy.
First. With the current system, the IOU that you get from the bank is indistinguishable from the currency. Say you deposit 100 USD in BoA account, the bank will show that you have 100 USD, not 100 BoAD that are redeemable 1 on 1 with USD. So, that's a big difference because that will mean we need another form of currency to make BTC currency work, right? Name it banks' IOUs, vouchers, litecoins, etc.
That's an interesting perspective. Your bank statement is basically a promisory note that the bank will redeem USD x on demand. You don't have USD x in the bank. It's not currency since it's not transferable but it's interesting to consider it that way.
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November 12, 2012, 03:46:31 PM |
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some would argue that it will be a problematic when the floodgates are being openend.
That "the floodgates" will be opened is something of an assumption. Those currently holding large quantities of BTC probably have different ideas at what amounts they will sell at and even then, if individuals have any sense at all, they will release just a few medium-loads of BTC every now and then rather than all at once otherwise they could tank the price and end up taking a big "loss" (A CEO with a lot of stock options will never dump them all at once).
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myrkul
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November 12, 2012, 04:18:05 PM |
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At the end, all money will belong to the bank as profits from interest payments. A bank is a business like any other. Its profits are not static. They flow out almost as fast as they flow in. Employees. Building maintenance. Rent. Water and Sewage. Security contracts. Banks are part of the economy they serve, not a drain upon it. The bank will not, and can not, ever own "all the money." They might however, at some point, own all the real assets, like buildings, roads, companies, production plants, resource mines, gold, etc... Money is just something that needs to flow around the economy, they don't want it, they know it's worthless paper and database bits in the end. Not likely. All of those expenses I outlined are services, and I just scratched the surface. Yes, it's possible (theoretically) for a bank to buy up everything, but it's also in competition with every other market actor to get those things. There's a reason you can never corner the market on anything.
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kjj
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November 13, 2012, 05:43:30 AM |
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What we have nowadays, though, is a bit different, right? Fiat currency isn't backed by gold and can be created at commercial banks by a magical process called credit creation (or "credit expansion"?): the bank puts a new loan into its books as an asset and at the same time increases the balance of the customers account who took the loan by the amount of the loan. New money has been created. The bank cannot do this indefinitely, though, it need some "other assets" to back up the loans. Is that correct? How exactly does this work?
To answer your question, laws limit the amount of deposited money that a bank can loan. The limit depend on the quality and size of the deposits. It is called the "reserve requirement" and it is set by the Fed in the U.S. Fractional reserve banking (FRB) works whether or not the currency is backed by anything. In a nutshell, it works like this: I deposit $100 cash in a bank. The bank loans $90 of that to someone else. I believe that I have $100 in the bank, and someone else has $90. The perceived amount of money is now $190, although the actual amount is still $100. That's how FRB works. There is no reason why bitcoin can't have fractional reserve banking. You have it backwards. Or rather the banks do it backwards. What really happens is that the bank makes a $100 loan first, and then seeks $10 in reserves.
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17Np17BSrpnHCZ2pgtiMNnhjnsWJ2TMqq8 I routinely ignore posters with paid advertising in their sigs. You should too.
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bitcoinbear
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November 13, 2012, 02:15:25 PM |
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To answer your question, laws limit the amount of deposited money that a bank can loan. The limit depend on the quality and size of the deposits. It is called the "reserve requirement" and it is set by the Fed in the U.S.
Fractional reserve banking (FRB) works whether or not the currency is backed by anything. In a nutshell, it works like this: I deposit $100 cash in a bank. The bank loans $90 of that to someone else. I believe that I have $100 in the bank, and someone else has $90. The perceived amount of money is now $190, although the actual amount is still $100. That's how FRB works. There is no reason why bitcoin can't have fractional reserve banking.
You have it backwards. Or rather the banks do it backwards. What really happens is that the bank makes a $100 loan first, and then seeks $10 in reserves. To the bank the order does not matter, as long as the reserve is in place before the regulators take a look at their balance sheet.
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bobitza (OP)
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November 13, 2012, 02:54:31 PM |
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Assume a bowl of water with exactly 15 units of water in it. You have a spoon (or ladle) removing 1 unit of water from the edge of the bowl. You scoop this water from as close to your right hand side of the bowl as possible. Then you pour it out into the same bowl as close to your left hand side as possible. How many times will you be able to perform this action before all the water piles up on the left hand side? The problem you have is that the water continues to move over time filling in the area where you scooped it from other nearby areas and moving outward from where you dumped it to other nearby areas. So the right hand side of the bowl can continue to pay the left hand side indefinitely as much interest as needed.
Lol, interesting example you found there. Here's a thought. For the loans+interest system to work, it has to have 100% efficiency. Meaning the bank will spend back into the economy all the interest money they collected, meaning there are no money "lost" somewhere in between, etc. Because in order to pay back interest without actually taking another loan, the money to pay back interest need to be be available somewhere in the economy, right? To use your example, one has to be very careful/fair with the spoon to not spill/pour a single drop of water on another bowl. I don't believe the system can be 100% efficient, or in other words all interest money will be re-circulated and there are no money "lost" in the process.
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DannyHamilton
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November 13, 2012, 03:41:15 PM Last edit: November 13, 2012, 04:08:03 PM by DannyHamilton |
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Assume a bowl of water with exactly 15 units of water in it. You have a spoon (or ladle) removing 1 unit of water from the edge of the bowl. You scoop this water from as close to your right hand side of the bowl as possible. Then you pour it out into the same bowl as close to your left hand side as possible. How many times will you be able to perform this action before all the water piles up on the left hand side? The problem you have is that the water continues to move over time filling in the area where you scooped it from other nearby areas and moving outward from where you dumped it to other nearby areas. So the right hand side of the bowl can continue to pay the left hand side indefinitely as much interest as needed.
Lol, interesting example you found there. Here's a thought. For the loans+interest system to work, it has to have 100% efficiency. Meaning the bank will spend back into the economy all the interest money they collected, meaning there are no money "lost" somewhere in between, etc. Because in order to pay back interest without actually taking another loan, the money to pay back interest need to be be available somewhere in the economy, right? To use your example, one has to be very careful/fair with the spoon to not spill/pour a single drop of water on another bowl. I don't believe the system can be 100% efficient, or in other words all interest money will be re-circulated and there are no money "lost" in the process. In the analogy, it is all a single bowl, there is no other bowl to pour into. Now you can spill outside the bowl, but that isn't interest, interest is still part of the economy. Interest (or any other money) that the bank keeps is "saved" or if you prefer "hoarded" currency. It is no different for the bank to "hoard" their money than it is for you to "hoard" yours. It doesn't matter if that money is acquired from interest payments, or from the sale of alpaca socks. "Hoarded" money is temporarily taken out of the economy until the hoarder eventually decides to spend it back into the economy. In the bowl analogy, hoarded money is placed in an area of the bowl that a participant has walled off. It is still in the bowl, but it isn't allowed to flow to other areas of the bowl. Eventually the owner may choose to spend some of the water in this area back into the generally accessible area of the bowl, or they may die without ever releasing the water back, at which time the hoarded water (currency) can be considered permanently removed from the bowl. Water spilled out of the bowl, is currency that is lost permanently. In bitcoin this means lost wallets. Bitcoin that is sent to an address for which nobody owns/knows the private key. This is deflation of the currency (water) in the economy (bowl), and as such the natural market forces end up forcing the participants to use spoons (transactions) that change size proportionally with the amount of water (currency) in the bowl (economy). Keep in mind that you have to be careful not to push the analogy to far in your mind. The flowing of the water throughout the bowl is meant to represent the relatively random nature of the transactions that everyone in the entire economy all engage in over time. The idea is that while some people may choose to hoard some of their currency, there is a certain amount that people will spend in their regular lives for the things they need or desire. By using an analogy where the water (currency) flows freely throughout the system it saves us from having to come up with examples of a few million transactions between a few million people to show how the currency got from the lender back to the borrower. In reality, water always finds its own level, and this gravitational force is what causes it to flow from where you dump it towards where you take it. In an economy, the forces that direct the flow of currency aren't quite as evenly applied as gravity. So those who spend significantly less than they earn will tend to have more of it over time, and those who quickly spend all that they earn will generally have none.
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DannyHamilton
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November 13, 2012, 04:19:07 PM |
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Assume a bowl of water with exactly 15 units of water in it. You have a spoon (or ladle) removing 1 unit of water from the edge of the bowl. You scoop this water from as close to your right hand side of the bowl as possible. Then you pour it out into the same bowl as close to your left hand side as possible. How many times will you be able to perform this action before all the water piles up on the left hand side? The problem you have is that the water continues to move over time filling in the area where you scooped it from other nearby areas and moving outward from where you dumped it to other nearby areas. So the right hand side of the bowl can continue to pay the left hand side indefinitely as much interest as needed.
Lol, interesting example you found there. Here's a thought. For the loans+interest system to work, it has to have 100% efficiency. Meaning the bank will spend back into the economy all the interest money they collected, meaning there are no money "lost" somewhere in between, etc. Because in order to pay back interest without actually taking another loan, the money to pay back interest need to be be available somewhere in the economy, right? To use your example, one has to be very careful/fair with the spoon to not spill/pour a single drop of water on another bowl. I don't believe the system can be 100% efficient, or in other words all interest money will be re-circulated and there are no money "lost" in the process. You seem to be stuck on the idea that there is something special or magical about interest. Interest is simply a form of rent. You need to think of it in the same way as you do renting a vehicle, an apartment, or a snow-blower. Interest is simply a special name that has been created for the idea of rent that you pay when someone lets you use their money for a period of time. If I allow you to live in an apartment valued at 10,000 BTC that I own and you pay me a 90 BTC monthly rent, then after a year you move out and return the use of the apartment to me... How is this different from me lending you 10,000 BTC that you need to purchase an apartment for yourself and you paying me 90 BTC interest on the loan each month, only to sell the apartment to someone else after a year and pay me back my original 10,000 BTC loan? In both cases I allowed you to use something valued at 10,000 BTC for a year, and in both cases you payed me a 1,080 BTC fee for that use. It doesn't matter wether it was an apartment valued at 10,000 BTC, or a loan valued at 10,000 BTC. In the end I lost the use of something valuable for a year and gained 1,080 BTC, and you lost 1,080 BTC and gained use of something valuable for a year.
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Richy_T
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November 13, 2012, 06:09:56 PM |
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Here's a thought. For the loans+interest system to work, it has to have 100% efficiency. Meaning the bank will spend back into the economy all the interest money they collected, meaning there are no money "lost" somewhere in between, etc. Because in order to pay back interest without actually taking another loan, the money to pay back interest need to be be available somewhere in the economy, right? To use your example, one has to be very careful/fair with the spoon to not spill/pour a single drop of water on another bowl.
I don't believe the system can be 100% efficient, or in other words all interest money will be re-circulated and there are no money "lost" in the process.
You just need to think of it like any other investment. You spend money, you obtain resources and you hope to be able to utilize those resources to obtain more money than you spent. A bank is effectively partnering with another entity to form a partnership. The bank brings the money and the profits are split.
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bobitza (OP)
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November 13, 2012, 06:35:30 PM |
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So money becomes an asset on its own rather than an exchange medium; you can make money just by having money. I understand that ... doesn't mean I agree with it, I mean look at where this approach got us into now. The power to create money should reside with people that create actual things, not with banks.
In your example, the rent I pay is the price paid for a service you're providing to me (shelter). Interest on a loan is not exactly the same; I agree to pay to the bank for their services, for managing money (aka opening account, assessing my credit worthiness, transferring money, etc.), but that should be like a fixed fee, not % of interest. I guess I'm starting to advocate for Islamic banking ... lol.
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DannyHamilton
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November 13, 2012, 06:44:53 PM |
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. . .In your example, the rent I pay is the price paid for a service you're providing to me (shelter). Interest on a loan is not exactly the same. . .
It is nearly the same. In both cases you are compensating someone for use of something of value for a duration of time.
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kjj
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November 13, 2012, 07:23:34 PM |
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To answer your question, laws limit the amount of deposited money that a bank can loan. The limit depend on the quality and size of the deposits. It is called the "reserve requirement" and it is set by the Fed in the U.S.
Fractional reserve banking (FRB) works whether or not the currency is backed by anything. In a nutshell, it works like this: I deposit $100 cash in a bank. The bank loans $90 of that to someone else. I believe that I have $100 in the bank, and someone else has $90. The perceived amount of money is now $190, although the actual amount is still $100. That's how FRB works. There is no reason why bitcoin can't have fractional reserve banking.
You have it backwards. Or rather the banks do it backwards. What really happens is that the bank makes a $100 loan first, and then seeks $10 in reserves. To the bank the order does not matter, as long as the reserve is in place before the regulators take a look at their balance sheet. I would say that it matters a whole lot. If you think that your deposit is enabling loans, and that banks can't make loans without them, you'll never understand how the system really works. Banks don't give a fuck about your deposit. 40 years ago, if you owned the steel mill in town, sure, your small town bank might care. That world is dead and buried. Banks accept deposits partly out of inertia, and partly out of hope that you'll bounce a check and pay them $35 for the privilege. Also, once upon a time, there was a meaningful difference in regulation between a deposit account and a demand account, but now through the magic of imagination they are effectively the same thing. They call this imagination a "sweep". In the modern world, banks just sweep up all of their deposits at the end of the day, and if they are under their reserve requirement their computer asks a computer in their local Federal Reserve district for an instant overnight loan and they pay a few millionths of a percent. If they do that too often, or for too much, the regulators start asking questions. Since the Fed has been bouncing on the zero-rate bound (for a while now), there isn't much point in even using the inter-bank lending process any more. Why borrow from another bank at a few thousandths of a point interest when the fed will do it for a few millionths? And those idiots making deposits will give it up for a few billionths, so they aren't entirely useless, but you have to wait for them to come to you, so the discount window keeps a thriving business. * parts of this post are exaggerated or otherwise inaccurate, but it is closer to modern reality than what you remember from It's a Wonderful Life.
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17Np17BSrpnHCZ2pgtiMNnhjnsWJ2TMqq8 I routinely ignore posters with paid advertising in their sigs. You should too.
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Richy_T
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November 13, 2012, 07:45:48 PM |
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So money becomes an asset on its own rather than an exchange medium; you can make money just by having money. I understand that ... doesn't mean I agree with it, I mean look at where this approach got us into now. The power to create money should reside with people that create actual things, not with banks.
In your example, the rent I pay is the price paid for a service you're providing to me (shelter). Interest on a loan is not exactly the same; I agree to pay to the bank for their services, for managing money (aka opening account, assessing my credit worthiness, transferring money, etc.), but that should be like a fixed fee, not % of interest. I guess I'm starting to advocate for Islamic banking ... lol.
Don't forget, that lender didn't just magic the number from nowhere (in a sane system), it either earned it or, more typically, was lent it itself. The bank is performing a service of matching a lender with a borrower.
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bitcoinbear
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November 13, 2012, 07:47:32 PM |
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To the bank the order does not matter, as long as the reserve is in place before the regulators take a look at their balance sheet.
I would say that it matters a whole lot. If you think that your deposit is enabling loans, and that banks can't make loans without them, you'll never understand how the system really works. It may not matter from the bank's point of view which comes first, the loan or the deposit, but it does matter for the money supply. If the banks can make loans before they take deposits, then they are able to create money out of nothing, whereas if they must wait for a deposit first then there must be at least a little bit of something behind the moenetary creation. Let's take the example of two banks, bank A and bank B. Bank A makes a loan to Bob, with no reserve, of 100$. Bob transfers that $100 to bank B. At the end of the day, bank A needs to raise their reserve, so they ask for a loan from bank B. Bank B has $100 on deposit, so they loan $50 to bank A, now both bank A and B have a 50% reserve, and the regulators are happy. Do I have that right?
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