Understanding the Parasite

[CoinCube]

Understanding the Parasite: Finance Part I

Modern finance leads inevitably to decimation of the middle class and eventual systemic collapse. Understanding how and why is critical to securing a future in a dangerous era. This post is the first in a three part series designed to highlight the dark machinery behind the glossy curtain of finance. Let’s take a moment to look past the propaganda. You may not like what you find.

The study of money, above all other fields in economics, is one in which complexity is used to disguise truth or to evade truth, not reveal it. The process by which banks create money is so simple the mind is repelled.

To understand finance we must first understand the process of money creation. Economic textbooks cover this topic in great depth. Inquiring minds are spoon-feed conceptions of money multipliers and reserve requirements. The "official" version of money creation is clean, comforting, and concise. It is also false.

Banks create money by making loans, but this process is not in any way constrained by reserves, deposits or a money multiplier. Banks do not need deposits to make loans. The idea that banks somehow lend out grandma’s savings is propaganda. Instead banks simply create money via accounting wizardry. When a bank approves a loan they simultaneously create a deposit in the borrower’s bank account and voilà new money is created. Banks do not function by lending out deposits. Instead the act of lending creates more deposits. This is the reverse of the sequence taught in almost all economic textbooks. Banks create deposits at will.

Economic texts often state that banks are constrained by reserve requirements. This is not entirely honest. There exists a number called reserve requirements. However, if a bank needs more reserves these reserves are simply supplied to meet this need. Depending on the country this is done either directly by the central bank or via interbank lending at interest rates that are suppressed by the central bank. The theory of the money multiplier is false. In reality there is a reserve multiplier. Central bank reserves are increased by a percentage of the amount of money banks choose to create.

In no way does the aggregate quantity of reserves directly constrain the amount of bank lending or deposit creation.

So what does limit money creation by the banking system? Primarily the banks themselves do. Individual banks have to find someone to lend to who is capable of paying them back or at least someone who has valuable assets they can seize if the loan is not paid.

The Banking Tragedy of the Commons

Modern banks are not limited by reserves. Instead, they decide how much to lend based on the profitable lending opportunities available to them. As banks have no real restraint on the creation of new money, they are prone to print excessively. Left to their own devices banks would flood the market with new dollars in a banking tragedy of the commons. In a hyperinflation scenario the supply of money increases so much that people start to spend it as quickly as possible. This supply-velocity feedback cycle left unchecked destroys the value of a fiat currency. The logical conclusion of such excess is abandonment of the fiat currency for an alternative like gold or perhaps someday cryptocurrency. Hyperinflation is thus banking armageddon. It represents the destruction of the system and must be avoided at all cost. Banks rely on a central bank to prevent this outcome.

If a bank ever finds it needs more reserves it simply gets them from another bank. This rate of interbank lending is set by the central bank. In the US this is interbank rate is called the federal funds rate. The FED sets a target for this rate and creates or destroys money via open market operations to make sure the actual interbank rate is what they want.  It is the spread between the interbank rate and the rate a bank can loan money that limits lending. Central banks thus raise and lower the interbank rate to maximize bank profits. Monetary creation from bank lending leads to inflation. When monetary creation becomes excessive the central bank will step in and raise the cost of reserves thus slowing the over-harvesting.

Newly created money travels through the system helping the early acquirers first. The purchasing power of money falls in response to an increase in the quantity of money. In the real world a hypothetical increases in the money supply by 100% does not as neoclassical economics assumes simply lead to an equal across-the-board increase of 100% in prices. The banks do not descend overnight and double everyone’s cash balance.

The banks create new money to be spent on specific goods and services. The demand for these goods rises, raising these specific prices. Gradually, the new money ripples through the economy, raising demand and prices as it goes. Income and wealth are redistributed to those who receive the new money early in the process, at the expense of those who receive the new money late in the day and those on fixed incomes who receive no new money at all.

This results in redistribution from the late receivers to the early receivers of the new money. This occurs both during the inflation process as new money finishes working its way through the system and leads to permanent shifts in income and wealth that continue even after the money has reached a new equilibrium. The simplest example of this is fixed income groups who receive no new money in this process.

Finance Part I: Understanding the Parasite
Finance Part II: The Parasitic Cycle
Finance Part III: Divide, Conquer, Enslave


References:
McLeay M, Radia A, Thomas R. Money creation in the modern economy. Bank of England Monetary Analysis Directorate Quarterly Bulletin 2014 Q1
http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf
Rothbard MN. The Foundations of Modern Austrian Economics, Edwin Dolan, ed. (Kansas City: Sheed Andrews and McMeel, 1976), pp. 160-184
http://mises.org/rothbard/money.pdf
Post Edited: 1/12/17 for brevity and clarity

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[twiifm]

This is well known already.   But there's nothing parastic or deceptive about this.  Its required for liquidity. 

[CoinCube]

This is well known already.   But there's nothing parastic or deceptive about this.  Its required for liquidity.  

Any explanation of the monetary system must start with the basics. The parasitic aspects and their consequences will be fully explained in parts II and III.

[twiifm]

This is well known already.   But there's nothing parastic or deceptive about this.  Its required for liquidity.  

Any explanation of the monetary system must start with the basics. The parasitic aspects and their consequences will be fully explained in parts II and III.

Don't try to politicize banking.   You'll never understand it that way.   Try to look at it from view of macroeconomics.

Approach money as stock & flow rather than commodity.   Liquidity is more important to money than value

[bobdutica]

Interesting and well written analysis. I look forward to parts II, III and IV.
In addition to your listed references, I highly recommend the book: The Creature From Jekyll Island, a very readable exposition of the history of money and how central banks have been sucking wealth from the U.S.A. and Europe for the past few hundred years.

  

[CoinCube]

Part II has been edited, finalized, and is now up (see link at bottom of first post).
Part III will probably be done next week.

[Dr.Zaius]

You haven't brought up anything new, other then the typical summary of someone's Austrian economic youtube video. By the way Von Mises completely diverged away from the original father of Austrian economics Carl Menger.

Cryptocurrency's are nothing more then a digital rehashing of an already failed monetary system, the 100% Gold standard. Murray Rothbard's dream was to have his sack of gold swell in value from labor of others. The unanswered and unsolved economic issue in the west is usury. None of these "schools" even adress it, they all make up absurd theories to try and justify it. The worst thing to ever happen to economics was when it was divorced from moral philosophy and became a pseudo-science.

When historian's look back on the internet, they will find not only was it not a harbinger of innovation but worse, a total propagator of bad ideas and old errors.

[CoinCube]

You haven't brought up anything new, other then the typical summary of someone's Austrian economic youtube video.
...
The unanswered and unsolved economic issue in the west is usury. None of these "schools" even adress it, they all make up absurd theories to try and justify it. The worst thing to ever happen to economics was when it was divorced from moral philosophy and became a pseudo-science.

When historian's look back on the internet, they will find not only was it not a harbinger of innovation but worse, a total propagator of bad ideas and old errors.

Time will be the judge of that. Personally, I think historians of the future will speak of the barbarisms of the industrial era. Schoolchildren will be shocked to learn of bloodletting, slavery, and central banking.    

The first was vanquished with scientific progress. The second required mass death and a civil war. The third may yet be done in by cryptocurrency. To call cryptocurrency a rehashing of a failed system is in my opinion myopic and represents a failure to appreciate potential.
  
You are correct this post Is deeply related to Austrian economic theory. Austrian economic theory has the advantage of being closer to truth.

Edit (post edited 1/12/17 for clarity): I agree that the unanswered and unsolved economic issue in the west is usury.

[minor-transgression]

Not to disagree entirely with your thesis, but your math is somewhat suspect.

Your PartII seems to suggest a predator-prey model instead of your Parasite-Host thesis.

Have you read any of Professor Keen's work? His models suggest that these cycles
will occur regardless of the intention of any banker actions. Of course they are in the
best position to recognise the state of the system and to maximise their take ;-)

As the scorpion said, "It's in my nature"

I have some thoughts on this also, but not yet ready for discussion.

[CoinCube]

Not to disagree entirely with your thesis, but your math is somewhat suspect.

Your PartII seems to suggest a predator-prey model instead of your Parasite-Host thesis.

Have you read any of Professor Keen's work? His models suggest that these cycles
will occur regardless of the intention of any banker actions.

I am not very familiar with Professor Keen's work. However, I know his models are based on the Hyman Minsky's financial instability hypothesis.

Minsky proposed that, in the normal life cycle of an economy speculative investment bubbles are a natural part of financial markets. Minsky argued that in prosperous times corporate cash flow rises beyond what is needed to pay off debt leading to a speculative euphoria. He argued that this euphoria soon leads to debts that exceed what borrowers can pay off from incoming revenues and this in turn produces a financial crisis.

In my opinion both Keen and Minsky make a major error. They assume fractional reserve banking is part of a natural economy. Fractional reserve is what enables the increase in debt. It facilitates the boom which leads to the inevitable crash. Some cycles would occur naturally as humans occasionally act as irrational herd animals. However, these booms would be small shadows of what we see today. Eliminate fractional reserve and the boom can only be fulled by actual savings. As the boom grows available savings would be depleted and further funding would only be possible at higher cost. It is this natural market damper that is usurped by fractional reserve. The result is massive cyclical boom and bust that impoverishes the middle class.

As the scorpion said, "It's in my nature"

Fractional reserve banking is simple theft. It is an ancient and institutionalized form of theft who's perpetrators have managed to convince the masses it is a "natural part of the economy".

Edit: This post on Fractional Reserve discusses this topic in more depth.

[OROBTC]

...

Very nice introduction, CoinCube.  I look forward to seeing more.   

I offer two thoughts:

1)  Money is traditionally defined as having three major characteristics:

-- Unit of Account ("keeping score", how much your company is worth)
-- Medium of Exchange (you pay $2.75 for that head of lettuce)
-- Store of Value (your "money" ($50,000 say) will, you hope, will still be worth a real $50,000 in 5 years...)

It turns out that it is difficult for any currency to function as all three of the above.

Google:

a) Triffin's Dilemma
b) FOFOA's Dilemma

2)  It is the Central Banks (the Federal Reserve here in the USA) that typically print (or direct the printing of) the currencies, as opposed to "the banks".  Also, typically, those who are closest to (early receivers of) the newly created money get the most benefit.  This certainly true here in the USA.

Also, IIRC, the amounts that individual banks can lend out actually is actually limited.  I believe the leverage (approximate inverse of the required reserves that the banks must hold, typically as directed by the Central Bank) in the USA is about 10 x.  Meaning that for each dollar they have in reserves (to cover people wanting to take cash out of their accounts, etc.) that they can lend out close to 10 times that (fractional reserve banking).  Thus is "creating money out of thin air".

***

Do consider writing about gold and its role as you see it in the financial system, the whole subject of gold interests me very much.

[minor-transgression]

"It is an ancient and institutionalized form of theft who's perpetrators have managed to convince the masses it is a "natural part of the economy". "

Hmmmm. I would see government as the parasite, favouring stable ongoing symbiotic relationships that enable the maximum to
be extracted from the host without killing it. Banks then function as a competing parasite or as a predator, with the dynamics
favouring the predator (IMHO.) I do not have a reference to hand, but some have suggested that parasite-host-predator systems
accelerate evolution, and that perhaps these systems are "a natural part of" the ecosystem.

I cannot comment on Minsky, and I cannot recall Keen speaking specifically on fractional reserve banking. My own view is
that fractional reserve lending ended when "we" broke the link to gold as the benchmark for money and replaced it with the
US dollar (FRN). Also, when "light touch" regulation was applied, governments gave the "market" the power to decide what bank
leverage ought to be. We now know how well that worked.

As regards your comment on slavery, most people have not begun to see the link between debt and slavery.

[spazzdla]

Well I hope part 4 is the rise of crypto and not the enslavment of all mankind.. it is seeming more like that is where we will end up.

[twiifm]

I actually agree with most of Minsky analysis which is essentially correct. However, both Keen and Minsky make a major error. They assume fractional reserve banking is part of a natural economy. Calling fractional reserve banking part of a natural economy is morally equivalent to arguing slavery is a natural state of mankind.

Fractional reserve banking is simple theft. It is an ancient and institutionalized form of theft who's perpetrators have managed to convince the masses it is a "natural part of the economy".

I don't think that's what Minsky or Keen says.  Rather they point out how money is actually created in regular banking operations -- as double entry balance sheet operations. 

Banks create deposits from loans.  They don't loan out a multiplier of their reserves as the fractional reserve myth alludes to.  After they create the loan they look for the reserves.  If they don't have the reserves available they borrow it.  If no one lends it to them the Central Bank as as lender of last resort.

Both Minsky & Keen have an endogenous view of money.  They would hate BTC because it's inelastic.  Most of Post Keynesians would hate BTC because they all have a liquidity preference for money. BTC is designed to be inelastic and non liquid

[johnyj]

There is no secret regarding modern money creation, I like the explanation on wikipedia:

http://en.wikipedia.org/wiki/Money_creation

Only central bank can create money, any other banks are just playing with those money created by central banks. Commercial banks can't create money through FRB, they just created lots of checkbook numbers (M1/M2). If they could create money out of nothing, then no banks would going bankrupt during financial crisis

The problem is the ownership, those who create the money get the ownership of those money (they can't lend out any money that does not belong to them), so all the money originally belongs to central banks. This is a very big difference after the gold standard has been removed, means central banks secretly created lots of money out of nothing and bought huge amount of assets on the planet. Under a gold standard, they must create gold first, which has a similar production cost as its value

[CoinCube]

Hmmmm. I would see government as the parasite, favouring stable ongoing symbiotic relationships that enable the maximum to
be extracted from the host without killing it. Banks then function as a competing parasite or as a predator, with the dynamics
favouring the predator (IMHO.) I do not have a reference to hand, but some have suggested that parasite-host-predator systems
accelerate evolution, and that perhaps these systems are "a natural part of" the ecosystem.

I cannot comment on Minsky, and I cannot recall Keen speaking specifically on fractional reserve banking. My own view is
that fractional reserve lending ended when "we" broke the link to gold as the benchmark for money and replaced it with the
US dollar (FRN). Also, when "light touch" regulation was applied, governments gave the "market" the power to decide what bank
leverage ought to be. We now know how well that worked.

I agree with your analogy of Government and Banks as competing parasites. My next post Finance Part III will cover the role of government. I will have it up in the next few days.

Arguing whether fractional reserve ended after the link to gold was broken is a matter of semantics.  Banks can now lend out near unlimited funds without being limited in any real way by the the amount of reserves they have. In effect what we now is is a fractional reserve system with a 0% reserve requirement. To prevent runaway inflation central banks still require "reserves" which banks must now buy when they want to lend. Central banks raise and lower the price of these "reserves" as an effective tax on lending and use this mechanism to control inflation.

There is no secret regarding modern money creation, I like the explanation on Wikipedia:

http://en.wikipedia.org/wiki/Money_creation

That Wikipedia article is outdated and wrong.  
If you want to read an accurate explanation of money creation read this paper on money creation just published a month ago by the Bank of England's Monetary Analysis Directorate

http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf

[twiifm]

@coincube

Seems like you understand money creation but I don't get how you can go from that to Rothbard.

IMO Minsky has a more "real world" understanding of banking like the pdf you link,  rather than the anti-Central Bank theme of your articles

To put it another way.  If money had to be backed by gold reserves & there was no Central Bank.  Banks would still create money (M1,M2, etc) from creating loans then they would look for the reserves later to balance their books.  If there was not enough gold then they would be at greater risk of insolvency.

I think Rothbard didn't understand banking the way Minksy did.  Rothbard thinks money is created from fractional reserves & that's why it leads him to the conclusion that Fractional Reserve Banking is harmful

[CoinCube]

Banks create deposits from loans.  They don't loan out a multiplier of their reserves as the fractional reserve myth alludes to.  After they create the loan they look for the reserves.  If they don't have the reserves available they borrow it.  If no one lends it to them the Central Bank as as lender of last resort.

Agreed this is how the current system works.

Both Minsky & Keen have an endogenous view of money.  They would hate BTC because it's inelastic.  Most of Post Keynesians would hate BTC because they all have a liquidity preference for money.
BTC is designed to be inelastic and non liquid

Agreed

I actually agree with most of Minsky analysis which is essentially correct. However, both Keen and Minsky make a major error. They assume fractional reserve banking is part of a natural economy. Calling fractional reserve banking part of a natural economy is morally equivalent to arguing slavery is a natural state of mankind.

I don't think that's what Minsky or Keen says.  

From the wikipedia article on the Minsky Financial Instability Hypothesis
http://en.wikipedia.org/wiki/Financial_instability_hypothesis#financial_instability_hypothesis

Minsky proposed theories linking financial market fragility, in the normal life cycle of an economy, with speculative investment bubbles endogenous to financial markets. Minsky claimed that in prosperous times, when corporate cash flow rises beyond what is needed to pay off debt, a speculative euphoria develops, and soon thereafter debts exceed what borrowers can pay off from their incoming revenues, which in turn produces a financial crisis. As a result of such speculative borrowing bubbles, banks and lenders tighten credit availability, even to companies that can afford loans, and the economy subsequently contracts.

Minsky choice of terms "normal life cycle" and "endogenous to financial markets" lead me to believe that he has incorporated fractional reserve into his models as a part of his "normal life cycle".

However, I admit to not having read the primary source only the Wikipedia page and another summary elseware. If his analysis is deeper then I have given him credit for please let me know. As we have seen in this very thread Wikipedia is far from a completely reliable source.

@coincube

Seems like you understand money creation but I don't get how you can go from that to Rothbard.

IMO Minsky has a more "real world" understanding of banking like the pdf you link,  rather than the anti-Central Bank theme of your articles

It might be more clear when I publish Finance Part III. I'll get it done this weekend since there is interest. However the short answer is because Rothbard is right. Saying that is easy. My job is now to convince you.

 

[johnyj]

There is no secret regarding modern money creation, I like the explanation on Wikipedia:

http://en.wikipedia.org/wiki/Money_creation

That Wikipedia article is outdated and wrong.  
If you want to read an accurate explanation of money creation read this paper on money creation just published a month ago by the Bank of England's Monetary Analysis Directorate

http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf

Do you believe that banks will tell you the truth that they print money to buy assets around the world?

All the bankers, when they were asked about money creation (Where does your money come from originally), they immediately bring out the totally non-sense topic of fractional reserve banking, saying money were created out of loan and credit. Why? Because that will cover what is really happening and mislead most of the people right away into the wrong path, so that they will never find out the truth. The complexity of FRB and loan are already enough to lose many talent minds

Bitcoin community also learned the trick, it is this dialog they presented to bankers:
Banker: What is bitcoin?
Bitcoiner: Bitcoin is the first decentralized digital currency backed by cryptographic and the largest distributed hashing networks on the planet

If you follow this path, you will never understand bitcoin, just like if you follow the FRB path, you will never understand money creation  

[minor-transgression]

@ CoinCube

I'm still inclined to the view that banker behaviour imitates predation, though
a formal and irrefutable proof would be difficult to prepare. There are significant
similarities in the behaviour of parasites and predators, as shown by this paper:
http://www.blackwellpublishing.com/pdf/42-3-pp-693-726.pdf
thus it is conceivable that in some specific conditions, there is no difference
between predation and parasitism.

In defence of my view on banking predation, admittedly a single instance -
the banking predator is discussed in the second half of this Max Keiser show E593:
http://www.youtube.com/watch?v=udBFJQqxNiM

Just a fun comment: If you can see a parallell between a fox acquiring the keys to the
henhouse from the farmer in exchange for a handful of counterfeit notes, we are
definitively talking about predation by the bankers.

If you have a particular argument for parasitic behaviour, I will be interested to
read it.