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 ParasiteFinance Part II: The Parasitic CycleFinance Part III: Divide, Conquer, EnslaveReferences:
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.pdfRothbard 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.pdfPost Edited: 1/12/17 for brevity and clarity
