Loans Do Not Come From Savings
It was widely believed and perhaps still is, that banks lend deposits. That is not how it works, but let’s review the theory.
Bank Incorrect Theory
- You get a paycheck, deposit that in you bank.
- The bank lends the money and it gets spent and redeposited.
- The redeposited money gets lent again and again.
GameStop Correct Theory
- You get money and buy shares of GameStop.
- The brokerage holding your shares lend them out.
- Someone buys the shares and the brokerage holding them lends the same shares out again.
Similarities and Difference
The GameStop theory is correct, the bank lending theory is incorrect.
However, the results are similar. But GameStop is easier to understand in three simple points because they are correct.
Money and monetary history is far more complicated. Let’s discuss M1, money that is supposedly available on demand.
M1 Money Supposedly Available on Demand
M1 consists of Currency, Demand Deposits, and Other Checkable Deposits.
Demand Deposits are checking accounts. Since it is your money, it should be in your account. It isn’t and hasn’t been since 1994.
The Fed used to be reserve requirements of 10% on checking accounts. This gave rise to the incorrect theory that banks lend out 90% of the checking accounts, the money get redeposited elsewhere and lent out again.
Too Big to Fail
In reality reserves never had anything to do with lending. Banks make loans based on “belief” in willingness of the borrower to repay. This blew up in the Great Financial crisis when people walked away from loans on houses.
Of course, the Fed stepped in to bail out the banks.
With that background let’s discuss a surge in M1.
What’s Behind the Surge in M1 Money Supply?
M1 was $1.153 trillion in September of 1994. It did not exceed that amount until it hit $1.208 trillion in September of 2001.
I discussed this on November 29, 2007 in Where’s the Cash?
Sweeps are automated programs that “sweep” funds from one type of account into another type of account automatically. In this case we are talking about programs that allow banks to “sweep” funds from checking accounts to other types of accounts such as savings accounts that allow money to be lent out. Sweeps were initiated by Greenspan in 1994.
Money that is supposed to be in your checking account isn’t really there at all. It is swept into savings accounts nightly so that it can be lent out.
There are no reserves on savings accounts. Coupled with sweeps, that meant there really no reserves at all.
Fictional Reserve Lending
That’s what inspired my 2009 post Fictional Reserve Lending and the Myth of Excess Reserves.
I did a follow up post to Where’s the Cash? on March 27, 2020 in Fictional Reserve Lending Is the New Official Policy.
With little fanfare or media coverage, the Fed made this Announcement on Reserves.
“As announced on March 15, 2020, the Board reduced reserve requirement ratios to zero percent effective March 26, 2020. This action eliminated reserve requirements for all depository institutions.“
Amusingly, a few days ago yet another article appeared explaining how the Money Multiplier works. The example goes like this: Someone deposits $10,000 and a bank lends out $9,000 and then the $9,000 gets redeposited and 90% of the gets lent out and so an and so forth.
True Similarities
- There may be little of your money in your checking account, allegedly available on demand.
- 40% or more of the shares of GameStop are fabricated but allegedly available on demand.
QE Monetary Expansion
The surge in M1 is related to the Fed’s expansion of its balance sheet. In other words, currency is due to Fed manufacturing dollars on the spot via QE, backed by nothing.
A New York Fed article explains why QE drives up M1: What’s Driving Up Money Growth?
M1 growth is highly positively correlated with the growth in reserves generated by Fed asset purchases. The reason for this is simple: Reserves held with the central bank are assets for banks. As the Fed expands reserves, banks must either sell other assets (keeping the overall level of assets unchanged), issue more liabilities or equity (expanding the level of assets), or some combination of the two.
Fractional Reserve Lending
Except for QE artifacts, money that is supposed to be available on demand is not available on demand.
Money you think you have available to you has already been lent out and then some.
Total Credit Market Debt Owed
Fractional Reserve Lending on Steroids
M1 is approaching $7 trillion. Total credit market debt is $81.8 trillion dollars.
Again, I discussed this setup all the way back in 2009 in my post Fictional Reserve Lending and the Myth of Excess Reserves.
There are no reserves, excess or otherwise, but at least it is now official policy.
The current setup is fractional reserve lending on steroids.
What the Fed has done is quite similar to GameStop except for one thing: The Fed can and will print unlimited dollars but there is no one who can print unlimited shares of GameStop.
Who Benefits From Fictional Reserve Lending?
In general, those with first access to money.
That group consists of banks, brokerage houses, the wealthy, hedge funds (until they blow up), etc.
Casino Rules
The top 5% get about 90% of the benefits.
The next 5% get about half the rest. The bottom 50% get no benefit at all.
I have railed against “fractional reserve lending” as “legalized fraud” for years.
That’s what QE is all about.
It’s not for you or me, and it is what the WallStreetBets crowd has exposed.
Fictional Reserve Shorting vs Fictional Reserve Lending
In reality, money supply is total fiction.
It’s just a bunch of numbers in the system, backed by nothing other than the Fed’s ability and willingness to bail out anyone big enough to matter in its semi-official Too Big to Fail policy.
Roughly speaking, Fictional Reserve Shorting ≈ Fictional Reserve Lending except the latter is backed by the Fed.
100% Gold Backed Dollar vs Too Big to Fail
In case you missed it, I tie the remaining pieces together in Naked Shorting is Illegal: So How the Hell was GameStop 140% Short?
All this fiction in money is why I have sought a 100% gold backed dollar.
Instead, the giant casino in money explains the giant casino in stocks.
Mish
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Mish, when you say you want a 100% gold backed dollar do you mean that individuals can exchange their dollars for gold meaning complete, without conditions convertibility?
Now that we have a new administration that really cares and controls both Houses what do you propose should Congress do to prevent naked shorting, protect the shareholding public and generally fix the financial system? There is even enough bipartisan support to vote a good solution. Will the Biden administration take a stand or will they duck out on this one?
Recursive debt turns society into a bunch of “traders” in the worst sense of the word: everyone just trying to outmaneuver and out-luck others out of their money. Why look for an actual productive enterprise to invest in when you can place a YOLO/”bar bell” bet on the next crowd-powered trade that will 10x in a few days?
Knock knock! Who’s there? Minsky…
I’m seeing new car loans for 84 months regularly now. Years ago it was 36, then 48, then 60, then 72… A woman who lost her husband to Covid after 65 days in the hospital received a med bill for $4M. Later she learned insurance would pay for it. But who’s really going to pay for that and so many others and when? High times in the market indeed. Is it like 1929? Is this where China inevitably crushes us? Or are they still dependent on our buying their stuff?
I have seen 96 month for car loans but that was about 4 years ago.
China’s debt situation is even worse, much worse. Much bad debt in the Big Four National Banks has been shoved into Special Investment Vehicles where all this bad debt is hidden. Also much private borrowing by corporations and financial firms is completely hidden from Chinese regulators. It is a world full of debt everywhere you look.
5 1/2 years ago… link to youtube.com
The Hershey bar is a well-recognized and trusted brand while the silver was just a generic silver bar. If he had run the same experiment with American Silver Eagles coins I bet that most people would have chosen the silver.
“The top 5% get about 90% of the benefits.
The next 5% get about half the rest. The bottom 50% get no benefit at all.
I have railed against “fractional reserve lending” as “legalized fraud” for years.”
The first two statements are why the third statement is true.
Since 1980, both tax policy and global trade have eviscerated median wages and net worth to the benefit of the top.
The Fed, in turn keeps household and government debt cheap, thus averting angst with campaign contributors while enabling the 90% to “survive”, as well as keeping banks, Fed members, lucrative.
more accurately, the bottom 50% lose
No debate, though my guess is those between the 50% to 90% are experiencing an increase in debt to income over time. I’d be interested in seeing breakdown of household debt to income per decile over time, does Fred have anything?
Yeah there must be one group, like those between 17% and 18% from the top or so, that is not effected by the FED policies… And then it’s interesting if those numbers are going down or up. I guess… down.