Money, Banking, and Financial Markets

Many people think that when a customer goes to the bank and deposits $1,000, that money goes into a vault and stays at the bank. Then, when the customer comes back to withdraw fund, the bank employees pull the money from a drawer in the vault marked with that person's name.

Nothing could be further from the truth.

First, because currency is homogeneous (that is, one dollar is the same as another dollar) it is pooled with all other deposits from that day. At the end of the day, all the money in the bank is totaled up. Anything over what they expect to need for tomorrow's business is bundled and set for transfer to a reserve bank.

Second, the moment a deposit is made, the bank considers the total deposit its asset. The bank invests its assets in individuals and companies who wish to borrow money. On average, a bank will loan 90% of your money that you have deposited with the bank.

In a perfectly legal maneuver, the bank will make a loan merely by creating an new account for the recipient of the loan and funding it with money from your account. The bank turns your $1,000 deposit into $1,900 of customer accounts - money out of thin air!

No one borrows money just to let it sit in a bank account, however, so the loan recipient with withdraw those funds and spend them on something. Whoever receives those funds may deposit them in another bank.

The second bank also treats those funds as its assets, so it will loan 90% ($810) to someone else. Those funds get withdrawn and redeposited and another loan of $729 is made. Now, your $1,000 deposit has turned into $3,439.

The process of withdrawal, deposit, and loan will continue until your $1,000 deposit has become $10,000 in checkable deposits. $9,000 of that has been created out of thin air.

The amount of the deposits the banks did not loan out (10%) is called their reserve. 1 divided by the reserve is called the money multiplier (denoted as m), in this case m=10. Your $1,000 deposit x m = $10,000 worth of deposits that can be supported by the $1,000 reserve you deposited.

Book Description
Economics of Money, Banking, and Financial Markets heralded a dramatic shift in the teaching of the money and banking course in its first edition, and today it is still setting the standard. By applying an analytical framework to the patient, stepped-out development of models, Frederic Mishkin draws students into a deeper understanding of modern monetary theory, banking, and policy. His landmark combination of common sense applications with current, real-world events provides authoritative, comprehensive coverage in an informal tone students appreciate. Mishkin's previous post as Executive Vice President and Director of Research at the Federal Reserve Bank of New York lends an insiders-view that helps to demystify this key institution for students.

Book Info
Contains many new insights on the monetary policy process, the regulation and supervision of the financial system, and the internationalization of financial markets.

Economics of Money, Banking, and Financial Markets, Update (7th Edition) (Addison-Wesley Series in Economics)

Economics of Money, Banking and Financial Markets plus MyEconLab plus eBook 1-semester Student Access Kit, The (8th Edition) (MyEconLab Series)

Despite backing by the Bank of England, Northern Rock customers are flocking to withdraw their money. They have come to the sudden realization that the fragile pyramid scheme of fractional reserve banking doesn't guarantee access to the funds they have on deposit.

In order for Northern Rock to have cash on hand to settle their customer's accounts, they have to withdraw funds they hold in reserve with the Bank of England. If that withdrawal depletes Northern Rock's reserves sufficiently, they have to borrow money from the Bank of England.

Where does the Bank of England get the money to loan? They just create it. Someone goes into the computer and increases the reserves of Northern Rock by the loan amount and presses enter. It really is that simple.

In other words, the cash being withdrawn from Northern Rock doesn't exist until the customer withdraws it. Therefore, with every withdrawal, the monetary base is inflated.

So, the "backing" by the Bank of England essentially comes directly from the accounts and wallets of all other holders of British Pounds - the purchasing power of the funds they hold are diminished by just enough to make the loan to Northern Rock.

In the final tally, the Bank of England profits by the interest on the loan to Northern Rock, Northern Rock gets the funds to pay their depositors and make new loans, and all other commercial banks are unaffected. The only people hurt are all the actual account and cash holders that, by the magic of legal tender laws, are required to use and accept.

If that doesn't sound fishy to you, you must have a large stake in banking stocks.

Since 1980, the Fed has enjoyed the absolute power to do literally anything it wants: to buy not only U.S. government securities, but any asset whatever, to buy as many assets, and to inflate credit as much as it pleases. There are no restraints on the Federal Reserve. The Fed is master of all it controls. - Murry N. Rothbard, economist

C.A. Phillips, T.F. McManus, R.W. Nelson - 1937

PREFACE

The task that is attempted in this book is a contribution to an understanding of the banking and financial events of the War and post-War period as the underlying causes of the Great Depression in the United States. There were many causes which contributed to this collapse; among others, mention might be made of misguided tariff policy, war debts, monopolistic practices. Our failure to accord certain non-monetary phenomena special treatment is not to be construed as disregarding their influence; we have preferred to focus attention upon those causes which we believe to be predominantly basic.

There is good reason for this belief. In no previous depression have all of the same non-monetary phenomena been present; in no previous depression have the monetary phenomena been absent. The financial mistakes of the past two decades are not dissimilar to those of England during and following the Napoleonic Wars, and the inflation of the Civil War and the depression of the 'seventies bear striking resemblance to the recent upheaval; the follies of the ages are repeated again and again. It is a melancholy fact that each generation must relearn the fundamental principles of money in the bitter school of experience. The inflationists, it would seem, we always have with us. It is nevertheless a duty of economists to devote attention to periodic reiteration of the ancient truths of monetary science; it is necessary to make as familiar as possible the workings of the financial machinery if further errors are to be avoided in the future. It is to the mismanagement of the monetary mechanism that most of our recent troubles are chiefly ascribable. And with the juggernaut of another inflationary boom already upon us, emphasis upon the monetary causes of the last depression, to the neglect of others, is not only warranted but needful if progress toward an understanding of business cycles is to be expected.

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