So every once in a while you see some excitable talk about how banks are allowed to create money. Wikipedia has table in their fractional reserve entry demonstrating this:
| Table 1: Private bank T-account | ||||
|---|---|---|---|---|
| Action | Assets | Liabilites | Reserves | |
| 1 | Customer A deposits 100 paper dollars | None | $100 in interest-bearing deposits | 100 paper dollars |
| 2 | Bank loans $70 to Customer B | IOUs worth $70 | $100 in interest bearing deposits | 30 paper dollars |
| 3 | Customer B deposits 70 paper dollars | IOUs worth $70 | $170 in interest-bearing deposits | 100 paper dollars |
| 4 | Bank loans $49 to Customer C | IOUs worth $119 | $170 in interest-bearing deposits | 51 paper dollars |
| 5 | Customer C deposits 49 paper dollars | IOUs worth $119 | $219 in interest-bearing deposits | 100 paper dollars |
The bank's IOUs and deposits are increasing; there is more money with each step in the process to a maximum of 333 (100 the initial deposit/30% the reserve requirement).
What I realized today is that you can do the same thing with lawnmowers. Suppose Kelvin owns a lawnmower. He brings it to Larry and offers to give him the lawnmower in exchange for a note that says "Redeemable for (1) lawnmower -Larry" Does Kelvin own a lawnmower? Certainly, he bought it first and has a legally binding contract saying he's owed one. Does Larry own a lawnmower? You bet! He's cutting the grass right now.
In fact, Larry could show up to a casting of Oprah and present everyone a certificate good for one lawnmower in exchange for an IOU for one. It's Oprah, EVERYONE gets a lawnmower.
The fractional reserve system would insist that Larry keep one out of nine lawnmowers he accepts just in case Kelvin decides to mow; keeping one out of one lawnmowers like some suggest would pooper the Oprah party, and who wants that?
4 comments:
Ah yes, everything I ever wanted to know about fractional-reserve banking. Thanks honey!
I remember learning about this in a class once, minus the lawnmower application. But how could Larry give each audience member a certificate for one lawnmower? He only has the one that he got from Kelvin. Customer A deposited $100 and the bank only loaned out $70, because of the requirement to keep 30% on hand for use by Customer A. Larry would have to keep some fraction of the lawnmower on hand for Kelvin. So the folks in the audience would be getting a wheel here and a piston there. Let's assume that these people actually wanted the particular part that they were awarded, and that Kelvin would be satisfied in the fraction of his lawnmower he got back from Larry when it was time to mow. I think if you assume those things then your model stands up just fine. Eventually, Larry will be able to construct new whole lawn mowers from the parts that come in on those IOUs.
Of course I am probably missing something, I've never been real good with lawnmowers. It's been years in fact since the last time I used one.
it's funny how I can always tell when it's john posting and not alison...I appreciate that you used family members names for the lawn mower example...I'm just trying to figure out why Kelvin would give my dad a lawn mower...
Kt, I don't think Kelvin would give Larry a lawnmower, but he definitely might give him parts to construct a self-aware planet saving automaton. That's my best guess anyway.
CougarG, you're right; you can't play the Oprah game unless the reserve requirement is zero, and you're also right in that if it isn't zero they'd be trading around parts and you would "create" more than one lawnmower in the end; with a 25% reserve requirement there'd be enough certificates to make four assuming infinite re-depositing. For what you'd actually do with certificates for fractional lawnmowers, see above.
Post a Comment