Best of the Week
Most Popular
1. Investing in a Bubble Mania Stock Market Trending Towards Financial Crisis 2.0 CRASH! - 9th Sep 21
2.Tech Stocks Bubble Valuations 2000 vs 2021 - 25th Sep 21
3.Stock Market FOMO Going into Crash Season - 8th Oct 21
4.Stock Market FOMO Hits September Brick Wall - Evergrande China's Lehman's Moment - 22nd Sep 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.How to Protect Your Self From a Stock Market CRASH / Bear Market? - 14th Oct 21
7.AI Stocks Portfolio Buying and Selling Levels Going Into Market Correction - 11th Oct 21
8.Why Silver Price Could Crash by 20%! - 5th Oct 21
9.Powell: Inflation Might Not Be Transitory, After All - 3rd Oct 21
10.Global Stock Markets Topped 60 Days Before the US Stocks Peaked - 23rd Sep 21
Last 7 days
Bitcoin Price TRIGGER for Accumulating Into Alt Coins for 2022 Price Explosion - 30th Nov 21
Omicron Covid Wave 4 Impact on Financial Markets - 30th Nov 21
Can You Hear It? That’s the Crowd Booing Gold’s Downturn - 30th Nov 21
Economic and Market Impacts of Omicron Strain Covid 4th Wave - 30th Nov 21
Stock Market Historical Trends Suggest A Strengthening Bullish Trend In December - 30th Nov 21
Crypto Market Analysis: What Trading Will Look Like in 2022 for Novice and Veteran Traders? - 30th Nov 21
Best Stocks for Investing to Profit form the Metaverse and Get Rich - 29th Nov 21
Should You Invest In Real Estate In 2021? - 29th Nov 21
Silver Long-term Trend Analysis - 28th Nov 21
Silver Mining Stocks Fundamentals - 28th Nov 21
Crude Oil Didn’t Like Thanksgiving Turkey This Year - 28th Nov 21
Sheffield First Snow Winter 2021 - Snowballs and Snowmen Fun - 28th Nov 21
Stock Market Investing LESSON - Buying Value - 27th Nov 21
Corsair MP600 NVME M.2 SSD 66% Performance Loss After 6 Months of Use - Benchmark Tests - 27th Nov 21
Stock Maket Trading Lesson - How to REALLY Trade Markets - 26th Nov 21
SILVER Price Trend Analysis - 26th Nov 21
Federal Reserve Asks Americans to Eat Soy “Meat” for Thanksgiving - 26th Nov 21
Is the S&P 500 Topping or Just Consolidating? - 26th Nov 21
Is a Bigger Drop in Gold Price Just Around the Corner? - 26th Nov 21
Financial Stocks ETF Sector XLF Pullback Sets Up A New $43.60 Upside Target - 26th Nov 21
A Couple of Things to Think About Before Buying Shares - 25th Nov 21
UK Best Fixed Rate Tariff Deal is to NOT FIX Gas and Electric Energy Tariffs During Winter 2021-22 - 25th Nov 21
Stock Market Begins it's Year End Seasonal Santa Rally - 24th Nov 21
How Silver Can Conquer $50+ in 2022 - 24th Nov 21
Stock Market Betting on Hawkish Fed - 24th Nov 21
Stock Market Elliott Wave Trend Forecast - 24th Nov 21
Your once-a-year All-Access Financial Markets Analysis Pass - 24th Nov 21
Did Zillow’s $300 million flop prove me wrong? - 24th Nov 21
Now Malaysian Drivers Renew Their Kurnia Car Insurance Online With Fincrew.my - 24th Nov 21
Gold / Silver Ratio - 23rd Nov 21
Stock Market Sentiment Speaks: Can We Get To 5500SPX In 2022? But 4440SPX Comes First - 23rd Nov 21
A Month-to-month breakdown of how Much Money Individuals are Spending on Stocks - 23rd Nov 21
S&P 500: Rallying Tech Stocks vs. Plummeting Oil Stocks - 23rd Nov 21
Like the Latest Bond Flick, the US Dollar Has No Time to Die - 23rd Nov 21
Why BITCOIN NEW ALL TIME HIGH Changes EVERYTHING! - 22nd Nov 21
Cannabis ETF MJ Basing & Volatility Patterns - 22nd Nov 21
The Most Important Lesson Learned from this COVID Pandemic - 22nd Nov 21
Dow Stock Market Trend Analysis - 22nd Nov 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Why the Money Supply is Collapsing

Economics / Money Supply Jan 22, 2009 - 05:31 AM GMT

By: Joseph_Toronto

Economics Best Financial Markets Analysis ArticleInflation and deflation are almost always monetary phenomena as are booms and busts, recessions and depressions. The current economic environment has surprised nearly everyone with the sharpness of the decline, it's suddenness and it's sheer ferocity. To better understand what is happening in the economy and how it began, I believe it is helpful to understand the nature of modern money and banking, and the central bank's role.


Modern money is all “debt”. Debt owed to the banking system. It is nothing more than that. Nearly all money now in circulation was created in the form a debt someone owes to the banking system.

Under money and banking theory, the money supply must grow in conjunction with economic growth. The money supply must always be sufficient to accommodate and facilitate economic activity, trade and commerce. In this role, money is defined as little more than “units of economic transaction”. What is a little more murky, is how does our banking system get the money supply to grow in lock step with economic growth so that we don't experience inflation or deflation, or booms and busts. Under our current system, where our government has delegated control of the money supply to a central banking system, there is one and only one way the money supply can grow and that is by the bank issuing a “debt” to someone. 

A bank cannot simply print bills and spend them or write checks and buy stuff. They can only issue a debt to someone else, some private party, and that person then can spend the proceeds of his loan at his favorite merchant or supplier. The loan must eventually be paid back, with interest or at least rolled over or extended and re-extended. This means that in order for new money to enter into circulation, someone must borrow money from a bank and spend the proceeds (the amount of the loan) at their favorite merchant who in turn pays his suppliers who then pay their… and on and on it goes. The new money, “created” in the form of a loan from a bank is now part of the money supply and has entered into circulation in the economy.

But why isn't the money a bank lends already part of the money supply. Don't they just get the money they loan out from other people who deposit money at the bank as savings or checking deposits and earn interest? Well, yes and no. Depositor's savings obviously are a liability to the bank because they have to pay it back to the depositor or the owner upon demand. But as long as the bank has this persons money,  it sits idle as part of the bank's reserves until it is put to work by being loaned out to someone else. You may be asking yourself how the money supply grows if banks can only loan funds that others have deposited. Well, they don't. They can lend more, a lot more.

Once a bank gets a new deposit, they can create a lot of money out of thin air and loan it out in our system called fractional reserve banking which creates an effect called the multiplier effect. This means that a bank may lend and maintain a portfolio of loans far in excess of the reserves necessary to fund the deposits which created those loans. At present, our banks are required to maintain cash reserves of only 6% of its loan portfolio. This reserve ratio together with the multiplier effect allows the banking system to generate new loans, new money, of up to ten times the amount of a new deposit. Here's how the Federal Reserve describes this effect:

“Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81. As the process continues, the banking system can expand the initial deposit of $100 into a maximum of $1,000 of money ($100+$90+81+$72.90+…=$1,000). In contrast, with a 20% reserve requirement, the banking system would be able to expand the initial $100 deposit into a maximum of $500 ($100+$80+$64+$51.20+…=$500).”

This multiplier effect can cause the money supply to grow, and as we have recently witnessed, can also cause the money supply to collapse when loans default or as loans are paid back. The reverse multiplier effect as we shall call it can become exacerbated when, in uncertain times, banks become afraid to loan and fearing future defaults stop lending. Likewise debtors too can become fearful of going into debt and don't want to borrow. As we are experiencing now, the reverse multiplier effect can be sudden and ferocious, much like a collapsing ponzi pyramid. But dare we actually call it that?

Very Best Regards,

Joe

Affiliated investment Advisors,Inc.

http://joesinvestoblog.com

joe@aiadvisors.com

Joseph Toronto has been a portfolio manager for 26 years for some of the largest institutions in the western U.S. In 1993, Joe founded Affiliated Investment Advisors, Inc., as a registered investment advisor for serious investors seeking professional management for superior safety and returns. Mr. Toronto is a Chartered Financial Analyst and is a member of the Salt Lake City Chapter of the Financial Analysts Society and the Association for Investment Management and Research. He has a Master's degree in investment securities and a B.A. degree with a dual major in finance and management.

Affiliated Investment Advisors, Inc. is a "traditional" portfolio manager for retirement plans, profit sharing plans, individuals, IRA's and other trusts. Affiliated's portfolio management services are NOT alternative "hedge" fund style and are “fee only” taking no commissions or performance incentives. Affiliated is not a stock broker or financial planner and does not sell any investment or insurance fund or product.

Opinions expressed in these reports may change without prior notice. Joseph Toronto and/or the staffs at Affiliated Investment Advisors, Inc. may or may not have investments in any stocks, funds or investments cited above. © Copyright 2009 Joseph Toronto and Affiliated Investment Advisors, Inc. All trademarks and copyrights of information referenced herein are owned by their respective owners.

© 2009 Copyright Joseph Toronto - All Rights Reserved


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in