The Essence of Money #7
>Article #98331 (98374 is last): >From: Edward Flaherty <email@example.com> >Date: Thu Nov 26 10:23:48 1998 >You argue that I contradict myself when I state that money is >destroyed when a loan is repaid, but then isn't really destroyed >because banks create deposits when they pay their operating >expenses, pay dividends, or buy assets. JCT: As I previously pointed out, Flaherty's first contradiction is stating that money is destroyed but then isn't really destroyed. He contradicts his statement that "banks create deposits when they pay their expenses, etc" later in this post and I'll ask if anyone can spot the two times he contradicts this statement.
>There is no contradiction. You insist on viewing the two transactions >separately, whereas I am looking at the combined effects. When a >customer repays a loan, the bank's balance sheets are affected in the >following manner:
Assets Liabilities ---------------------------------- - loans | - deposits Money is destroyed because customer deposits have declined. Any profits, such as interest, that the bank gets are added to its capital accounts. This is the first transaction. To stop the analysis here as you do is silly. Banks must pay their operating expenses like any other firm. The bank now has fewer deposits, so it also now has more excess reserves from which it can create new deposits. Suppose the bank pays its employees by writing them checks against its own reserves. The employees then deposit those checks back into the bank. This is the second transaction. The bank's balance sheet is affected thusly: Assets Liabilities ---------------------------------- | + deposits | - capital
>Money is created because customer deposits have risen... and yet >*there is no corresponding increase in the amount of debt owed by the >non-bank public.* The bank has seemingly created new money, but when >BOTH transactions are viewed together, the bank has only re-created >the money that was previously seemingly destroyed. In other words, >*banks MUST spend as much money back into the economy as they collect >in interest.* >This demolishes the Debt Virus myth that the only source of deposit >money is the bank lending process. Oh, and then there's all that >pesky data that shows the money supply greatly exceeds the total >volume of bank credit. If the lending process is the only source of >money creation, as the DV hypothesis so strenuously asserts, then >where in the hell did all the extra money come from? >------------ >In addition, allow me to offer a translation. What you call a >"reservoir" in your Figures 3 and 3b, economists call "excess >reserves." *All* deposits a bank creates are done by using these >excess reserves. It does not matter whether the deposit is created >to pay operating costs, to pay dividends, to buy fixed assets, or to >buy another kind of asset -- loans. JCT: Of course, I agree that deposits are created when banks "buy" loans but disagree that deposits are created to pay operating costs since he contradicts this statement himself a little later.
>So, in terms of your figures, everything is connected to the >reservoir. JCT: I think that stating that new liquidity is created in a piggy bank without a source and that liquidity is destroyed in a piggy bank without a sink would get him laughed out of any engineering models class. Any engineer could explain that if something new is created, there has to be a source and if something is destroyed, there must be a sink.
>When the public makes a new cash deposit, the bank's excess reserve >go up; that is, its reservoir rises. >When the public makes interest payments to the bank, the bank's >deposits go down, but this frees up reserves which converts them to >excess reserves; that is, the reservoir goes up. JCT: I say that when interest payments are made, the reservoir goes up. Flaherty states that it goes down and up.
>When the public makes a loan principal payment the same is true. JCT: I say that when a loan principal payment is made, it has no effect on the reservoir though he thinks it goes up and down again.
>When the public withdraws cash, the bank's total reserves and excess >reserves decline; that is, the reservoir falls. When the bank pays >its operating costs, dividends, or buys fixed assets, its excess >reserves decline; that is, its reservoir falls. And the same is >true when the bank makes a new loan. JCT: I have to agree that when the public takes out money or the banks pay its operating expenses, the reservoir falls. But I disagree that bank loans have any effect on the reservoir at all.
>So congratulations, JCT, you have successfully almost illustrated a >bank by using a plumming analogy. Just eliminate your + and -, and >connect all arrows to the reservoir and you'll have it right. JCT: Eliminating the + source and - sink leaves us with the piggy ank model in Fig. 2. Yet, without any source or sink, no engineer could accept that you've created or destroyed anything.
>Article #98358 (98374 is last): >From: Edward Flaherty <firstname.lastname@example.org> >Date: Thu Nov 26 18:05:29 1998 >The bank has every incentive to acquire some new asset, a bond, a >new loan, office supplies, or whatever, rather than maintain idle >reserves. So my earlier statement still stands: bank income has only >three possible outlets: expenses, dividends, or assets -- even if >those assets are reserves. JCT: I thought that he earlier said that it was spent on expenses, dividends, assets or loans.
>Article #98359 (98374 is last): >From: Edward Flaherty <email@example.com> >Date: Thu Nov 26 18:20:58 1998 >firstname.lastname@example.org wrote: >>The IMPORTANT issue is the way in which this money is "spent" back >>into the economy: How much of this money is spent to pay bank >>employees and/or to pay realistic rent for the space required for >>such employees. >FDIC data indicates that about 50% of bank expenses is interest on >customer deposits. About 30% is employee compensation. The rest is >miscellaneous stuff. JCT: I agree that of the money spent back into the economy, 50% is for interest on customer deposits, 30% on salaries and 20% on other stuff.
>Any "new cash deposit" made by the public came from the proceeds of >a loan or from the creation of dollars by the Fed in exchange for >extiquising a loan to the government from the public. JCT: Flaherty doesn't seem to disagree with this statement.
>Article #98409 (98413 is last): >From: email@example.com (GChand4059) >Date: Fri Nov 27 17:52:55 1998 >Turmel wrote: >>It's obvious that you can't answer the the questions and you >>keep trying to hide that fact with evasions and insults.> >I observe Prof. Flaherty answers questions using t-accounts. Engineer >Turmel explains using a plumming diagram. Engineers are not trained >in double-entry bookkeeping; economists are not trained in plumming >diagrams. JCT: Actually, I have quite a lot of experience in accounting. Not only did I take Accounting 100 but fluked taking Accounting 200, "for accountants only" which just happened to a study of present values: interest rates. I find it an amazing fluke that I was allowed to take this course which should later be of such use to me in my current Abolish Interest Rates project. >However they should both lead to the same answer. JCT: Sure we both get the same answer for the sum of deposits but the question is where those deposits come from. Flaherty insists there is no source of new deposits and no sink for old ones and that liquidity magically appears in the circuit. Any engineer would have to agree with me that this is silly.
>Following t-accounts requires some accounting background. Plumming >diagrams take some drafting background. JCT: Fortunately, I have both. So, though Prof. Flaherty's knowledge of engineering models may be laughable, it's not fair to assume that my knowledge of accounting is laughable too.
>To make matters worse, neither t-accounts nor plumbing diagrams >transmit very good over the internet. JCT: That's why I provided both the plumbing for Flaherty's piggy bank model in Fig. 2 and for my chartered bank model in Fig. 3 of http://turmelpress.com/bankmath.htm . I don't know why it would be so very difficult for people to download both graphs and print them out to enable them to stay with our discussions. Besides, the engineers use plumbing to model electrical flows accurately and I'd think that having an accurate plumbing model for financial flows could only ease the confusion and difficulties.
>Article #98413 (98413 is last): >From: firstname.lastname@example.org (Grinch) >Date: Fri Nov 27 19:52:17 1998 >If you believe that then you can hire an economist to construct a >building for you and an engineer to manage your business's financial >accounts. Different fields of study develop different tools of >analysis because they work and others *don't*. >You confuse them at you peril. JCT: The money system is not immune from systems engineering modelling as my models will eventually prove. Finally, I hope readers have noticed the times Flaherty contradicted his original statement. I'd also point out that it's been a week since I posted the original 10 questions. Though Flaherty's taken the time to make 6 different posts to this stream, all he does is parrot his standard contradictions and simply refuses to deal with the questions. If he can't take the 10 minutes to answer the questions, then I'll assume that the parrot has withdrawn from the debate and answer them myself on Monday night. -------------------------------
TURMEL: The Essence of Money #8
>Article #98492 (98532 is last): >From: Edward Flaherty <email@example.com> >Date: Sun Nov 29 02:19:50 1998 >John Turmel wrote: >>JCT: I think that stating that new liquidity is created in a piggy >>bank without a source and that liquidity is destroyed in a piggy >>bank without a sink would get him laughed out of any engineering >>models class. Any engineer could explain that if something new is >>created, there has to be a source and if something is destroyed, >>there must be a sink.
>Suppose Bank A has the following balance sheet:...
>Now suppose the borrower repays the loan with interest,..
>Let's start again with the original balance sheet...
>What if the bank pays $100 to its employees?...
>Suppose the borrower writes a check for $100...
>And this is where JCT's engineering metaphor seemingly breaks down. >Engineers cannot assume, say, energy magically coming from nowhere >when designing a system. However, in a banking system the extra >$900 in liquidity can seemingly come from nowhere because it's just >bookentries. That is why we refer to a deposit multiplier, >specifically, excess reserves times (1/required reserve ratio) for >a banking system. Note that I used the word "seemingly." This is >because that is not what really happens. The extra $900 comes from >the public via the voluntary loan transaction. The banking system >creates new deposits and gives them to the public in exchange for a >new financial asset, loans.
JCT: Prof. Edward "The Parrot" Flaherty insists on repeating the same old canards about how he thinks the creation of money works but notice that once again, he failed to take the few minutes necessary to answer the original questions. I wonder how many jokes about him backing down it's going to take before he answers them like other have done? Frankly, I'll let him parrot his errors all he wants but I don't think it's fair that I answer him until he has answered me. No matter how many pages of text he publishes, it's still fishy that he continues to back down from answering a few simple questions. If he hasn't answered the questions by tomorrow night, I'll go further into discussions with those who did. If he can't answer, I hope he keeps his nose out of a debate he has proven he's not up to participating in. You have to admit, he's taken some pretty substantial ridicule for his failure to respond and no amount of pontificating can hide that fact. Don't you wonder why he's so scared? Though I'm sure he doesn't even know how the questions could trap him, he's still so scared that he'll probably suffer my abuse right to the end. But I'll also bet that once I publish my explanations, he'll be the first to try to get back into the debate. I don't think someone who hasn't had the nerve to deal with the actual questions deserves to be taken seriously.
>Article #98514 (98532 is last): >From: firstname.lastname@example.org (GChand4059) >Date: Sun Nov 29 13:00:50 1998 >Also, sorry for unfairness about your accounting literacy. JCT: No problem about the accounting. Like I pointed out, it was an oversight on the part of the accounting department that a non- accountant fluked getting into the second accounting course about interest rates. Still, many engineers do take accounting figuring that it's the most useful knowledge an engineer would need.
>I was just trying to understand why you and Prof. Flaherty don't >communicate better. JCT: How does one communicate with a parrot. Sure it may have a substantial vocabulary but don't expect it to answer questions.
>Further, I believe applying engineering thinking to economics has >great potential. Keep up the good work (and get the kind, gentle >economists on our side.) JCT: Actually, this discussion has not only given me a much better insight on how economist view the creation of money but has also shown me how to best explain it to them. My upcoming post will offer new insights I hope clear up the confusion to everyone's satisfaction.
>Further, are you familiar with Piping and Instrumentation diagrams? JCT: That's what the plumbing diagrams are. Perhaps if you asked someone with a Pentium to pick and print the two figures, you'll agree that Carleton University taught me my engineering modelling well.
>If we can add some gates and valves and measuring devices to the >economics system we may move things forward. JCT: It's already been done and thing are moving forward. -------------------------------
The Essence of Money #9
>Article #98570 (98597 is last): >From: Edward Flaherty <email@example.com> >Date: Mon Nov 30 12:36:04 1998 >John Turmel wrote: >>JCT: Prof. Edward "The Parrot" Flaherty insists on repeating the >>same old canards about how he thinks the creation of money works but >>notice that once again, he failed to take the few minutes necessary >to answer the original questions. >John, maybe you missed my post in which I said that I did not answer >your Ten Questions because William Hummel answered them correctly. >Let me spell that out for you since it was not evidently clear to >you: I endorse Hummel's answers. >In other word's: >My answers = Hummel's answers. >Do you understand? Should I use fewer syllables? >How about a crayon? JCT: His answers are Hummell's answers but perhaps he didn't notice that Hummell didn't answer the questions either. Why would I keep challenging both Hummell and Flaherty to answer the questions if Hummell had answered them. Anyway, I've given up waiting for Prof. Edward "The Parrot" Flaherty or William Hummell to answer the 10 questions at the basis of this discussion. After a week of prodding him and half a dozen of his posts, we have to admit that there's something intriguing about his hesitancy to respond. I'll bet that after I've published my answers he'll stick his nose into the discussion but I hope no one takes my refusal to answer him as any weakness on may part. I just don't engage in conversation with parrots. So here goes:
PLUMBING For those who can't download Fig. 2 and Fig. 3 from http://turmelpress.com/bankmath.htm , they are actually the simplest of all the graphs and are quite easy to draw yourselves.
Draw two rectangles side by side labelling the left rectangle "piggy bank" and the second "chartered bank."
Draw three arrows down onto the top of each rectangle to represent the financial flows into the system.
From left to right, label the: first arrow: Savings deposits IN pipe second arrow: Interest and Fees IN pipe third arrow: Loan payments IN pipe
Now draw three arrows from the bottom of each rectangle to represent the financial flows out of the system.
From left to right, label the: first arrow: Savings withdrawals OUT pipe second arrow: Bank expenses OUT pipe third arrow: Loans made OUT pipe
These input and output pipes represent all the possible financial flows into and out of a banking system. Everyone's piggy bank works the same way. People can make savings deposits and can withdraw them. They can pay their interest and bank fees and the bank can spend those fees on expenses. They can borrow loans and make payments on their loans. All banks have the same inputs and outputs.
Within the first rectangle labelled "piggy bank," draw another large rectangle into which you may run the three input pipes and out of which you may run the three output pipes.
Professor Parrot made the point: >So everything is connected to the reservoir.
>Just eliminate your + and -, and connect all arrows to >the reservoir and you'll have it right.
SIMMS' EXAMPLE Now we'll use the piggy bank model to run through the example given by Dr. Simms:
>Firstly, yes, you are exactly right concerning the process of credit >creation I described the other day. It is just like a SHARED >piggybank. >Suppose Alan puts #100 in the piggy-bank. Because it's a shared >piggy-bank, he also puts in a note, "The PB owes Alan #100". >Brenda needs some cash. Looking in the piggy-bank, she sees the #100 >cash and the note "The PB owes Alan #100". She thinks, Alan won't >need all his cash at once, I'll take #90, and leave an IOU, "Brenda >owes the PB #90". >Brenda then pays Charles for all the cleaning, cooking and shopping >he has done for her (when are they going to set up their LETS?!). >Charles doesn't want to carry #90 around with him, so he puts it in >the piggy-bank, together with a note "The PB owes Charles #90". >In the piggy-bank there is now #100 cash, and three notes: Brenda >owes the piggy-bank #90; the piggy-bank owes Alan #100; and the >piggy-bank owes Charles #90. >A few days pass and Brenda needs some more cash. She goes to the >piggy-bank, sees the #100, and the two notes: Alan has a claim of >#100, and Charles has a claim of #90. She thinks that she should >leave #10 in case Alan needs any cash, and #9 in case Charles needs >any cash, and she borrows #81. And so on. >Brenda might stop borrowing cash when she sees that although there is >#100 in the piggy-bank, there are claims for #1000, so at any one >time the claimants between them might need the #100. At this stage >there is #100 in the piggy-bank, together with loan notes totalling >#900, and claims on the piggy-bank of #1000. JCT: This is certainly how the transactions take place through the piggy bank plumbing. At the end of all the transactions there is #100 together with #900 in loan notes and deposit slips claiming #1000. Since Economics says that money is the total of deposits, it is then claimed that #900 in new money has been created. Yet, I only see the original #100 with a bunch of deposits slips and loan notes. If a man comes in to cash checks from Alan for #100 and Charles for #90 on the same day, the piggy bank only has #100 to pay out and I doubt that man seeking to cash those checks is going to accept anyone else's deposit slips. He wants cash. And as it's been pointed out, all the bank has to offer him is #100 in cash and deposit slips. It's pretty clear that a piggy bank cannot create new money. Yet, in reality, even though a piggy bank model does not have a source and cannot create new money, only new notes and deposit slips, when someone does come into the bank to cash those checks, the bank actually does pay him #190. So how is this possible? Where did the new money come from to pay out both checks when the piggy bank only had #100 money, #900 in loan notes and #1000 in deposit slips? The answer was provided in 1939 by the Governor of the Bank of Canada, Graham Towers, under questioning by Social Credit members of Canada's Parliament. Though Social Credit have always said that all Social Credit politicians must end up corrupted by the political process and for that reason condemn striving for Social Credit via the political process, if it had not been for those intrepid Social Crediters in Parliament, we would have never gotten this admission from the Governor of the Bank of Canada. He said:
>"The banks, of course, do not lend out the money of their depositors' >funds. Each and every time a bank makes a loan, new bank credit is >created, new deposits, brand new money." JCT: For the first time in recorded history, we have the clear statement that loans do not come from the piggy bank reservoir but come from a source of new money which now makes sense to an engineer. The loans out pipe is actually not connected to the reservoir but is actually connected to a source from which new liquidity emerges. To get accurate plumbing therefore, draw the second rectangle within the second chartered bank below the first two arrows but not the third. As with the piggy bank, savings and withdrawals, interest and bank expenses go through the reservoir but loans out are connected to a source I have labelled (+) and loan payments are connected to a sink I have labelled (-). This explains when the economists say that money is created when banks make loans and destroyed when loans are paid off. This can be modelled using the same original piggy bank but also including a source and a sink. Now we'll go over the example again:
>Suppose Alan puts #100 in the piggy-bank. Because it's a shared >piggy-bank, he also puts in a note, "The PB owes Alan #100". >Brenda needs some cash. Looking in the piggy-bank, she sees the #100 >cash and the note "The PB owes Alan #100". She thinks, Alan won't >need all his cash at once, I'll take #90, and leave an IOU, "Brenda >owes the PB #90". JCT: As Graham Towers stated, Brenda did not take any of Alan's chips but instead drew some new chips from the casino cashier in exchange for her promissory note.
>Brenda then pays Charles for all the cleaning, cooking and shopping >he has done for her (when are they going to set up their LETS?!). >Charles doesn't want to carry #90 around with him, so he puts it in >the piggy-bank, together with a note "The PB owes Charles #90". >In the piggy-bank there is now #100 cash, and three notes: Brenda >owes the piggy-bank #90; the piggy-bank owes Alan #100; and the >piggy-bank owes Charles #90. JCT: Actually, after Charles had made his deposit, there are now #190 chips in the savings piggy bank, two deposit slips for that #190 and Brenda's #90 loan note.
>A few days pass and Brenda needs some more cash. She goes to the >piggy-bank, sees the #100, and the two notes: Alan has a claim of >#100, and Charles has a claim of #90. She thinks that she should >leave #10 in case Alan needs any cash, and #9 in case Charles needs >any cash, and she borrows #81. JCT: Yes, but she doesn't borrow the depositors' funds from the savings section. She's getting new chips from the casino cashier.
>And so on. Brenda might stop borrowing cash when she sees that >although there is #100 in the piggy-bank, there are claims for #1000, >so at any one time the claimants between them might need the #100. JCT: Actually, she will see the actual currency supply go up and up until it reaches #1000 to match the claims for it. Notice that when the man comes into the bank with both Alan's and Charles's checks, the bank has no problems taking their savings deposits and cashing his checks. Since banks to create new money and are able to cash those checks for their full amount, I hope it's clear that the Governor of the Bank of Canada is correct when he states that loans do not come from depositors' funds or those checks could not be cashed for more than the original money in the piggy bank. So a chartered bank has a tap and is not the pure reservoir system like a piggy bank model though it operates in such a way and is taught in such a way as to disguise that there is a source. Notice that if you count the total deposits in the chartered bank's savings section, it does represent the total money supply but counting the deposits in the piggy bank does not give us the total money supply, it gives us the total "deposit slip" supply. All economists have to do is accept Governor Towers' statement that loans do not come from the reservoir but from a tap of new liquidity and everything they teach about the creation of money will be true. That the creation of money has been taught in such a way as to disguise the source and make it look like a simple piggy bank can only be explained with a conspiratorial view of history. As long as banking is taught as a piggy bank model, where money comes from must necessarily become a very mysterious subject, as it has always been. Once the source is identified and the piggy bank model exposed as a false cover, then it becomes possible for people build their own sources of currency a la LETS.
So now, I'll answer the 10 questions using Bryant's work:
BRYANT'S ANALYSIS >>1) Where did the $90 come from? >Already stated: It came from the non reserve deposits of the >1st bank. JCT: We know that the loan came from a source which Bryant calls "non-reserves" and which the Parrot calls "excess reserves." I'd prefer to call it "potential money" because the $100 deposit acts as a reserve for the creation of a new $90 though it has not yet been created. In reading the Parrot's statements, when a bank has deposit in excess of the amount of loans they are allowed to lend out, he calls this potential money "excess reserves." I find this confusing as reserves are actual money and excess reserves are not money loaned out yet and only become money when they are loaned out.
>>2) How much money is now in the first bank? >$10 (required reserves) >+ $90 (non reserve deposits-fully loaned) = $100 JCT: Right. This agrees with Governor Towers as the loan did not reduce the actual $100 on deposit. It came from the source.
>>3) What is the total money supply after the loan? >M1 = >1st bank >required reserves = $10 >non reserve deposits-fully loaned = $90 >2nd bank >required reserves = $9 >non reserve deposits-unloaned = $81 >Total = $190 JCT: Again, right. It shows that the $90 was newly created and deposited into the second bank. Also note that this newly created $90 does act as real reserves for the second bank allowing them the opportunity to create a new $81 in "unloaned non reserve deposits" or as the Parrot would call them "excess reserves."
>>5) Where did the $81 come from from the second bank? >Already stated: from the non reserve deposits of the 2nd bank JCT: If the non-reserve deposits are the potential money to be loaned out of the tap of the second bank, right.
>>6) How much money is now in the second bank? >$9 required reserves >+ $81 (non reserve deposits-fully loaned) = $90 JCT: Right. The original $90 is still in the second bank even though it loaned out a new $81 to its borrower because "the bank, of course, did not lend out its depositor's funds."
>>7) What is the total money supply? >1st bank >required reserves = $10 >non reserve deposits-fully loaned = $90 >2nd bank >required reserves = $9 >non reserve deposits-fully loaned = $81 >3rd bank >required reserves = $8.10 >non reserve deposits-unloaned = $72.90 >Total =$271.00 JCT: Right.
>>8) What is the final total money supply? >Maybe the loans out = $900, not $1000??? >$100 = %10 of total deposits (required reserves + non-reserve >deposits-fully loaned), not the loans themselves. >M1 = [1/0.1 (reserve requirement)] times [$100 (initial FED >deepest)] = $1000. JCT: Right. Total new loans are $900 added to the original $100 deposit makes for a total money supply of $1000. Notice that in bankmath.htm, I explain it in a very similar way:
> BoC Accts IOUs New$ >Deposit old $100: $10 BoC $90 Bank 10 90 > Loan out new $90 for $90 IOU 90 90 >Deposit new $90: $9 BoC $90 Bank 9 81 0 > Loan out new $81 for $81 IOU 81 81 >Deposit new $81: $8 BoC $73 Bank 8 73 0 > Loan out new $73 for $73 IOU 73 73 >Deposit new $73: $7 BoC $66 Bank 7 66 0 > Loan out new $66 for $66 IOU 66 66 > [................... to infinity] > ---- ---- ---- ---- > $100 $900 $900 $0 > OLD NEW NEW IOUS > > Where the system started with only $100, after the expansion is >over, the Bank of Canada is holding the original $100 as the banks' >10% reserves and the banks' reservoirs are holding the other $900 of >the savers' new deposits. So, $900 newly created dollars were added >to the system by the private fractional reserve banks for every $100 >issued by the Bank of Canada. This limit is the inverse of the >reserve ratio. A reserve ratio of 5% would generate total new money >of 1/.05 = 20 times the initial high-powered Bank of Canada money. >This is how an ordinary bank creates new money as new loans based >not on the production possible but on past savings of money. > Just as money is newly issued from the tap when a bank makes a >loan, money is destroyed down the drain when a borrower makes a >principal payment. Interest payments go back into the reservoir and >not down the drain. > The injection of new money from their taps has been well hidden >from the public view because the Bank Act insists that before any new >money may be loaned into circulation, old money must be deposited >into their reservoirs. It's just as if a casino were to insist on old >chips being put into the safety deposit section before it would issue >new chips. By merely matching new loans to deposits, this brilliant >cover for the turning on of the tap misleads observers into falsely >concluding that a chartered bank operates like a piggy bank. With a >lawful reason to seek deposits before they can lend, there is no >outward difference between chartered bank and a piggy bank. Yet, >banks do not seek deposits to lend to other people. They seek them to >lawfully turn on the tap of new money leaving depositors' old >deposits in their accounts. > It's a fascinatingly tricky mechanism but it's purpose is to >foster the impression that borrowers are getting savers' deposits >and that savers therefore deserve to get interest for lending >borrowers their money. This may have surely been true when banking >did operate like a piggy bank without the creation of new money but >it certainly is not true now that banks operate more like a casino >banks issuing new liquidity. The matching of loans to deposits >successfully hides the fact that no one is giving up the current use >of their money since it is new money being loaned out and therefore >no one is being deprived of the use of their money.
>>9) Would anything be different if the original $100 had been >>transferred from an out-of-state bank rather than the FED? >Not if it is a US bank. However, if the source is foreign banks or >capital investment, then it will be like FED deposits and increase >the amount of US bank reserves. JCT: This is odd. He's right that it acts like the FED if the original $100 had come from another US bank and acts like a FED if it comes from a foreign bank but implies that there's a difference.
>>10) Where will the banks "have distributed the $100 of reserves" to? >As before, the banks in the daisy chain. JCT: Right. Part of each depositor's funds is "designated" as reserves for the FED in each bank in the daisy chain.
THE PARROT'S CONTRADICTIONS Finally, we'll deal with Professor Parrot's recent contradictions.
>You argue that I contradict myself when I state that money is >destroyed when a loan is repaid, but then isn't really destroyed >because banks create deposits when they pay their operating >expenses, pay dividends, or buy assets. JCT: First of all, he argued that the money is destroyed and then really isn't destroyed. That's pretty funny. Then he argued that when they pay their operating expenses, pay dividends or buy assets, they create new money from the source.
>It does not matter whether the deposit is created to pay operating >costs, to pay dividends, to buy fixed assets, or to buy another kind >of asset -- loans. JCT: Again he states that the source of money for loans is the same as the source of money for operating expenses, etc.
>When the bank pays its operating costs, dividends, or buys fixed >assets, its excess reserves decline; that is, its reservoir falls. JCT: But now he says that paying operating expenses comes from the reservoir, a clear case of double-think. He double-thinks that when money comes out of the tap, the reservoir of old money goes down. Clearly, if the bank expenses pipe is connected to the reservoir as I say, this is true but then the statement that they come from the tap must he then false. They can't both be true. What's funny is that I've pointed out to him many times in the past that they can't be coming from both but he just can't see it. That's why I wrote:
>I have to agree that when the public takes out money or the >banks pay its operating expenses, the reservoir falls. But I disagree >that bank loans have any effect on the reservoir at all. JCT: That's because loans come from the tap and expenses come from the reservoir.
>bank income has only three possible outlets: expenses, dividends, >or assets -- even if those assets are reserves. JCT: Now he's once again saying that the money to pay for operating expenses comes from the bank's income, not the source.
>>The IMPORTANT issue is the way in which this money is "spent" back >>into the economy: How much of this money is spent to pay bank >>employees and/or to pay realistic rent for the space required for >>such employees. >FDIC data indicates that about 50% of bank expenses is interest on >customer deposits. About 30% is employee compensation. The rest is >miscellaneous stuff. JCT: Here once again, he agrees that bank expenses are paid with money "spent back" into the economy. Not from newly created deposits.
>JCT's persistent error is to confuse reserves with excess reserves. >He apparently defines his "reservoir" to include only the bank's >actual reserves. JCT: That's right. The reservoir holds the money actually in circulation while excess reserves are money that may be brought into circulation but are not yet.
>Following this, he argues that there must be a source for new >reserves if there is to be a source for new liquidity. JCT: That's right and what I call the source of the potential money but not yet money, he calls "excess reserves."
>His predictions on what would happen to a bank's reservoir under a >variety of transactions are inaccurate, but become completely correct >when we redefine his reservoir to be excess reserves, not just >reserves. JCT: This is completely backward. Excess reserves do not yet exist and have no need of a reservoir. Reserves do exist and do settle in the reservoir. The reservoir is properly connected and properly holds real reserves, not phantom "excess reserves."
>This is what I perceive to be his mistake. >JCT is right in that anyone in an engineering class suggesting things >just magically appear and disappear would be laughed at. That is not >what is happening here. JCT: It's not laughable if you understand Governor Tower but it is laughable if you "understand" the Parrot.
>The changes in deposits we observed in each transaction affected the >bank's excess reserves. JCT: No. Only loans reduced the potential money of excess reserves. All other transactions deal with the reservoir.
>This is where new bank-created deposits come from when they are >created and is where they go when they are destroyed. JCT: So it's pretty clear that newly created money from the source he calls excess reserves. So if we were to use the casino analogy, I used to say that when the safety deposit section informed the cage that there was a deposit of $100 chips, the cage could not lend out a new $90. Imagine therefore that when the savings section did do this, the cashier moved $90 in chips from the vault to his till and only the chips in the till are available for loans. Now Flaherty's "excess reserves" can be thought of as being held in the till. If another $100 chip deposit is made to the savings section, another $90 in chips is added to the "excess reserves" till. Notice that these chips are not yet in circulation on the casino floor and have no effect on the actual monetary mass. Furthermore, if someone withdraws $100 chips from the savings section, the cashier takes $90 from the till and returns them to the vault and it can be said that excess reserves have gone down.
>In addition, allow me to offer a translation. What you call a >"reservoir" in your Figures 3 and 3b, economists call "excess >reserves." *All* deposits a bank creates are done by using these >excess reserves. JCT: Actually, this is backwards. What I call a reservoir is what economists call reserves, not "excess reserves." And all deposits a bank creates do not come from the reservoir, they do come from what you call "excess reserves" which are in the till and not the reservoir. So that's how Flaherty manages to confuse created chips with non- created chips. All he's got to do is admit that whether the chips coming from the cage are moved to till or left in the vault makes no difference but that in both cases they are coming from the source and there's no reason not to accept Governor Towers's statement that all loans are new money, not depositors' funds.
>Actually, his predictions do not turn out to be completely correct >when we redefine his reservoir. He predicted that the reservoir would >not be affected by bank lending, JCT: If the loans out to the economy come from the source and not the reservoir, why should the reservoir of deposits go down though the number of potential chips in the till may be said to go down.
>From this perspective it becomes clear that all Bank A has done is >convert its idle excess reserves into a performing asset: loans. JCT: Pretty clear that the unissued supply of chips in the till are what he considers to be "idle excess reserves" which are issued into loans. More proof that loans do not come from actual reserves in the reservoir.
>Or in the other cases, a performing asset in the form of an ATM, or >to pay its expenses. JCT: Once again, he's saying that bank expenses come from the till and not the reservoir. I only wish it were so because then there would be supply of new money with which to pay the interest on the debts. Unfortunately, no matter how desirable it would be that banks issue new money in exchange for assets without any interest due, that is not the case. As he stated earlier, bank expenses are paid with bank income all of which go through the reservoir, not the tap or the drain.
>Regardless, the source for all this liquidity creation is the bank's >excess reserves. JCT: The creation of "excess reserves" is simply moving chips from the vault to till but not issuing them into circulation until there's a loan. He confuses real reserve money with potential excess reserve money which isn't money yet.
>And this is where JCT's engineering metaphor seemingly breaks down. >Engineers cannot assume, say, energy magically coming from nowhere >when designing a system. However, in a banking system the extra $900 >in liquidity can seemingly come from nowhere because it's just >book entries. JCT: Even though credit may be only a book entry, new credits cannot appear magically. Governor Towers's new deposits do not appear magically but have a logical basis. The collateral is simply converted to new tokens. I see no reason why magic should apply to the financial accounting system when it doesn't apply to physical systems.
>That is why we refer to a deposit multiplier, specifically, excess >reserves times (1/required reserve ratio) for a banking system. Note >that I used the word "seemingly." JCT: Yes. It's good to point out that things which seem to be true in Economics are not.
>This is because that is not what really happens. JCT: That's what I've been trying to point out.
>The extra $900 comes from the public via the voluntary loan >transaction. JCT: Of course, the extra $900 comes from the source to the public via loans.
>The banking system creates new deposits and gives them to the public >in exchange for a new financial asset, loans. JCT: He can't fool us by now arguing what we've been saying all along. Haven't I been the one who has been arguing all along that the banking system's loans are newly created deposits? Now he's making my point for me after having formerly condemned that point numerous times. Talk about double-think.
>Money is destroyed because customer deposits have declined. JCT: Using the piggy bank example, if Alan withdraws #50 and deposits go down, money hasn't been destroyed by the piggy bank. That's the problem with economics. Rather than plot the financial flows from the tap to the drain, they simply count the deposits and call them money. If deposits go down, they "assume" money is destroyed. This is only true because there is a tap and a drain and cannot be true for the piggy bank model. >The new deposits the system can create are much greater than >the system's initial level of excess reserves. JCT: Now he's confusing reserves with excess reserves again. Loanable excess reserves are always 90% of the actual deposited reserves, less, certainly not greater.
>Hell, that's why they call it "leverage." Speaking of Hell, Christ and Mohammed and most of the greatest prophets tell us to abolish interest while Flaherty says:
>I do not equate a critique of interest with an attack on capitalism. >Nevertheless, interest is a seemingly necessary mechanism to allocate >scarce resources and to allocate consumption patterns through time. JCT: Since Christ said do this without charging interest and Flaherty says it's okay, he'd better not speak of Hell to quickly.
REALLY WRONG ANALYSIS >Article #98512 (98532 is last): >From: "Michael L. Coburn" <firstname.lastname@example.org> >Date: Sun Nov 29 13:19:56 1998 >We finally arrive at the point: When loans are repaid the money goes >into the checking accounts of all the people who work for the bank >and/or into the accounts of the shareholders of the bank, and, or >into the accounts of the treasury as a result of taxes. >In the final analysis ALL money is the result of a loan in one form >or another and once this money exists it is never extinguished unless >the government collects it as taxes. JCT: No, the loan payments are destroyed. Only the interest and bank fees find their way into these accounts. And it is certainly not extinguished when government collects it in taxes. It's sad but this kind of erroneous thinking is still going on. So I hope I've covered the creation of money by the banking system in a way that is acceptable to some economists. Though it's true that I've never been rebutted, it is also true that no economist other than Graham Towers has ever admitted publicly that the banks do not operate like piggy banks and that:
>"The banks, of course, do not lend out the money of their depositors' >funds. Each and every time a bank makes a loan, new bank credit is >created, new deposits, brand new money." JCT: So remember that no matter how much it looks like a piggy bank, a chartered bank has a source and a sink, even a till, which has been hidden and is now exposed. -------------------------------
The Essence of Money #10
>Article #98634 (98646 is last): >From: Edward Flaherty <email@example.com> >Date: Tue Dec 1 12:26:13 1998 >Ok, John, you win. JCT: Thank you. Enough with the parrot jokes. I regret having been so brutal in my remarks. I've told you before that I consider the top economist in the world for your public defences of the profession. I've always thought that getting you on the LETS bandwagong would be much like St. Paul's conversion on the road to Damascus, from one of the greatest impediments to Christ's monetary reform movement to one of the greatest advocates.
>Article #98638 (98646 is last): >From: firstname.lastname@example.org (GChand4059) >Date: Tue Dec 1 14:03:56 1998 >John Turmel wrote: >> JCT: So remember that no matter how much it looks like a piggy >>bank, a chartered bank has a source and a sink, even a till, which >>has been hidden and is now exposed. > >Great post, once again sir. A fast scan makes me conclude you have >described a fractional banking system. I have copied it and will draw >myself the diagrams and get back to you. >Does use of the term "till" imply something crooked? (like," till", a >place to dip fingers into?) JCT: No. It was just used to represent a place where potential new money resides until put into circulation in contrast to the infinite amount of chips available from the source. Another way of thinking of it would be to have a sub-reservoir below the pump where the limit of the new currency resides for the purpose of explaining the increase or decrease in "excess reserves." I've often considered adding such a reservoir of potential money linked to the tap though the fact the chips are not actually in the money supply made it seem overkill. Still, the mere fact that a limit on new money from the pump exists made that addition superfluous and possibly confusing.
>Also, in flow diagram: a box in a box? How does engineering analogy >use a box in a box? JCT: Actually, the first box represents the outlines of the bank vault. The interior box represents an actual reservoir and is necessary when we consider that the reservoir in the second chartered bank is only connected to the savings/withdrawals and interest- fees/bankexpenses pipes leaving room within the vault for the pipes from the loans out to be connected to a tap and the loans in to be connected to a drain.
>For example, should the box in a box have in/out arrows? >The same "till"? JCT: Yes, the arrows into the bank vaults should continue to the reservoir and the arrows from the bank vaults should be running out of from the reservoir. Actually, the interior box should be labelled reservoir while the outside box should be labelled either "piggy bank" or "chartered bank." And no, there is no real use showing the potential liquidity in the till.
>Also, shouldn't Flaherty's t-accounts show the same flaw? JCT: I think my accounts labelled BoC, New Money and
> BoC Accts IOUs New$ >Deposit old $100: $10 BoC $90 Bank 10 90 > Loan out new $90 for $90 IOU 90 90 >Deposit new $90: $9 BoC $90 Bank 9 81 0 > Loan out new $81 for $81 IOU 81 81 >Deposit new $81: $8 BoC $73 Bank 8 73 0 > Loan out new $73 for $73 IOU 73 73 >Deposit new $73: $7 BoC $66 Bank 7 66 0 > Loan out new $66 for $66 IOU 66 66 > [................... to infinity] > ---- ---- ---- ---- > $100 $900 $900 $0 > OLD NEW NEW IOUS
JCT: This can certainly be done with T accounts where all the Bank of Canada entries are debits, all the deposits to accounts are debits, all the IOU loans are debits and when the New$ go from $90 to zero, the zeros could be represented by balancing credits. For those who are unfamiliar with accounting, one would think that debiting an account is a negative withdrawal and crediting an account is positive addition but it's actually reversed. So if one credits one's cash account, it is a reduction and if one debits one's account, it is an addition. Interesting that it is intuitively backwards but that's how accounting works. That's why T accounts are a very confusing explanation for the uninitiated but they certainly do provide the right answers. Using T accounts, it would look like this
DEPOSITS BoC Accts IOUS New Money ------- ------- ------- ------- 10 | 90 | | |100* *outside money gone down | | 90 | 90 | 9 | 81 | | | 90 | | 81 | 81 | 8 | 73 | | | 81 | | 73 | 73 | 7 | 66 | | | 73 ETC. for a total ------------------------------------------------- 100| 900| 900| | 100* original money gone down | | | | BoC Accts Loans In line #1, of the original $100 deposit, $10 is held for the depositor by the Bank of Canada and the other $90 is held for the depositor by the bank and money outside goes down $100. In line #2, loan IOUs rise by $90 and new money rises by $90. In line #3, of the next $90 deposit, $9 is held for the depositor by the Bank of Canada and the other $81 is held for the depositor by the bank and the new money outside goes down $90. In line #4, loan IOUs rise by $81 and new money rises by $81. In line #5, of the next $81 deposit, $8 is held for the depositor by the Bank of Canada and the other $73 is held for the depositor by the bank and the new money outside goes down $81. In line #6, loan IOUs rise by $73 and new money rises by $73. In line #7, of the next $73 deposit, $7.3 is held for the depositor by the Bank of Canada and the other $65.6 is held for the depositor by the bank and the new money outside goes down $73. This cycle continues until we're left at the end with the original $100 held for depositors by the Bank of Canada, a new $900 is held for depositors by the bank, a new $900 in loans is held by the bank backing up the new deposits and of course, the original $100 from outside remains out of outside circulation. So as expected, the T accounts can handle the situation in exactly the same way as the plumbing though perhaps in a more difficult way.
>This is gonna take some time, hope all have lots of patience. >Thanks again, George........ JCT: Once you have Fig. 3, it should all fall into place quite quickly.
>I have been trying to figure out where all the confusion, inherent in >John Turmel's correspondence, is coming from. Both he, and the >economists he so vilifies, are describing the same process of banks >creating deposit money. At the moment I can only suppose that it is >stemming from a failure to communicate what all parties understand by >their definitions of money. >Does this answer your questions, John, or have I missed your point >altogether and can join the other 99%? Regards to you all, Jonathan JCT: Of course, the confusion stemmed from the non-visibility of the source of new money. One reason I spend so much time on this is that Fig. 3 is actually the same plumbing as a LETS. In a world starved for money, identifying the source of new money has the potential to save our world which is dying due strictly to a lack of funding. Read any newspaper and you'll notice that 90% of all problems stem from lack of funding. Our world is threatened by environmental catastrophe and we don't have the money to pay to save ourselves. Finding the source of money is critical to saving our planet. A LETS bank is simply a regular chartered bank that operates without a reserve ratio which only collects fees and no interest. Notice that when a member needs to pay another member #50, it's as if, without a previous deposit, he got a loan of #50 which was then put into the account of the other member. Loans are called commitments and registered as negatives in his account so that when the loans commitments go up #50, the deposits went up. His account went negative #50 and the other member's account went positive #50. Once economists properly identify the source of money, they will then see the similarity in the plumbing of LETS. It may be easier to accept the validity of the LETS banking system once it is recognized that it operates virtually exactly like an orthodox banking system. I must admit that I lay in bed for hours last night shocked that Mr. Bryant had aced my test. I wonder what school he went to. He is the first economist in 19 years who has ever stated that loans were not reserve deposits, but new non-reserve deposits. He's the first I've ever met who was not caught by my two question double-think test. It certainly bodes well for the future. Of course, how the present system functions or malfunctions is nowhere as important as how the perfect LETS banking system operates and how to best get its benefits to the poorest of the world the quickest. I've always felt like the kid who cried "Look, the king has no clothes" but without being believed. Having major economists come to the same conclusion can only enhance the message that interest-free money can be issued a la LETS without causing inflation and getting it accepted that LETS operates like a regular bank without causing inflation is important to the funding of the salvation of our world. And I hope no underestimates the saving potential of identifying a source of non-inflatable money. I just hope the prestige of a few Economics professors may be added to the battle. I'm exhausted after 19 years and could wish for nothing more than an interest-free credit line so I could take a break from the financial worries of the world. I don't even find playing Poker any fun anymore. It's a job. It could be lucrative play if I wasn't faced with monthly bills. Financial Heaven's almost here. Just imagine living without the pressure of due dates on one's debts, just the pressure of the pride in being winner enough to meet them eventually. So let's hope Professor Flaherty's statement induces other economists to take a serious look at LETS interest-free banking. We could sure use some high-powered support if we hope to have a Global Employment Trading System installed before the end of the millennium. Praying for an end to debt slavery, I am, Sincerely yours. -------------------------------
The Essence of Money #11
>Article #98649 (98680 is last): >From: "Chas" <email@example.com> >Subject: Inflation 101. >Newsgroups: sci.econ >Date: Tue Dec 1 15:43:39 1998 > >For those of you who by now have been completely exhausted and >confused by all these egotistical engineers and their crack-pot >banking theories, I would like to interject a little basic economics >into the confused muddle.
>Article #98734 (98742 is last): >From: firstname.lastname@example.org (William F. Hummel) >Date: Wed Dec 2 14:30:16 1998 >Good. Let's hope our confusion about inflation will be cleared up >with some basic economic theory offered by the monetarist, Anderson.
JCT: Isn't it funny that even after Professor Flaherty acknowledged the presence of a source of money which he describes as "excess reserves, the guy who couldn't keep up with others in the debate and admits he's confused still has the nerve to throw insults. After failing to offer one input to the debate due to his confusion, he has the temerity to label the advanced engineering model analysis which I thought had just been proven as a crack-pot theory. That's what I mean when I say many economists have no integrity. Same goes for Hummell. They're both perfect examples. After being challenged over and over comment on the debate and after backing down over and over again, we now hear Hummell pipe up to agree with his low-tech contemporary's slur. I cannot fully describe the contempt I feel for these no-guts chickens but I'm going to tear them apart in the Inflation 101 debate as the continue to parrot the same old canards about inflation. Still, if only one or two economists have now seen the source of money in the bank plumbing, then it makes dealing with all the jerks worthwhile. -------------------------------
The Essence of Money #12
>Article #98979 (98984 is last): >From: email@example.com (Lantern002) >Date: Sat Dec 5 19:25:31 1998 >Turmel wrote: >>JCT: So remember that no matter how much it looks like a piggy >>bank, a chartered bank has a source and a sink, even a till, which >>has been hidden and is now exposed.
>Your idea of a plumbing diagram to illustrate the banking system is >excellent. I have tried to draw your diagram from the directions in >Essence Post #9. One question and one suggestion: >1. Can I draw pipes instead of arrows? (That is, three pipes into >piggy bank and three pipes out?) If I do this the diagram dumps the >contents of the bank/reservior out of the bottom three pipes onto >the floor. Shouldn't it be closed loop somehow? JCT: In my original diagrams, I did use two lines to represent pipes but found that one line worked out just as well and easier. It may seem that the reservoir in the piggy bank dumps out of three pipes onto the floor but imagine that it is the floor of the pool representing the whole economy. Money in circulation as cash or checks before they get redeposited into bank accounts. So in a sense, since the money falls into the economic pool and comes from the economic pool to go into the banks, it is a closed loop.
>2. Suggestion: Economists don't get lab courses like engineers. No >hands-on, work with it stuff. How about working your diagram to the >point we can build a plumbing system from it? JCT: Sure it's possible to actually use pipes and liquidity to model the flows. Should be quite easy too. A few years ago, I thought about using two vats, each with 3 in pipes and 3 out pipes attached. The first represented the bank and the second representd the economy.
The Savings pipe Into the piggy bank vat was connected to the Savings pipe Out of the Economy vat. The Savings pipe Out of the piggy bank vat was connected to the Savings withdrawals Into the Economy vat.
The Interest/fees pipe Into the piggy bank vat was connected to the Interest/fees pipe Out of the Economy vat. The bank expenses pipe Out of the piggy bank vat was connected to the bank expenses paid into the Economy vat.
The Loan payments pipe Into the piggy bank vat was connected to the Loans paid pipe Out of the Economy vat. The Loan made pipe Out of the piggy bank vat was connected to the Loans borrowed pipe Into the Economy vat.
Of course, in the case of the chartered bank, nothing changes but the fact that loans paid go to a sink rather than the reservoir and loans out from from a tap rather than a reservoir.
>An Econ101 lab course then could have the students building a model >banking system. I can dream of a bank/plumbing system made out of >cheap plastic pipes and glass beakers. Kids would love it. Pour the >water in the top three pipes and then it would "flow". Whatcha >think? JCT: Of course, it would work. You'd need some kind of valve and meter on all outlets to control flows but all you'd have to do is raise the Economy vat higher than the bank to let flows from the economy flow by gravity into the bank or raise the bank vat higher than the economy vat for flows bank to the economy.
>If you patent this idea I get a cut <:) JCT: I doubt it's patentable but it certainly would make for an interesting project. You might even create the sub reservoir connected to the tap and drain to handle the potential money you'll be allowed to lend out from the tap, the excess reserves, so that even though no loans are made, savings withdrawals and savings deposits will affect this sub- reservoir or "till" of potential liquidity available for loans. Yes, such a model of a "creationary bank" is easy to construct and would be of great use in demonstrating how the banking system pumps new liquidity into circulation.
>Article #98983 (98984 is last): >From: LMackinnon@hotmail.com (Lauchlan Mackinnon) >Date: Sat Dec 5 20:25:27 1998 >Didn't someone already do this in the UK to illustrate circular flow >in the economy? It had different coloured water that swished around >various glass tubes and so forth and the students could play with >parameters and see what happened. I cant remember who or where. LM. JCT: It makes sense to model a liquidity system in such a way and am not surprised that it may have been already done though had it been done right, I'd have assumed that it would be more prevalent in economic literature than it seems to be. So I think there's a greater likelihood that my plumbing model is a first though I won't be surprised if it is not. -------------------------------
The Essence of Money #13
>Date: Mon Dec 7 12:27:21 1998 >From: Roy.Davies@exeter.ac.uk (Roy Davies) >Subject: Hydraulic Models of the Economy >To: firstname.lastname@example.org >In one of John Turmel's latest postings he quotes a question about >hydraulic economic models and gives his opinion of their utility but >did not actually answer the question about their origin so I will do >that.
>>>From: LMackinnon@hotmail.com (Lauchlan Mackinnon) >>>Date: Sat Dec 5 20:25:27 1998 >>>Didn't someone already do this in the UK to illustrate circular >>>flow in the economy? It had different coloured water that swished >>>around various glass tubes and so forth and the students could play >>>with parameters and see what happened. >>JCT: It makes sense to model a liquidity system in such a way and I >>am not surprised that it may have been already done though had it >>been done right, I'd have assumed that it would be more prevalent in >>economic literature than it seems to be. So I think there's a >>greater likelihood that my plumbing model is a first though I won't >>be surprised if it is not.
>The person who built the hydraulic model of the British economy was >A.W.H. Phillips, a New Zealander who after World War II studied >economics at the London School of Economics (LSE). He became >interested in Keynesian economics but thought that Keynes' interest >theory was muddled with confusion between stocks and flows and, >according to a biographical in a volume to honour his memory, after >setting out the theory in mathematical form he realised that he had >the model of a hydraulic system and so proceeded to build one out of >perspex in a friend's garage in Surrey. JCT: Actually, modelling the economy is far more complex than modelling a bank. I'd be interested in finding out if he situated his source-pump and his sink-drain within the chartered banks or not. I have given more thought as to how to model the banks in Fig 2 and Fig. 3 of http://turmelpress.com/bankmath.htm and I think I've come up with a workable solution which doesn't need pipes. Rather than send a certain volume down the pipe, we'll use cups or shot glasses as wallets to transfer the liquidity. To model the piggy bank reservoir, use a large bowl.
PIGGY BANK Of course, someone has to deposit liquidity into the piggy bank before any can be lent out so get 10 cups of water and deposit them into the piggy bank bowl. Give 10 deposit slips to the saver. If the saver withdraws some liquidity from the bank, he gives back the right number of slips. If someone takes out a loan, fill 9 cups from the bowl and exchange it for his IOU. Out in the economy, he can trade his cups of money to someone else to buy something and that person can deposit the cups of money to the piggy bank and receive deposit slips. In this way, 9 new deposit slips and 9 new IOUs can be created by lending out the the original 9 cups of money. The cycle is repeated over and over with smaller and smaller loans as in the early example.
CHARTERED BANK To model the chartered bank in Fig. 3, put the bowl in a sink with a tap. Of course, bank laws insist someone deposit liquidity into the chartered bank reservoir before the tap can be turned on so get 10 cups of water and deposit them into the reservoir-bowl. Give 10 deposit slips to the saver. If the saver withdraws some liquidity from the bank, he gives back the right number of slips. If someone takes out a loan, fill 9 cups not from the bowl but from the tap and exchange them for his 9 IOUs. Out in the economy, he can trade his cups of money to someone else to buy something and that person can deposit the cups of money to the bowl and receive deposit slips. The cycle repeats just like the piggy bank model. If someone pays off their IOUs, the cups of money do not go into the bowl but are poured down the drain. Finally, flows of interest and fees earned or expenses paid out of either bank come into or out of the bowl, not the tap. There you have simple a simple hydraulic models of either the pure reservoir piggy bank in Fig. 2 or the reservoir with tap and drain of a chartered bank in Fig. 3. Try them out to see how banks create money in a way which makes them look like piggy banks which do not create money. Notice finally that though all the flows into both banks create new deposits and IOUS, only the chartered bank creates new money.
>Leeds University became interested and bought the model. James Meade >persuaded Phillips to make another one for the LSE and, as interest >grew, a modest business emerged and a plastics firm in Finchley >manufactured copies of the machine. Oxford, Cambridge, Birmingham, >Manchester and Melbourne all bought them and at LSE two were joined >together to problems of trade between countries. Among overseas >customers were Roosevelt College, Chicago, the Central Bank of >Guatemala, and the Ford Motor Company. JCT: All I'd really like to know is whether he had placed the source and sink in the right place. In the chartered banks and connected to the loans pipes to the economy.
>(Perhaps John Turmel should start selling hydraulic models!). JCT: I could certainly sell the bowls and the cups but they'd have to use their own sink and tap.
>This information is taken from the book: >Stability and inflation: a volume of essays to honour the memory of >A.W.H. Phillips / edited by A.R. Bergstrom ... [et al.]. Chichester: >Wiley for the New Zealand Association of Economists, 1978. >ISBN 0-471-99522-3. >Today Phillips is probably remembered mainly for the "Phillips >Curve", i.e. the theory he put forward in 1958 that there is a >regular relationship between the rate of increase in wages and the >level of unemployment. Subsequently it was widely believed that >unemployment was a cure for inflation. Although most economists would >accept that there is some trade off between the two (if enough people >lose their jobs worry about losing theirs will make those who are >left in work moderate their wage demands) the relationship in later >years did not prove to be as regular as it had been for the period >Phillips studied. JCT: Sad because it is only true that unemployment seems a cure for inflation only if interest is assumed. If interest is abolished, thye money becomes chips backed one-to-one with collateral which are impossible to inflate and involuntary unemployment is eliminated. But if you assume interest in your model, then you're stuck with elements of both inflation and unemployment and reducing one aggravates the other.
>Article #98993 (99039 is last): >From: Edward Flaherty <email@example.com> >Date: Sun Dec 6 01:20:47 1998 >William F. Hummel wrote: >>Apparently you mistook Ed Flaherty's signoff as an agreement with >>your position. >An astute observation. JCT: It's not a position, it's a model. The issue was whether the creation of money was done with Fig 2, my piggy bank model or Fig 3., my chartered bank model. Professor Flaherty had stated that it was Fig. 2: >So everything is connected to the reservoir. >Just eliminate your + and -, and connect all arrows to >the reservoir and you'll have it right.
I pointed out that the Governor of the Bank of Canada had testified in 1939 that: >"The banks, of course, do not lend out the money of their depositors' >funds. Each and every time a bank makes a loan, new bank credit is >created, new deposits, brand new money." JCT: This meant that loans and payments were not connected to reservoir as in Fig 2 but were connected to the source of new money, the tap and the drain as in Fig. 3. Then Professor Flaherty wrote: >Article #98634 (98646 is last): >From: Edward Flaherty <firstname.lastname@example.org> >Date: Tue Dec 1 12:26:13 1998 >Ok, John, you win. JCT: Now he writes: >>Apparently you mistook Ed Flaherty's signoff as an agreement with >>your position. >An astute observation. JCT: I don't understand what's astute about thinking that "OK, John, you win," was not an agreement with my position that Fig. 3 represented the creation of money bank. Are you now telling me that "OK, John, you win" really means "Not OK, John, you lose?" Or is it just that I have won because you can't argue with me but that you still don't believe Fig 3 to be true? Somehow, I could understand how you would continue to disbelieve what you can't argue with simply on the basis that I'm not an economist and therefore must be wrong. That wouldn't surprise me at all. Of course, it's what I meant when I talked about integrity. No engineer would ever say "I can't disagree with your model but I don't believe it anyway." And of course, the fact that's it's Hummel, the biggest chicken of them all making the statement that I find offensive. He backed down from every challenge I made to answer the questions and instead of hiding in shame at chickening out from a test which another economist aced, here he's back with his ignorant attitude. Unfortunately, it seems that that his statement has now allowed Flaherty to conclude that I must be wrong because another economist says so even though the one who did was the biggest loser of them all. Isn't it funny that the only time we heard from Hummel was to insult me though at no point did he join in the debate? Is it any wonder that economists are joked about with examples like these showing their lack of integrity in public. -------------------------------
The Essence of Money #14
>Date: Fri Dec 11 14:51:01 1998 >From: GHyman@compuserve.com (Geoffrey Hyman) >I was very interested to read your remarks about the Phillips curve, >linking inflation and unemployment. I am aware of many different >theories about its basis and (lack of) stability, but none of them >have previously referred to interest rates. So your brief remarks are >intriguing.... Can you expand on this topic? JCT: It all starts with the "Miracle Equation" derived in: http://turmelpress.com/bankmath.htm . I do my favorite example at the gaming table where I explain how to make poker chips inflate even though they are backed up one-to-one by collateral in the cashier's cage and never inflate as a rule. I simply point out that all we have to do to make usually non- inflatable currency inflate is to charge interest and create a death- gamble. You can try it out in the same was as the example at the end of the bankmath.htm. You're the banker and all 10 players pledge their watch as collateral and you "lend" them all 10 chips. At the end of the game, you insist that they repay you the principal and 10% interest. Now, it's impossible for all 10 borrowers who each only received 10 chips to all repay 11 chips so someone has to get knocked out of the game. Hence the contract bearing interest is aptly named "mort- gage" from the Latin "Mort" meaning "death" and old English and French "gage" meaning "gamble." A mortgage is an elimination deathgamble. You seize the watches of the ratio (I/(P+I)) of the guys who get knocked out of the game and then explain to the survivors (P/(P+I)) that their 100 chips now only buy 9 watches so that, even though there was no increase in money supply, their chips have suffered inflation and now buy less. That's the easy example but it works the same way in the regular economy where businesses borrow new money into circulation to pay their costs, inflate their prices to recuperate both the principal and the interest, and pray they sell knowing there is insufficient money in circulation for all to survive. Those who cannot sell their goods (I/(P+I)) fail and have their businesses foreclosed upon so that the minimum ratio of those forced into unemployment is the same minimum ratio of foreclosure inflation suffered. That is how the usury deathgamble generates both unemployment and inflation at the same time. Of course, if the bankers increase loans of new money, they can delay the failure and inflation. So they can fiddle with the results. So that is the essential relationship between inflation and unemployment in relation to their cause: interest. Of course, if one thinks one is dealing with inflation as a too much money rather than too much foreclosure, then I can imagine that fiddling with one may may seem to change the other. But if inflation is properly perceived as too much foreclosure of watches, then the connection of unemployment and inflation to interest rates seem evident. That an interest-free casino chip system does not suffer inflation but does when interest is charged and that an interest-free casino chips system provides enough liquidity for all to participate in economic activity but charging interest knocks some out of the game are good indications that interest is the root cause of both effects.
>What are the appropriate stocks and flows in the capital, labour and >product markets? How can the model be verified econometrically? JCT: A casino cashier doesn't worry about capital, labour or product markets because that is accomplished by the invisible hand. The cashier doesn't plan how many chips he will issue tonight. That is purely dependent on the amount of collateral or labor pledged. And since the tokens are always one-to-one with the products, the product markets always equal the products available for sale. Again, it is not up to the cashier to determine these things, it is only up to the cashier to issue the requisite number of chips depending on demand. Read the story of the relation of the stationary engineer who delivers steam to the manufacturing firm written by one of Canada's greatest Social Crediters, Louis Even, in my Wachitsuh Hussle at: http://turmelpress.com/watch80.htm . I think it is the most brilliant analogy for the malfunctioning money system ever written. He's also the one who wrote Salvation Island which explained the bankers scam.
>If these questions are too tough, please supply the name of the >plastics firm in Finchley, so I can order my own copy of the >hydraulic model! :-) Geoff Hyman (NetReacher) >Kentish Town, London JCT: As I explained recently, all my model needs is a bowl and a cup in a sink with a tap in order to model either the piggy bank model or the chartered bank model. -------------------------------
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