Central Banks get their act together

[Swing low, sweet chariot. Comin' for to carry me home.]

I am pretty impressed by the way the Federal Reserve has pulled its act together and have coordinated a worldwide round of interest rate hikes -  the European Central Bank raised its key interest rate a quarter percentage point Thursday, and Central bankers in India and South Korea also unexpectedly raised their key interest rates Thursday.

The board members of the central bank have been making coordinated speeches and are all singing the same tune: "we are concerned about inflation and determined to get out ahead of the curve."

In response:
1) the 10 year note has dropped below 5%
2) the dollar has firmed
3) Gold has dropped more than $100 an ounce in the past month
4) copper is down 25% in the past month

With the housing market continuing to cool, this should help offset the price pressures inherent with 4.6% unemployment and $70 oil.

[Swing low, sweet chariot. Comin' for to carry me home.]

Glad the copper price is dropping! People are stealing copper wire from off the railroad tracks here!

Notwithstanding the price of oil, copper prices worry me the most.  Even with today's 6% drop, copper prices are still 65% higher on the year.

[Swing low, sweet chariot. Comin' for to carry me home.]

Its hard to think of the Fed as inflation fighters since almost all of the long term inflation in the country occurred after the fed was born. Thanks to their policies the dollars has lost 95% of its value.

The Treasury Department sets dollar valuation policy, not the Federal Reserve.

[Swing low, sweet chariot. Comin' for to carry me home.]

The Treasury Department sets dollar valuation policy, not the Federal Reserve.

If ignorance was bliss, you'd be having an orgasm by now.  The Federal Reserve reports to no one.  It isn't part of the government.  There's nothing federal about it and there are no reserves.

In case you haven't noticed, you are choosing to act like an ass, so please allow me to retort:

Your comments regarding whether or not the Federal Reserve should exist and whether it is actually "federal" were NOT the topic of this thread.  So, responding to me as if I were addressing those issues is ignorant.  At least introduce your tangential remarks as topics that should be discussed, instead of acting as if you’re giving an intelligent response.

Furthermore, it is an established fact that the Federal Reserve does indeed exist and that it derives its authority from the U.S. Congress, the legislative branch of the United States federal government, which just so happens to be the overseer of the Federal Reserve.

[Swing low, sweet chariot. Comin' for to carry me home.]

The fed in conjunction with all banks create money out of nothing by making loans with money they don't have.

What?...wrong

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If the banks get $1000 in deposits they can make about $10,000 in loans.

wrong

Banks can loan up to 90% of deposits sitting in transaction accounts, not 1000% of deposits as you claim.  In time deposit accounts (e.g. CDs), the bank can loan up to 100% of the deposits, but NOT over 100%.

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Then they collect interest on the money that they created.

wrong

banks make money by loaning out up to 90% of their transaction deposits (100% of their time deposits).  They are charging a higher interest rate to loan customers than they pay to customers holding deposits, that's how banks earn their profits.

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In the process the extra money in the economy creates inflation.

see wrong assumptions #1, #2, and #3 above

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Safe to say you have never studied banking.  I, on the other hand, have designed and implemented banking systems that deal in exactly this very issue. 

In fact, if you have money in a cash account at a stock broker, chances are that I had a hand in building the system that automatically sweeps money from your cash account held by your broker into a higher yielding savings account at a bank.  There are two types of accounts created by the brokerage in your name at that bank:  transaction deposits and time deposits.  If you can write checks out of your account at your broker, then that money is transferred from the time deposit account into the transaction account.  The bank MUST keep 10% of the money in transaction accounts in reverse, but they can loan out the other 90%.  For the money in the time deposit accounts, the bank loans out up to 100% of the amount deposited, but NOT over 100%.

The customers at the brokerage win because their money is earning a higher interest rate and is protected by the FDIC when it is sitting in a bank.  The brokerage wins because they skim-off and pocket some of the interest paid by the banks to these accounts.  The banks win because they have more deposits to lend out.

Dude, this whole preoccupation you have with bashing the banking system, as well as your problem with how the M3 money supply is calculated, is based on your near TOTAL misunderstanding of the purpose and function of currencies and centralized banking systems.

[Swing low, sweet chariot. Comin' for to carry me home.]

There's nothing federal about it and there are no reserves.

I missed this part of your statement...

The "Reserve" is the 10% part of transaction deposits that the banks MUST not lend out (the other 90% of transaction deposits can be used to make loans).  This 10% is held by the Federal "RESERVE".

So, not only is there a reserve, but it is very real and NOT simply some IOU like the ones sitting the Social Security Trust Fund.  When you open a checking account or hold a balance in a checking account, 10% of your balance is sent to the Federal Reserve to be held in "reserve".

The Federal Reserve uses part of the "reserve" to make overnight loans to banks to cover liquidity imbalances and charges the banks the "Fed Funds Rate" for these overnight loans.  (This very same Fed Funds Rate is the rate raised when the Fed raises short term interest rates.)  And, if I am not mistaken, this Fed Funds Rate is how the Federal Reserve is funded - it is NOT funded by taxpayer dollars, rather it is funded by banks, through the Fed Funds Rate, as part of the cost of doing business within the federally regulated banking industry.

By raising or lowering the Feds Fund Rate, the Federal Reserve can control the cost of liquidity within the banking system.  The cost of liquidity is passed on to those barrowing money through higher interest rates charged to them by lending institutions.  And when the cost of barrowing goes up, the demand for barrowing goes down,,,the economy slows which reduces demand and THEREFORE helps to control inflation by controlling the price paid for goods and services.

[Swing low, sweet chariot. Comin' for to carry me home.]

I, however, MADE it the discussion.

$10 in 1780: $10
$10 in 1916: $16
$10 in 2006: over $1,900

Your precious federal reserve steals more money from Americans than any other organization, even the government.

1) Name one currency that has not experienced inflation. 

2) You claim that money is being stolen from Americans by the federal reserve...but where is this pile of "stolen money" being held?

[Swing low, sweet chariot. Comin' for to carry me home.]

Is your knowledge in this realm basically from on the job experience, or did you dabble in banking/economics/finance in college?

job experience...when I am not on projects involving energy trading transactional systems, I'm on projects involving brokerages and banking. 

Banking is boring, it is usually just dealing with debits or credits, though the nightly sweeping of money into different accounts is interesting.  When your bank is closed for the day, the money is invested overnight...money never sleeps.

[Swing low, sweet chariot. Comin' for to carry me home.]

The Federal Reserve uses part of the "reserve" to make overnight loans to banks to cover liquidity imbalances and charges the banks the "Fed Funds Rate" for these overnight loans.  (This very same Fed Funds Rate is the rate raised when the Fed raises short term interest rates.)  And, if I am not mistaken, this Fed Funds Rate is how the Federal Reserve is funded - it is NOT funded by taxpayer dollars, rather it is funded by banks, through the Fed Funds Rate, as part of the cost of doing business within the federally regulated banking industry.

I had a friend who works for one of my past clients correct me on this during lunch today...

The Fed Funds Rate is used by banks in overnight loans to other banks to help meet their 10% reserve requirements.  When the Fed Reserve loans directly to banks, the Discount Rate is used, not the Fed Funds Rate.

Disclaimer:  The systems I have been involved with only deal with allocating and sweeping money from individual accounts at brokerages into and across transactional and time deposit bank accounts, along with calculating the resulting 10% reserve requirements and the interest accrued and paid to the accounts.  The systems didn't involve overnight reserve loans between banks, which is why I was mistaken on exactly who was loaning the money during the overnight periods...sorry for the confusion.

It is correct, however, that the Fed Reserve is not funded by Congress, and therefore is not funded by taypayers…”The Federal Reserve's income is derived primarily from the interest on U.S. government securities that it has acquired through open market operations. Other sources of income are the interest on foreign currency investments held by the System; fees received for services provided to depository institutions, such as check clearing, funds transfers, and automated clearinghouse operations; and interest on loans to depository institutions (the rate on which is the so-called discount rate). After paying its expenses, the Federal Reserve turns the rest of its earnings over to the U.S. Treasury.” (quote from http://www.federalreserve.gov/generalinfo/faq/faqfrs.htm#6 )

[Swing low, sweet chariot. Comin' for to carry me home.]

For those interested in Fractional Reserve Banking and how it corrupts the money supply...
Corruption, corruption, corruption, beyond belief.  We allow private individuals to create money and charge interest on it.  We, the people, pay interest, get fake worthless fiat money in return.  And just watch when YOU, the private individual, starts printing your own money.  The government and federal reserve gets their panties all tied in a knot.  For some reason THEY are allowed to print money, devalue EVERYONE ELSE's money, but you're not to.

A Fractional-Reverse-Banking is exactly what I described – banks are required to keep a fraction (10%) of demand deposits in reserve.

The creation of money you are attempting to describe is NOT corruption; rather it is an increase in the amount of oil needed to lubricate an increasingly bigger engine.

In simple terms, if one quart of oil is needed to lubricate a 100cc engine, then more oil is needed to lubricate the engine as the engine gets bigger.  If an economy requires x% of liquidity, then the amount of liquid (currency) will have to increase grow along with the economy.

If I mine iron ore to make hammers at a profit, then I have created wealth because I have produced something of value.  Currency is the mechanism that allows me to exchange the hammers I made for cash so that I can turn around and buy other goods with the profit I earned.  If the money supply doesn’t grow with the economy, then we would be left with a barter system.

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Now back to the fractional system using a real-world example:

1) PersonA deposits $10k in BankA…PersonA leaves the picture and is earning interest from BankA.
2)  BankA takes 10% ($1k) and places it in reserve and lends out $9k to PersonB who wants to buy a car. .BankA, who still owes PersonA $10k, is now out of the picture and is receiving payments from PersonB and holds the title of the car as collateral guaranteeing repayment.
3) PersonB goes to a DealershipA and EXCHANGES his liquid asset ($9k) for a nonliquid asset (a car) and goes home owing $9k to BankA….at this point in time PersonB is out of the picture.
4) DealershipA deposits the $9k he EXCHANGED for the car he sold to PersonB in BankC…DealershipA earns interest on his deposited $9k and is now out of the picture.
5) BackC take 10% ($0.9k) and places it in reserve and lends out $8.1k to PersonC who wants to buy a spa.  BankC, who still owes DealershipA $9k, is now out of the picture and is receiving payments from PersonC and holds something as collateral guaranteeing repayment.
6) PersonC goes to PersonD and EXCHANGES his liquid asset ($9k) for a nonliquid asset (a spa) and goes home owing $8.1k to BankC….at this point in time PersonC is out of the picture.
7) PersonD deposits the $8.1k into a BankD…and the process repeats again and again.

So, even though the money supply has increased, it increased as a result of goods being produced and sold (in this case, a car and a spa).  That is NOT creating money out of thin air; rather that is creating money by exchanging it with the PRODUCTION of goods (a car and a spa).  The money that was “created” is actually represented by the car and the spa that was produced.

The inflationary aspect is NOT that money was created to accommodate a growing economy, rather the inflationary side is that lending creates demand for goods and services by allowing people to purchase items on credit.  If PersonB and PersonC in our example were not able to borrow, then they would be subtracted from the demand side of the equation and would lower the demand for cars and spas to be produced….hence, by lending money, you are creating demand (which, in turn, encourages more supply).

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Now, lets take the case where the money supply does NOT increase:

An economy’s GDP at Time0 is $10B and its money supply is $1B and there is NO lending and no debt.  The citizens multiply and become more productive, increasing GDP to $100B at Time1 which allows them to increase their standard of living by buying more and better goods and services PROVIDED they still have a currency to trade goods and services.

Now, in order for the $100B of goods and services to be exchanged then $100B in money has to exchange hands.  So, if we are stuck with the original money supply of $1B, then the VELOCITY (the rate at which the money changes hands) of the $1B money supply has to increase 10 fold…OR the money supply has to increase…the only other choice is for the citizens to resort to a barter system which is difficult and very inefficient.

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So, how on earth would you grow the money supply if you didn’t allow people to borrow in order to exchange the borrowed money for goods….As you can see, for a growing economy to continue to exchange goods efficiently, the currency (money) supply has to grow.

If you set a Gold Standard, they you are limiting the growth of the economy by forcing gold production to increase at the same clip as the economy.  If growth of production of gold (which in not exactly abundant, hence the title precious metal) does not keep pace with the growth of the economy, then the value of gold in relation to goods will increase, which decreases the value of goods in relation to the dollar since the dollar is tied to a Gold Standard. 

So, if the value of a goods and services is decreasing in relation to the dollar, why in the world would anyone invest dollars to produce goods and services if they services are depreciating in relation to the dollar?!

This causes people to hoard currency, which destroys the purpose of having a currency.  If the oil of the engine is hoarded, then it can not be used to lube the engine…if the engine can not be lubed, it grinds to a halt (e.g. The Great Depression).

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Think of it in terms of physics:  mass times velocity equals momentum.  Money is the currency used to transfer momentum throughout the economy.  But a certain amount of money can only transfer a certain amount of momentum.  So for money to be able to transfer the growing momentum of an expanding economy, you have to increase the mass of money (increase the money supply) OR increase the velocity of money (the speed at which money is exchanged).

There are many ways to increase the velocity of money:  increase efficiency of delivery of goods to market, increase efficiency of check clearing, increase accessibility to money through the use of ATMs, etc…but these efforts have their limits and the velocity of money doesn’t increase as fast as the economy grows.

So, if the velocity increases at a slower rate than the growth of the momentum of the economy, the mass (supply) of money has to increase.

Example:

If the momentum (GDP) increases 3%, and if the velocity only increased (1%), then the mass has to increase by 1.98% (1.03/1.01).  So, if the GDP grows by 3% and the velocity of money grows by only 1%, then the money supply has to grow by 1.98% in order to accommodate the selling of the increased goods and services.

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Putting it all together:

Using the equation: mass (money supply) times velocity (rate at which money changes hands) equals momentum (GDP)…we can see that the lending of money helps grow the economy.  The Federal Reserve can either encourage (lower rates) or discourage (raise rates) borrowing to influence the growth of money supply which will then impact the growth of the economy.

Of course, there are drawbacks to this approach, the Fed can guess wrong and a) over stimulate the economy causing increase inflation and a unsustainable boom followed by a bust, or b) under stimulate the economy causing it to not perform up to its potential.

[Swing low, sweet chariot. Comin' for to carry me home.]

But those are different banks, the point is only 90% of the money gets lent out. It's irrelevant whether some of that gets re-lent out.

No it is not fernboy.  Banks create money this way, inflating the money supply, creating inflation.

But jfern's point, mirroring the point of my spa/car loan example, is only 90% of the money is being used in the economy at any given point in time.

If PersonA had $100 and lent it to a BankA, and BankA turns around puts 10% into reserves and lends $90 to BankB who then lends it to another and another and another who then lends it to PersonB, there is still only $90 that can be put into service at a given point of time and it is in the possession of ONLY PersonB.

If PersonA comes back to BankA to demand his $100, then BankA has to find other assets or deposits totaling $100, or borrow overnight from another bank with EXCESS reserves, or face being forced to close its doors.

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Here is an example from the web page you cited at http://en.wikipedia.org/wiki/Money_multiplier

“For example, let's assume that a primary deposit of $1000 is made into bank A. If the cash reserve ratio is 12%, then $120 must be kept on hand by the bank and $880 is available to be lent to someone else (called the excess reserve). Now if bank A uses its $880 in excess reserve by lending it out, and that is deposited in bank B, it represents a primary deposit to the second bank. Bank B must keep 12% of $880 on hand but can lend out $774.40. If that $774.40 is eventually deposited in bank C, the third bank must keep $92.93 on hand but can lend out $681.47. The process continues until there is no excess reserve left (For simplicity we will ignore safety reserves.). By adding all the derivative deposits we can calculate the amount of money created… The initial change in deposit of $1000 will increase total deposits by $8333.33 given a reserve ratio of 12% (1000/.12=8333.33)”

Even though it may be counted across this various accounts as an increase in the money supply, what is really going on is the borrowing has increased the VELOCITY of the money, not the amount of money – and the money, as it changes hands, can only be used once at any given point in time.

The actual result of the example above is that the entire $1000 went into reserve and the resulting $8333.33 of "increased" money supply is NOT liquid.  If any attempt is made to withdraw any portion of the $8333.33 held across the accounts, the banks are going to have to come up with additional deposits to cover the additional reserves and we wind up back at the beginning:  $1000 dollars initially deposited with $120 in reserve and $880 of liquidity to loan.

[Swing low, sweet chariot. Comin' for to carry me home.]

A Fractional-Reverse-Banking is exactly what I described – banks are required to keep a fraction (10%) of demand deposits in reserve.

No it is not.  David S clearly said

If the banks get $1000 in deposits they can make about $10,000 in loans.

And you opposed that, proving how uneducated you are.  I proved that with fractional reserve banking, a $1,000 deposit is turned into $10,000.

You are missing the point that of that $10k only $1k of liquidity is available to the system.  The entire $10k can NOT be liquidated until the bank finds other deposits totally $10k.

[Swing low, sweet chariot. Comin' for to carry me home.]

Defining success...Huge one day drop (13-Jun-2006):

Gold (CMX) August 06 ($US per Troy oz.) 566.80 -44.50
Silver (CMX) July 06 ($US per Troy oz.) 9.63 -1.44
Platinum (NYM) July 06 ($US per Troy oz.) 1,118.50 -52.90
Copper (CMX) July 06 ($US per lb.) 3.01 -0.22