Why does printing more money cause inflation?

[Beej]

I don't claim to be an expert, but I'll have a go:

Again the APRA tables also seem to confirm this situation (Total loans $1,483B, total deposits $1,243B). But if you download the spreadsheet at the link I posted, you will see that "Total Resident Assets" of all banks in Australia is $2,324B, which includes cash and liquid assets held, trading securities, investments (+ all loans) and so on. Ie, if you take the loans out, there are still another $900B of other non loan assets held in the system. So by that measure the banks appear to be well capitalised relative to the size of their loan/deposit books to me?

Just wanted to correct some typo's above - where my original post states $900M I of course meant $900B. Additionally I used decimal points in some of the other numbers where I meant to use comma's! Corrections in the quote above.

In a country with no bank, there is $1 mill of currency. you and a group of entrepreneurs pool your money together and start up a bank with $100k of capital.

Your first customer takes out a loan of $10k with 10% interest per annum.

Total Loans are greater than total deposits by $100,000, unless you count the 100k of capital as deposit.

Excellent example, and I think that's very much the situation with Australian banks, as this shows where the "extra" $900B in resident assets has probably come from (share-holder equity + retained earnings/cash-flow etc).

PS: Thinking about this some more, if we presume an average interest rate margin of say 2% on all outstanding loans, that generates some $30B a year in net cash-flow (ie after paying all funding costs, interest to depositors etc etc), equals 2.5% of the total deposit book pa. We haven't added in cash-flow from bank fee's yet either, which is a similar amount from memory. I would reckon all this cash-flow, plus the non loan related $900B worth of other liquid assets mentioned above, would be more than enough for the banks to cover any deposit withdrawals that might arise under any "normal" circumstances. Does that show how the situation is quite sustainable?

PPS: Looking at all this, it's no wonder the banks have such high earnings and high dividend yields in Australia.

Cheers,

Beej

 

[ducati916]

From Mish

http://globaleconomicanalysis.blogspot.com/2009/10/fractional-reserve-lending-constitutes.html

Fannie Mae makes a loan of $1,000,000. Let's be more than reasonably fair and assume Fannie Mae issued bonds for the entire amount, not borrowing a single cent into existence. So far there is no fraud.

$1,000,000 goes to the home builder. That home builder deposits $1,000,000 into a Bank of America checking account. Ignoring sweeps that would allow Bank of America to loan out every cent, let's assume BofA keeps 10% in reserves and lends out $900,000 to a new furniture store on the corner strip mall.

The furniture store owner buys $900,000 of furniture from a wholesaler. The wholesaler deposits $900,000 into a Citigroup checking account. Again, ignoring the likelihood Citigroup sweeps the whole amount into a savings account thereby able to lend out the entire amount (savings accounts have no reserve requirements), let's assume that Citigroup keeps 10% in reserves and lends out $810,000 to a High Roller who takes out a home equity loan on his house that is supposedly worth $3,000,000.

High Roller buys a yacht from a boating manufacturer for $810,000. The yacht manufacturer deposits $810,000 in a checking account at Wells Fargo. Following the same pattern, Wells Fargo keeps 10% in reserves and lends out $729,000 to a plumbing supply company, because home sales are going gangbusters and the plumbing supplier needs more supplies.

I think you can see where this is headed.

On the original $1,000,000 this is what FRL allows to be lent out.

$900,000
$810,000
$729,000
$656,000
$590,000
$531,000
$478,000
$430,000
$387,000

See where this is going?
I am going to arbitrarily stop the chain right there, but the total so far is $5,511,000 out of $1,000,000 was lent out.

jog on
duc

 

[Macquack]

In a country with no bank, there is $1 mill of currency. you and a group of entrepreneurs pool your money together and start up a bank with $100k of capital.

Your first customer takes out a loan of $10k with 10% interest per annum.

Total Loans are greater than total deposits by $100,000, unless you count the 100k of capital as deposit.

Dont you mean "Total Loans are greater than total deposits by $10,000"

My take.

The Banana Republic Bank lends out $10,000 to their first customer, Fred Blogs to buy a piece of land. A bank cheque is made payable to Mr Keating the land holder.

Surprise, suprise Mr Keating turns up the very next day at the Banana Republic Bank and deposits his cheque and decides to open a savings account (paying 8 % interest).

Total loans (asset) = $10,000 , Total deposits (liability) = $10,000.

The Bank collects the 10% interest from Fred Blogs, but has to pay Mr Keating 8% on his deposit. The Bank makes the 2% spread so long as Fred keeps up his repayments.

Also, no cash changed hands. The bank still has the $100,000 cash in the vault. The bank must have created the $10,000 loan out of thin air!

 

[alter1217]

In a country with no bank, there is $1 mill of currency. you and a group of entrepreneurs pool your money together and start up a bank with $100k of capital.

Your first customer takes out a loan of $10k with 10% interest per annum.

Total Loans are greater than total deposits by $10,000, unless you count the 100k of capital as deposit.

Fixed.

Dont you mean "Total Loans are greater than total deposits by $10,000"

My take.

The Banana Republic Bank lends out $10,000 to their first customer, Fred Blogs to buy a piece of land. A bank cheque is made payable to Mr Keating the land holder.

Surprise, suprise Mr Keating turns up the very next day at the Banana Republic Bank and deposits his cheque and decides to open a savings account (paying 8 % interest).

Total loans (asset) = $10,000 , Total deposits (liability) = $10,000.

The Bank collects the 10% interest from Fred Blogs, but has to pay Mr Keating 8% on his deposit. The Bank makes the 2% spread so long as Fred keeps up his repayments.

Also, no cash changed hands. The bank still has the $100,000 cash in the vault. The bank must have created the $10,000 loan out of thin air!

Well, yeah, that's what usually happens... Until the government implements a piece of regulation called "reserve requirements"... there could potentially be unlimited money created (until a bank run occurs, lol)?

 

[Macquack]

Well, yeah, that's what usually happens... Until the government implements a piece of regulation called "reserve requirements"... there could potentially be unlimited money created (until a bank run occurs, lol)?

"Unlike central banks in a number of other countries, the RBA imposes no reserve requirements"
http://www.rba.gov.au/MarketOperations/Domestic/open_market_operations.html

Reserve requirements/ratios are old school.

Capital adequacy is the new buzz word used by central bwankers. What does it mean? It means that private banks can create more money out of thin air than they could when there where minimum cash reserve ratios in place.

"Removing controls on banks will almost certainly result in a surge in credit growth...A regulated financial system often tends to result in credit rationing, so there is unsatisfied demand for credit in the community; this is able to be meet once the controls are removed."

"Australia's Experience with Financial Deregulation"
Rick Battellino
Deputy Govenor
Reserve Bank of Australia

 

[jono1887]

Reserve requirements/ratios are old school.

Capital adequacy is the new buzz word used by central bwankers. What does it mean? It means that private banks can create more money out of thin air than they could when there where minimum cash reserve ratios in place.

There aren't any specified capital adequacy ratio in Australia isn't there.. its up to the banks choice on what their capital adequacy ratio's are..

 

[JimmyJones]

There aren't any specified capital adequacy ratio in Australia isn't there.. its up to the banks choice on what their capital adequacy ratio's are..

From wikipedia:

"Australia, through its Australian Prudential Regulation Authority, implemented the Basel II Framework on 1 January 2008"

Also:

http://www.riskmanagementmagazine.com.au/articles/74/0c03eb74.asp
http://www.apra.gov.au/ADI/Basel-II-implementation-in-Australia.cfm

I thought the Basel rules were voluntary for the countries signing up to them. If that's the case why didn't the U.S. government lower the capital requirements for their own banks thus negating the need for the taxpayer-funded bailouts??

 

[Macquack]

I thought the Basel rules were voluntary for the countries signing up to them. If that's the case why didn't the U.S. government lower the capital requirements for their own banks thus negating the need for the taxpayer-funded bailouts??

Wasn't that the problem, US private bank reserves were already too low.

America’s Federal Reserve””maintained them (reserve requirements), but had such loopholes in them that they became basically irrelevant. Thus the US Federal Reserve sets a Required Reserve Ratio of 10%, but applies this only to deposits by individuals; banks have no reserve requirement at all for deposits by companies.
Yueh-Yun C. OBrien, 2007. “Reserve Requirement Systems in OECD Countries”

 

[jono1887]

From wikipedia:

I thought the Basel rules were voluntary for the countries signing up to them. If that's the case why didn't the U.S. government lower the capital requirements for their own banks thus negating the need for the taxpayer-funded bailouts??

I think considering the state of the financial system.. reducing the requirements would have no effect. The banks were all scared of bank-runs, and by reducing their own capital reserves, they would be increasing this risk. Didn't the US govt find that even with the injection of the billions of dollars.. the banks were simply unwilling to hand out any more credit, hence the credit crisis and they were preferring to sure up their balance sheets and minimise risks by increasing their own capital reserves above the specified rate.

 

[Sean K]

Good You Tube on Inflation I think;

 

[Macquack]

Good You Tube on Inflation I think;

In reference to Mugabe cutting loose with the printing presses.

By July 2008, it cost 100 billion Zimbabwean Dollars to buy three eggs.

In April of 2009, the Zimbabwean currency was officially declared dead and completely worthless.

Zimbabweans were forced to transact in gold.

Is there a message in this for the rest of the world?

 

[boofhead]

Many in Zimbabwe trade in neighbouring currencies and the South African Rand is popular.

 

[Timmy]

ducati916 - if you are around - or any others, of course, thoughts on money velocity in the US?

First tick up in a while, possible foreshadowing of the inflation you were looking for?

Graph below, from: http://research.stlouisfed.org/publications/mt/page12.pdf
(Red oval mine)

 

[GumbyLearner]

I've tried to track stats on IMF Special Drawing Rights. Who borrowed, how much and when?

Can anyone on ASF please point me in the right direction?

Here's a great informative article by Joe Stiglitz.

This is the paragraph that got me thinking!!!

Thanks to the Deficit, the Buck Stops Here
August 30, 2009

http://www.washingtonpost.com/wp-dyn/content/article/2009/08/28/AR2009082802111.html

In its interim report in June, the commission described a number of alternatives. Some involve building on the International Monetary Fund's "special drawing rights," or SDRs -- a kind of "IMF money" -- but making the issuance of this global reserve money annual and more predictable. (Currently, issuances of SDRs are small and episodic.) Other proposed reforms are more complex and ambitious, such as issuing new global reserves in ways and amounts that could be used to stabilize the world's economy or to invest in "global public goods," such as helping developing nations reduce greenhouse gas emissions.

So what are these small and episodic events?

 

[paulhood]

simple defintion of inflation is: an increase in the supply of money......therefore more money in the system reduces the purchasing power of existing dollars that are already in the system......hope this helps.....

 

[Timmy]

Gumby - the IMF website has info on SDRs and the 4 times they have been allocated ... hope that helps. (It appears one of the allocations was after Stiglitz's article appeared in August '09)

http://www.imf.org/external/about/sdr.htm

 

[Wysiwyg]

So is Australia currently experiencing the effects of inflation due to USA printing more paper money?

 

[tothemax6]

So is Australia currently experiencing the effects of inflation due to USA printing more paper money?

What other countries do to their currency should have no effect. The only thing that effects inflation in Australia is the Australian money and credit supply. Note the appreciation of AUD against USD since the US started printing away.