How does the Fed create credit?

If I am not mistaken, you ask this question every few months. I'm so easy.

Suppose I agree to sell you my car for $20,000. You don't have the money so I allow you to pay over time. Now your IOU to me isn't all that negotiable but some banks will take it off my hands at a discount from face value.

Now I'm sure you want to go on about the "debt virus" but please don't. Where did the $20,000 I "lent" you come from? Both parties thought they got something better in the exchange or the trade wouldn't have been made. Suppose you die in a car crash. How much then is that IOU worth and while I could get the car back in exchange for the IOU based upon non-performance of the terms, why would I want a squished car with no retained value except as scap I'd have to pay someone to haul away?

On Aug 1, 2:19 am, RichD wrote: (paraphrasing here) --- "Can anyone explain" (how the federal reserve creates money? )

------------- reply follows ----------------- See >

Where I try to answer that question and give sources of related information.

Marty Carbone

excellent

much better than the other response

Not sure if this is a good place to start. Maybe begin at the beginning with the 'creation' of real wealth which would be deep in the manufacturing process.

Maybe better to start with a grain of corn.

If I was wrong about RichD trolling for a way to introduce the "debt virus" I was wrong to start where I did.

Certainly the distinction between financial and material wealth would be a good place to start as would be the purpose and properties of "money". Since this isn't where RichD wanted to start and he said he had started reading an article on finance and came to focus on this minor issue I assumed he had an agenda. Focusing on the Fed isn't a good starting point for understanding money.

heh I've been scrunching my brain over the banking system for a while.

I won't.

PS I have no desire to jabber about the debt virus. PPS I never heard of it. PPPS What is the debt virus?

Fascinating, really fascinating. Except it hardly addresses the questions I raised...

1) My IOU is a promissory, to pay back in currency ($$). It is not currency.

But when the Fed issues its credit, it IS currency/money/dollars.

2) In what form does the Fed create, and issue, credit? Is it something other than Federal Reserve notes?

If it is merely numbers in a computer memory, who receives it, and how?

3) The Fed creates money, by some mystical method. How does it remove money from circulation? When was the last time that happened? 3) Consider all the 'money' in the world, denominated in dollars; greenbacks, bonds, etc. Now suppose everyone wants to convert to green paper bearing portraits of deceased emperors. Are there enough greenbacks floating around in the world's bank vaults to satisfy them?

Please do try to focus, if you can...

3 is the highest I learned to count...

You're going to find it strange but the Fed doesn't create money in any sense you'd care to think about. It buys cash at printing cost from the Treasury and coin at face value from the US Mint.

When the Fed want to inject liquidity into the economy it does it through open market operations, that is it buys Treasury bills on the open market. The National government sells bonds on the open market as well. Intrest on the bonds held by the Fed that isn't used for operational costs is returned to the Treasury. The Fed doesn't just buy cash and buy bonds with the cash. It adusts the velocity of the money by modifying reserve requirements and Fed funds rates. Mostly it just asserts where it thinks the cost of money should be and lets the market do the work. It seldom modifies reserve requirements.

If you understand double entry accounting, you know that the balance of debts and credits is zero.

Here's the history of how the Federal Reservee was formed:

Is this correct?

Suppose you agree to sell the car, the buyer hasn't the money so you agree he can pay you the $20K in $250 monthly installments. However, in order for you to do this, you want an additional $2000 (interest) paid over that time to cover the costs of keeping track of the payments and the cost of not having the total amount of $20K and just to make a little more money off of the deal also. You shake on the deal, the buyer agrees and after the set time pays off the debt in cash.

In order to pay this debt off the buyer worked (as you had done) to buy the car and to pay you the extra dollars. The car was traded for work.

Now the bank. Another buyer goes to the bank to get a loan to pay you off completely. All 20K. the bank does not give the buyer actual money but a line of credit so that he can write a check which you accept and can deposit in your own bank account.

You CAN cash this check but most likely do not. One reason being that the bank, neither bank, really has the cash on hand to back up all the checks it has assigned value to, that is, if all people who had money at this bank, or any bank, were to come in and want actual money, it would be impossible. The bank can, by law, loan out more money than they actually have on hand.

Back to the buyer. He is paying off this bank loan with money based on work. However, the loan did not have an equivalent value but was created as 'checkbook money' sort of 'poof', it's there cause everyone says it is.

The buyer goes to work and says to his boss, "well ok 'poof' my work is there just because I say so." Hilarity ensues.

You did not have, nor did you need to have the $20k in cash. You held title to the car that was worth $20k. I would assume that if the guy with which you made the deal does not pay, then you would get the car back, i.e. you still have an enforceable claim to the car. And I imagine you would demand that the buyer have full insurance coverage on the car as a part of this credit arrangement. If the buyer does not pay you repossess the car and sell it to someone who will pay. I assume you were smart enough to require a reasonable down payment that would cover the repossession and re-marketing costs. If not then you are a thieving Republican.

This is a 3 party deal and the bank is acting as a financial intermediary. The bank will require the safeguards as described above. The car is the backing for the "loan". The current car owner (manufaturer?) of the car will be given "bank money" which he will deposit in a bank. All the banks are interconnected. It is a game of musical chairs in which there are the right amount of chairs. SO long as little banks (few depositors) make little loans and big banks (lots of depositors) make the bigger loans than all is well. At the end of the day the bankers go have a beer and sort all this out and see if they need to loan one another some money so that the Fed don't raise hell.

The bank has essentially done the same thing as you have done in the 2 party transaction. The bank has "liquified" the car. The car has a value of $20k and that is the backing for the loan. There need be no vault full of gold. If the buyer does not pay then the car is repossessed and sold to someone who will pay.

So..... The bank did not get the value of the loan. The seller/manufacturer got the money. the major portion of "interest" is used to pay the people that provide banking services. They have to eat too.

Why is the real word hilarious to you?

How, with what, does it pay?

That means the net money overall is just the currency created by the Fed?

Also, the article claimed the declining dollar causes other countries to purchase T bills (to impede appreciation of their own currency), which is inflationary as it injects dollars into the american economy.

However, since dollars are the world's reserve currency, there is no net addition to the world financial system, so I find this questionable.

And it stated that fractional reserve banking creates money, which is also inflationary. I find this dubious also. I bring it up, as it seems worthy of discussion.

There are many definitions of money. The only one's tracked by the Fed these days are M0, M1, and M2.

From

The most common measures are named M0 (narrowest), M1, M2, and M3. In the United States they are defined by the Federal Reserve as follows:

M0: The total of all physical currency, plus accounts at the central bank that can be exchanged for physical currency. M1: M0 + those portions of M0 held as reserves or vault cash

• the amount in demand accounts ("checking" or "current" accounts). M2: M1 + most savings accounts, money market accounts, and small denomination time deposits (certificates of deposit of under 0,000). M3: M2 + all other CDs, deposits of eurodollars and repurchase agreements.

The Federal Reserve ceased publishing M3 statistics in March 2006, explaining that it cost a lot to collect the data but did not provide significantly useful information.[77] The other three money supply measures continue to be provided in detail.

They could have purchased T bills all along. Why didn't they?

I doubt the dollar will remain king. It is only a store of value as long as it retains its value. I recently heard China has moved 500,000,000 people into the middle class in the last twenty years. The middle class in China isn't like the middle class in the USA but as people find themselves with more choices they will make more consumer choices and this will level prices from this downward spiral.

The moves the Fed makes are a best second order. They take the reverse requirement into consideration when they make their moves.