Absolutely superb book explaining just how much I didn't know about how money works. I have already put several of your investment suggestions to work, so my future self thanks you for protecting my assets from the governmental machinations ahead!
Hello Jim. I have read Black Hole, including all the appendices, and I would say you have convinced me. Well, at least mostly. What still bothers me is that banks have always really seemed mighty eager to get depositors. Also, they encourage depositors to increase their deposits. I just don't understand why they seem to care so much, since they don't need depositors to make loans. If you addressed this in Black Hole, I must have missed it. (But honest!, I thought I read it carefully.) In any case, can you help me understand why that is?
Hi, Dave, thanks for the question, and thanks for reading "Black Hole." You're asking a great question, which I addressed briefly (but not thoroughly) in Chapter Three, "Good Money Creation: The Capitalist Money Factory." You are right, banks DO need depositors. The primary reason they require depositors is that they need cash reserves as a buffer against cash withdrawals or a bank run, and these reserves are transferred from bank to bank on a one-for-one basis with deposits. Therefore, if a bank loses deposits to another bank, it will also automatically lose an equal amount of reserves to that other bank, and vice versa. As these reserves diminish, the bank becomes more vulnerable to a panic, or bank run. (This is what happened to Silicon Valley Bank back in March 2023.) Banks can also borrow reserves from another bank, but doing so often signals the market that the bank is desperate for reserves, so big borrowings of reserves are unusual.
Here is how the mechanics of reserve transfers work: Suppose you buy a piano from a friend and write her a check. She deposits the check into her account at another bank. At this point, her bank has credited her account with money, but is holding your check as a claim against your bank. Your deposit was the bank's promise to pay out cash on demand. You transferred that promise to your friend in exchange for the piano. Your friend's bank now holds that promise (your check says, "pay to the order of" and your friend has endorsed this check over to her bank). Theoretically, your friend's bank could record this receivable on its books, similar to a loan. However, banks are generally not interested in maintaining accounts with other banks; they would rather have that debt paid off. So your friend's bank will immediately present the check you wrote to your bank, demanding payment in cash. This is how and why cash reserves are transferred from one bank to another. So, you can see that if a bank runs out of deposits, it may also run out of reserves.
One way banks gather deposits is by paying interest on deposits, but the bank must be cautious not to pay too much, lest its costs eat into its interest income.
There are other very good reasons banks like to gather deposits. They earn fees for transaction services. If they have numerous deposits, they can often persuade customers to transfer some to an affiliate company, such as a money market fund, which will earn the bank an ongoing fee. Banks also earn fees acting as custodians for assets. The relationship with the depositor will often lead to profitable loans, such as credit cards and business loans. Good banking is a relationship business.
So, while the primary purpose and source of income in banking is lending (money creation), deposits are an essential and integral part of the business.
I hope all that helps. Sorry, I couldn't be more concise. Thank you again for your interest in 'Black Hole.'
Hi Jim. It's been a long time. Thanks for the book plug. When did you first encounter the credit creation theory? And were you immediately persuaded by it?
Hey Michael, hope you're well. Back in 2018, I came across an academic article by Richard Werner (whom I had been introduced to in various investment publications) called "A Lost Century In Economics." This article articulated the three theories of banking, placing each in historical context. Most importantly, the article contained an empirical experiment, conducted by Werner and a cooperating bank, that demonstrated the validity of the credit creation theory. Further investigation corroborated Werner's findings and discredited Samuelson's at every turn. As I delved further, I came across many more references that accurately describe money creation in the modern economy. Here is a link to that article, which I referenced repeatedly in my book.
A reader reported that the link to the TOS review came up empty. I have corrected this error, I think. It works in the updated version of my post. Thanks for the heads up!
Absolutely superb book explaining just how much I didn't know about how money works. I have already put several of your investment suggestions to work, so my future self thanks you for protecting my assets from the governmental machinations ahead!
Russell, thanks for the kind comments! I very much appreciate your interest.
Hello Jim. I have read Black Hole, including all the appendices, and I would say you have convinced me. Well, at least mostly. What still bothers me is that banks have always really seemed mighty eager to get depositors. Also, they encourage depositors to increase their deposits. I just don't understand why they seem to care so much, since they don't need depositors to make loans. If you addressed this in Black Hole, I must have missed it. (But honest!, I thought I read it carefully.) In any case, can you help me understand why that is?
Hi, Dave, thanks for the question, and thanks for reading "Black Hole." You're asking a great question, which I addressed briefly (but not thoroughly) in Chapter Three, "Good Money Creation: The Capitalist Money Factory." You are right, banks DO need depositors. The primary reason they require depositors is that they need cash reserves as a buffer against cash withdrawals or a bank run, and these reserves are transferred from bank to bank on a one-for-one basis with deposits. Therefore, if a bank loses deposits to another bank, it will also automatically lose an equal amount of reserves to that other bank, and vice versa. As these reserves diminish, the bank becomes more vulnerable to a panic, or bank run. (This is what happened to Silicon Valley Bank back in March 2023.) Banks can also borrow reserves from another bank, but doing so often signals the market that the bank is desperate for reserves, so big borrowings of reserves are unusual.
Here is how the mechanics of reserve transfers work: Suppose you buy a piano from a friend and write her a check. She deposits the check into her account at another bank. At this point, her bank has credited her account with money, but is holding your check as a claim against your bank. Your deposit was the bank's promise to pay out cash on demand. You transferred that promise to your friend in exchange for the piano. Your friend's bank now holds that promise (your check says, "pay to the order of" and your friend has endorsed this check over to her bank). Theoretically, your friend's bank could record this receivable on its books, similar to a loan. However, banks are generally not interested in maintaining accounts with other banks; they would rather have that debt paid off. So your friend's bank will immediately present the check you wrote to your bank, demanding payment in cash. This is how and why cash reserves are transferred from one bank to another. So, you can see that if a bank runs out of deposits, it may also run out of reserves.
One way banks gather deposits is by paying interest on deposits, but the bank must be cautious not to pay too much, lest its costs eat into its interest income.
There are other very good reasons banks like to gather deposits. They earn fees for transaction services. If they have numerous deposits, they can often persuade customers to transfer some to an affiliate company, such as a money market fund, which will earn the bank an ongoing fee. Banks also earn fees acting as custodians for assets. The relationship with the depositor will often lead to profitable loans, such as credit cards and business loans. Good banking is a relationship business.
So, while the primary purpose and source of income in banking is lending (money creation), deposits are an essential and integral part of the business.
I hope all that helps. Sorry, I couldn't be more concise. Thank you again for your interest in 'Black Hole.'
Hi Jim. It's been a long time. Thanks for the book plug. When did you first encounter the credit creation theory? And were you immediately persuaded by it?
Hey Michael, hope you're well. Back in 2018, I came across an academic article by Richard Werner (whom I had been introduced to in various investment publications) called "A Lost Century In Economics." This article articulated the three theories of banking, placing each in historical context. Most importantly, the article contained an empirical experiment, conducted by Werner and a cooperating bank, that demonstrated the validity of the credit creation theory. Further investigation corroborated Werner's findings and discredited Samuelson's at every turn. As I delved further, I came across many more references that accurately describe money creation in the modern economy. Here is a link to that article, which I referenced repeatedly in my book.
https://www.sciencedirect.com/science/article/pii/S1057521915001477
And here is a link to an equally persuasive article from the Bank of England: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2416234
I'd never really appreciated the difference between cash and money before. Thanks for that.
True was an excellent book
Thanks, Andy
A reader reported that the link to the TOS review came up empty. I have corrected this error, I think. It works in the updated version of my post. Thanks for the heads up!