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  1. #31
    pathwise dependent FDG's Avatar
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    Quote Originally Posted by reason View Post
    I have a question.

    Are banks legally required to withdraw a depositors money upon demand?

    I have often read that one of the primary purposes for the Federal Reserve is to prevents runs on banks. To that end they are empowered to provide banks with liquidity during a crisis. But why cannot the banks simply deny withdrawals during a time of crisis?
    They can, but the client can call the police/judicial authority to declare insolvency. Bank accounts held by clients are inscribed as debt in the balance sheet of the bank, so they are subject to a legislation similar to the one applied on debt of a random firm. This is the reason why when there is a bank run and the credit institute cannoy pay the money asked, it's usually declared as bankrupt.

    When it's bankrupt, its assets (both material and immaterial) can be sold to pay money back to the customers.

    It seems to me that modern banks are really an amalgamation of a bank and an investment company. A traditional bank held 100% of its deposited funds in reserve, while an investment company holds 0%. Instead, investment companies invest desposited funds and offer the possibility of a return. Modern banks are a mixture of these two: some of the deposits are kept in reserve and some are invested.

    With investment companies it is accepted that deposits may be lost, and that restrictions may be placed on a depositors ability to withdraw money. Nobody pretends that such desposits are gauranteed, since it is simply beyond the power of anyone to gaurantee that gaurantee!
    No, actually, it's not exactly like this. Banks provide a wide variety of services, one of them is standard bank accounts where withdrawal should be available all the time as stated by the contract. Those are not considered as investment (in fact, the interest rate is usually close to nihil), but merely as deposits - in this particular case, banks act exclusively as intermediaries of trade. Many other types of account provide a fixed return after, say, 3 months, but the contract explicitly states that they cannot be withdrew whenever you wish - only past a precise date.

    This is one of the reasons why banks are categorized as "investment banks" and "commercial banks". The former exclusively provide investment services, that is, risky but with a sizeable interest rate; whereas the latter also provide standard entry-level bank accounts that must be - paradoxically - less risky than the risk-free bond (given that they give a lower rate of interest).

    The two sets are intertwined: usually commercial banks are also owners of an investment branch. However, money invested by the customer in one branch or the other is clearly separated, because it's considered as a different type of the debt (namely, the commercial banks consider account money as a short-term debt, whereas investment banks consider it as mid or longer term, depending on the due date stated on the contract).

    So, what you say is correct in the sense that most banks, nowadays, are both an investment and an intermediary of trade kind of company; however, this does not mean that they can treat the money we lend to them always in the same way.

    Almost half of the world's U.S. dollars are held by foreigners. Every dollar is a claim on goods and services in the U.S. Foreigners hold dollars because they want to make purchases from the U.S. or to store value. Because dollars have historically retained purchasing power, many foreigners exchange them in lieu of the own currency (which may have been debased by inflation).

    The last 10 to 20 years have seen an erosion of savings and an explosion of debt. The U.S. has went from being the world's largest creditor to its largest debter. Many goods have been imported using borrowed money which will never be repaid. Those dollars were sent out to places like China, and one day foreigners will begin using those dollars to buy goods from the U.S. (because of inflation or government securities being downgraded).

    When they try I expect they will have a nasty surprise. While living on credit, the U.S. economy has become very insular. It has stopped producing as many goods and services to be exported. Those plants and factories have been closed and replaced with shopping malls and golf courses. Foreigners will discover that there is not much for them to buy from the U.S., and many others bidding for what little there is.

    When the penny drops so will the dollar. Prices will rise and foreigners will see their dollar savings being devalued. It will then become much more expensive for Americans to pay for imports from places like China. If dollars are less valuable to foreigners, then they will demand more of them in exchange for goods and services.
    It's very hard to make this type of predictions. If the dollar drops, then usually exports rise. While I see what you mean when you say it's become very insular, I still think that it's top-notch in many high-tech, services and human-capital oriented services. I also think that we need to consider both sides of the equation, namely, why would a developing country whose power much lies in exports (due to the population still being poor, on average) want their currency to appreciate? They wouldn't, since it would mean a decreas in exports (that's what has happened to Europe with the "strong" Euro currency); since their exports, right now, are mostly based on goods whose demand is highly elastic, then the damage would be double, since the quantity is likely very sensitive to price. This is the "game" the U.S. plays with developing countries, basically. Firms, as a whole, don't profit from paying their employees very little money, since they end up lowering the demand. The principle upon which this situation is based is similar.
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  2. #32
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    Quote Originally Posted by FDG View Post
    Banks provide a wide variety of services, one of them is standard bank accounts where withdrawal should be available all the time as stated by the contract.
    Even if the interest rate is close to 0%, banks should not be selling contracts where they gauratee that withdrawal will be available at any time. Under particular circumstances, such as a bank run, it is possible for a depositor to lose their money regardless. Banks ought to be upfront and clear that under such circumstances withdrawals may be restricted (perhaps limited to whatever fraction of reserves the bank actually has). This would protect against bank runs and remove the need for the Federal Reserve to provide liquidity. It seems a novel idea that banks should tell the truth about this.

    It does not concern me here that some bank deposits are not "considered an investment". What matters is that the bank uses some fraction of the deposit for investment purposes, not whether the depositor enjoys a large return.

    So, what you say is correct in the sense that most banks, nowadays, are both an investment and an intermediary of trade kind of company; however, this does not mean that they can treat the money we lend to them always in the same way.
    Of course.

    Thank you for the thoughtful response.
    A criticism that can be brought against everything ought not to be brought against anything.

  3. #33
    pathwise dependent FDG's Avatar
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    Quote Originally Posted by reason View Post
    This is what I am curious about. Even if the interest rate is close to 0%, banks should not be selling contracts where they gauratee that withdrawal will be available at any time. Under particular circumstances, such as a bank run, it is possible for a depositor to lose their money regardless of any gaurantee. Banks ought to be upfront and clear that under such circumstances withdrawals may be restricted (perhaps limited to whatever fraction of reserves the bank actually has). This would protect against bank runs and remove the need for the Federal Reserve to provide liquidity.
    That's right. My personal opinion is, that fractional reserve banking - while being considered as a good means to economic expansion - is a fraud. Because if I'm lending money to a firm, and that firms leverages on its debt, then I'm fine - I have accepted the risk before lending the money. But, as you say, a bank leveraging is using a deposit that she has guaranteed to return in any circumstance.
    So yes, I think that banks:
    - either they should give an higher interest rate to make up for the risk
    - or they should not use deposits for the fractional reserve game

    There's the usual problem that this type of thing is kind of hard to apply. Much of our world, to my dismay, is based on debt, so by increasing the fraction of deposits that have to be held the economy would slow down considerably. Perhaps forcing banks to provide an higher interest rate would be simpler.
    ENTj 7-3-8 sx/sp

  4. #34
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    Quote Originally Posted by FDG View Post
    If the dollar drops, then usually exports rise. While I see what you mean when you say it's become very insular, I still think that it's top-notch in many high-tech, services and human-capital oriented services.
    Production of manufactured goods has shifted to places like China and much of it was bought with borrowed money, while in the U.S.'s labour has shifted to the service sector. It is much easier to sell manufactured goods to foreigners than service sector goods (langauge barriers, local specialisations, etc.). If what I described occurs, then exports will increase, but not fast enough. It will take years of restructuring a reinvestment to meet the demand for exports, because the U.S. economy will need to reverse back to a more manufacturing base.

    I also think that we need to consider both sides of the equation, namely, why would a developing country whose power much lies in exports (due to the population still being poor, on average) want their currency to appreciate? They wouldn't, since it would mean a decreas in exports (that's what has happened to Europe with the "strong" Euro currency); since their exports, right now, are mostly based on goods whose demand is highly elastic, then the damage would be double, since the quantity is likely very sensitive to price. This is the "game" the U.S. plays with developing countries, basically. Firms, as a whole, don't profit from paying their employees very little money, since they end up lowering the demand. The principle upon which this situation is based is similar.
    China are foolishly doing exactly what you describe. They are trying to prop up the dollar, because they do not want demand from the U.S. to dry up. But I think this is a mistake for the Chinese, because it will end up with them sending goods to the U.S. and getting something less in return (reflecting the underlying reality that U.S. consumers are less wealthy than before). Eventually they will realise their mistake and find new trade partners. In the long run, the U.S.'s coming depression will be good for the Chinese, since they can start trading with nations who actully give them something in return (Americans were sending them IOUs which are turning out to have less buying power than originally thought).
    A criticism that can be brought against everything ought not to be brought against anything.

  5. #35
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    Additional comment regarding the U.S. dollar:

    All these bailouts and stimulus packages are creating inflation. When the government borrows or prints money to pay for these atrocities, they are pushing prices upward. Inflation debases a currency by reducing its buying power and induces less saving. In other words, dollars will be spent instead of saved because of inflation.

    My understanding is that many of the dollars held by foreigners are savings. Historically the dollar has held its value, and while it is not quite 'as good as gold', it is still preferrable to many other currencies. But as the government continues upon its current inflationary course, foereigners will have more incentive to get out of the dollar. Either they will try and buy goods and services from the U.S. or other currencies. In both cases the dollars will return to the U.S. and push prices upward.
    A criticism that can be brought against everything ought not to be brought against anything.

  6. #36
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    A rewrite:



    The above table shows supply and demand for some product at varying prices. At $100 many units are supplied but none are sold; at $0 no units are supplied but many are demanded. In both cases there is no profit to be made, because either nobody buys or nobody sells. Under normal conditions the price would move toward $50. If the price is higher, then suppliers have too much inventory, and if the price is lower, then they are turning away potential customers. It is more profitable for suppliers to adjust the price toward $50.

    Sometimes sellers are prohibited from setting prices. A politician passes legislation to control the price and decides upon a price ceiling of $30. What would then occur? A quick glance at the table above tells us that 700 units will be supplied and 1300 demanded, creating a shortage of 600 units. At $30 nobody sells after 700 units have been bought. Suppose that each buyer purchases 1 unit at $50 and 2 at $30 (more of a the product is bought at lower prices). When the price is $50 there are 1000 people who buy 1 unit each; when the price is set at $30 there are only 350 people who buy 2 units each. With the price ceiling fewer people enjoy more product at lower prices, but at the expense of a greater number of people who must go without.

    An important role of prices is to ration resources. Shortages and surpluses are created when politicians interfere, and scarce resources are thereby misallocated. When products are made which nobody wants to buy, resources have been directed away from making products that people want to buy more. When products are not made when there are willing buyers, resources have been directed toward making products which people want to buy less.

    Interest rates are the price of credit. Like the anonymous product above, when the price is high more is supplied and less is demaned, and vice versa when the the price is low. If a politician passes legislation to enforce a price ceiling below what would otherwise prevail, then a shortage will be created. A shortage of credit induces a boom and bust cycle, because it is not rationed sensibly. With an interest rate ceiling fewer people enjoy more credit at low prices, and a credit supply that would have been issued over a ten year period might instead be depleted in half that time. Extra money is enjoyed in the present at the expense of the future.

    While it would be misleading to suggest that suppressed interest rates cause economic bubbles alone, they do create a situation in which bubbles more easily arise. Investors are less cautious when the price of borrowing money is low, and the value of their investments seems to keep on rising as more borrowed money enters the economy. Add to this some favourable government regulation and the economy is primed to create a bubble. All this sets off the boom and bust cycle, a series of malinvestments followed by a painful corrective recession.

    One qualification: the Federal Reserve does not actually set interest rates by enforcing a price, but instead manipulates the price by changing the money supply. When more money is available at banks for lending the price of credit (i.e. the interest rate) declines, and when less money is available the price of credit increases. But the eventual consequences are very similar to just setting a price ceiling, but perhaps even worse.
    A criticism that can be brought against everything ought not to be brought against anything.

  7. #37
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    When economists talk about an economic stimulus, they mean a program which affects a positive change in GDP. But it should not be taken for granted that a stimulus is a good thing; it is possible to have a positive change in GDP at the expense of long term prosperity.

    In any case, about economic stimulii:

    Suppose that in some year the United States's GDP is $9 trillion (i.e. the final price of all goods and services bought in the United States). The next year the U.S. Government initiates a $1 trillion dollar stimulus package accompanied by a 5% increase in wages due to tax cuts.

    Since the U.S. Government has not created $1 trillion of goods and services (but instead borrowed), there are now $10 trillion being spent on the same quantity of goods and services as before. Prices are then going to rise by about 10% on average. Since the tax cuts only increased wages by 5%, the net effect is an inflation-tax increase of 5%.

    People in the U.S. have stopped spending and started saving. But the government wants them to keep spending. By inflating the money supply and debasing the dollar they are disincentivising saving, whilst also invisibly consficating income by way of inflation and spending it on the public's behalf. All the while they have the nerve to claim they are cutting taxes.

    That's a scam.
    A criticism that can be brought against everything ought not to be brought against anything.

  8. #38
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    I have made some breakthroughs in my understanding of macroeconomics last night and this morning. Though it may be difficult to believe, the Fed, Congress, and their montary and fiscal policy is an even bigger scam than I previously realised, and even more detrimental to the economy. I will consider how to explain these ideas clearly and post soonish.
    A criticism that can be brought against everything ought not to be brought against anything.

  9. #39
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    And another thing. A good economy does not create jobs but destroys them. People are more prosperous when they do less work to achieve their desired standard of living, not more! Jobs are the cost of getting what you want, not the benefit. Many government policies may create jobs, but they often increase the amount of work needed by society as a whole to maintain its standard of living. Like most things the government gets up to, it's a scam.
    A criticism that can be brought against everything ought not to be brought against anything.

  10. #40
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    Borrowing money has a negative externality.

    Suppose there is an economy of 10 people. Monthly income and expenditure is $1000 each. All expenditure is on 100 products bought every month by each member of the economy (the average price of these products is $10). Each person deposits their income in a local bank. So the local bank has $10,000 in deposits of which it keeps 90% in reserve. It uses the other $1000 to make a loan to John, a member of the economy. He is required to pay off the loan over four months.

    Each member of the economy has $1000 to spend on 100 products, but now John has an additional $1000 (the total money supply has increased to $11,000). He can now bid more than anyone else for the same products and buys 181. The average price of the products is now $11 and everyone else can only buy about 91. By borrowing money, John has devalued the money of everyone else. He has created a negative externality: inflation.

    But not to worry, because John is going to pay back his loan. Over the course of 4 months John's budget is reduced to $750, the total money supply is $9,750, and prices decline, Everyone else can purchase more than usual for a time. By paying back debt, John has increased the value of money held by others. He has created a positive externality: deflation.

    The Federal Reserve tries to prevent any deflation so that we're forever accumulating debt and never paying it off. During the inflationary period John consumed, and during the deflationary period John produced. In the long run consumption and production need to balance, otherwise John will not return enough purchasing power to others through deflation, and eventually the economy will become impoverished.

    The Fed tries to rig the economy so that we have a never ending run of inflation and consumption. They call the deflation a 'recession', but it is the time when we pay for what we enjoyed during the boom. And there would not even be such booms and busts in the first palce if they were not always inflating the money supply.
    A criticism that can be brought against everything ought not to be brought against anything.

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