I understand how fractional reserve banking works. First let's take the US gvt. out of the equation. The US gvt. does *not* control monetary policy. They're not even allowed to look at the books that the FED keeps. Now the FED, they do control the money supply. On top of this they *also control* the rules of fractional reserve banking. Here's the difference between when the FED prints money and the banks lend money: FED prints money = permanent increase in dollars in circulation. Banks loan money = temporary increase in dollars in circulation. If you loan 33k based on my 1k deposit what happens? The borrower might spend that 33k, does something to earn 35k which came from someone else and then takes that money and repays his loan. He might repay 35k because it's 33k principal and 2k interest. Did money get created? No. The bank gave the borrower 33k and the borrower took 35k from the economy at large and gave it to the bank. Temporary effect: The bank created 33k to lend to the borrower. Permanent Net effect: nothing was created or destroyed but 2k drained from the economy at large and went into the bank. So what is more important in terms of inflation? The only thing that permanently creates dollars, the FED printing it. But the banks do have a big *temporary* impact on market prices. That's why we can have a situation like we have now: The FED is printing money like crazy (inflation) but the banks are creating less temporary cash via fractional reserve lending, causing the inflation of the FED to be *delayed* in affecting prices. Now lets look a little more closely at the part where the bank seems to have created temporary dollars out of thin air. Did it really create those dollars? Well we already know that the answer is NO. So what did it do? It spent MY deposit money together with 32k in deposits from other people on giving that loan. But how can it do this to a leverage of 33:1 as in your example? Simple, the bank is permanently in debt to me and every other depositor. If me and the other depositors come in to demand our money, the bank will either call back the 33k loan immediately to pay us back, or go bankrupt as 89 banks have done to date this year. To recap: No money was created. The bank is simply lending more than it has and is itself going into debt to it's depositors. The weirdest part of all this is that when you open an account with a bank you are becoming a creditor to an institution who is massively in debt at near zero interest and without your knowledge!
Yes, correct. But increase or decrease in availability of loans does not make any permanent changes to the money supply. Furthermore when the banks do return to "normal lending environments" you WILL see the inflation ridiculousness caused by the crazy FED money printing. Loan contractions is *temporary*. FED printing is *permanent*. The inflation is being generated *now* and it's effect on market prices is being somewhat *masked* right now by loan contraction.
I'm not sure I can really agree with that though. Banks have essentially put massive amounts of temporary money into circulation (as you've stated). When defaults happen, there is a permanent damage done to the bank. They loaned fictional money out. So, when other borrowers pay back dollars, those dollars are now back to permanently sitting on the balance sheets of banks (filling in the gap of "funny" money which never really existed). So the "net affect" is the same of the amount of temporary and real dollars in circulation. I could see inflation being a problem if the new dollars being printed had the ability to increase the "temporary" money in circulation (thus inflating the entire money supply). But I don't see how just filling in a gap will have much of an impact. In other words, the permanent damage being done by defaults isn't going to give the banks the ability to really put the new dollars being printed into circulation. It is "stop gap" money. And with future higher regulatory requirements I'm anticipating will come upon banks, the need for stronger balance sheets will even be higher, thus encouraging banks to permanently keep larger quantities of real dollars on their balance sheets.
Well if you don't believe me, then here is a graph of the US money supply. http://upload.wikimedia.org/wikipedia/en/9/95/Components_of_the_United_States_money_supply2.svg
uexkuell, can't agreed more. Looks like many fund managers are USD bearish. and too many people on that wagon. Look at the chart attach. If you follow technical at all.