From: jwales@silver.ucs.indiana.edu (jimmy donal wales)
Subject: Re: why gold
Organization: Indiana University
Date: Tue, 15 Dec 1992 21:30:36 GMT

Jamie writes:

>Correct me if I'm wrong.

O.k., if you're wrong, I'll correct you.

>Banks never lend more than they borrow (or anyway, more than they
>have).
>They often lend more than they keep in reserves.
>If a bank lent out all of its cash, it would have zero reserves, but
>it would still have not lent out more than it borrowed.

Banks can, in general, lend out more money than they have.
Let me make up a quick example, the kind that economists like best...
the kind in which the most interesting aspects of the problem are
assumed away.  

Just imagine a free-standing bank, and forget about the Fed and
reserve requirements and etc. etc.  

The bank has 100 dollars, which it got from depositors.

Jamie and I come into the bank and each ask to borrow 100 dollars.
The bank looks at our incomes, credit histories, etc. and then
shudders, but against better judgement decides to take a risk and
make both loans.  The bank makes the loans by just making a note
in its computer and giving us some blank checks.

Now, Jamie and I go on about our business.  We do regular banking
business, i.e. we go shopping and the grocery and pay by check,
and we deposit our earnings.

Just so long as we don't spend TOO much of our money, then the bank
has no problem coming up with the cashola when Mr. Grocer comes by
to cash the checks that we wrote.

So, at the beginning, this bank has 100 in cash (reserves) and 200
in deposits.  The 200 is the money that the bank created... money
that it lent out that it didn't have.

How much money should a bank keep in reserves?  Well, enough so 
people can come by and cash a check.  There is some randomness in
that, so the bank is always taking a risk that, just by chance,
everyone will come by at the same time.

Now, in our economy, the Fed gets to tell banks how much money to
keep in reserves.  But this induces a kind of irony into things.
The 'reserve' is supposed to be the amount that is available for
the bank to pay out to depositors in case of trouble.  But the way
the Fed works this, the money in 'reserve' is NOT available for
depositors.  But this isn't that important, don't worry about it.

The main thing is that by regulating the reserve requirement, the
Fed can control the amount of money in the economy.

Some people have protested (a) that banks could behave in a more
economically efficient manner if they were able to find an equilibrium
reserve and (b) the government is apt to mess around with the
reserve requirements for political reasons (i.e. to juice the economy
before an election, etc.)  I think that both claims have some serious
merit, especially if posed in a more rigorous and cautious fashion.

This whole thing can be thought of at another level.  Suppose every
bank is restricted to just lending out CASH, rather than just making
deposits up by bookkeeping notation.  Do you see how things are
actually the same in that case?  Because people can then take the 
CASH out and deposit it in another (or the same) bank.

Then the bank will want to keep some of the cash it gets and lend
out the rest.  But the lent out part doesn't just go into a mattress.
It gets depositied in this bank or another one.  And then some part
of THAT gets lent out, and etc.

The other side of this discussion is apparently confused about the
effect that a gold standard would ahve on this process.  I think that
what he means to advocate is  FREE BANKING, rather than a GOLD
STANDARD.  

>Too bad none of our list economists is a macro economist.

But maybe one of them is a financial economist.

--Jimbo





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