patrick.net

If banks find credit worthy customers, they love to lend. That's the real problem. People have been fooled by the mainstream garbage called "money multiplier theory".

Banks don't need deposits to make loans. Instead, loans create deposits or that investments create savings. Check this: http://blog.andyharless.com/2009/11/investment-makes-saving-possible.html

Since banks don't need deposits (and/or reserves) to lend, why they want deposits? To make more profits. Reserves are required for payment clearing mechanism. Imagine you have an account with BofA and wrote a check for $10K to your friend, who deposits it at JPM Chase. Here, BofA reserve account at Fed debited by $10K, and JPM chase's reserve account is credited by $10K.

If BofA doesn't have enough reserves to settle, Federal reserve is *forced* to lend to BofA: here, you hear discount window, discount rate. This discount rate is always higher than the rate that banks pay for their depositors. So, having deposits, banks make more spread.

Banks also borrow from each other from interbanking markets. That has to do with psychology and stock markets. If Bank A borrows money from Fed, others see that Bank A has some problems. So, they borrow from fellow banks.

In sum, lack of credit worthy customers is the real cause. Sure, you may have some bright idea to start a small business in Emeryville, CA. If I were a banker, I won't loan you $100K because of the risk involved. However, I could loan you for your car because you have a stable job.

Interest rates, interest policies, etc just change the portfolio composition. In the end, they don't play any role in increasing aggregate demand or aggregate consumption.

As an aside, Canadian banking system runs with ZERO reserves. Banks are constrained by two facts: capital requirements (regularity regime requires capital for various risks); and creditworthyness of borrowers. The whole interweb is full of nonsense with reserves, fractional reserve banking, money multiplier theories, metrics like M1, M2, ...Mk. If you understand endogenous money (horizontal money) and exogenous money (vertical money), you can see what is going on and how to fix the mess in various countries. But entrenched interests don't like to fix it anyway, unless there is a benevolent dictator.

Probably not a surprise to you that this will take me some time to digest. I do appreciate it though. Very well composed and thought out. Now, to read and re-read it until I understand it!

Thanks!

Read this post as well:

http://www.nakedcapitalism.com/2012/04/scott-fullwiler-krugmans-flashing-neon-sign.html