Fractional Reserve Banking? Pfff

Fractional Reserve Banking? Pfff

"Money" here is useful units of exchange. They can be lent into existence.

TLDR; Fractional Reserve Banking, Central Banks, Money Multipliers aren't the thing.

Goldbug nonsense doesn't map onto the reality of the modern monetary system. Media that bypasses accuracy for shock or ideology should be dismissed.

If the system is disfunctional, address the real system.

Can also look at the last contentious post: Misconceptions about Central Banks


Alright, going long...

Starting mostly with excerpts from a 2022 paper. The paper gets a lot of the space correct, but is missing quite a bit.

Instructors of macroeconomics have traditionally included some discussion of how banks create money through the money multiplier process although recent changes in the curriculum as well as in the monetary system itself (such as the ample reserve regime followed by the US Fed) have made this choice less attractive. This paper is intended to provide instructors with a framework for teaching how the modern banking system operates by using the money multiplier as a prologue to understand­ing that the now-prevailing shadow banking system generates new forms of money and presents monetary policymakers with new challenges. Hopefully, the framework will prove useful to practitioners and economists who take an interest in the finan­cial side of macroeconomics as well.

Often called the shadow banking or eurodollar system... this is the global wholesale banking system.

Central Banks were left behind. This new global banking system arose in the 1950s-60s, and Central Banks largely ignored it.

A substantial amount of money market funding for shadow banks takes place through the repo market where agents exchange cash for collateral, usually Treasury debt and typically overnight or for short term. Dealer banks, also called broker-dealers or investment banks, participate in the repo mar­ket both as a borrower and a lender. First, as a market maker in the capital market, dealer banks borrow from the repo market to fund their inventories of securities.

Because there's never enough reserve issuance to purchase government debt issues. It's the global banking system that "monetizes" government debt. Central banks are largely irrelevant to this process. This can be demonstrated by the low reserve levels vs. progressively larger debt issuance by the US prior to 2007.

The collateral that dealers take in through reverse repos can be re­pledged, or hypothecated again, as collateral in their repo borrowing; such reuse of collateral is called rehypothecation. Dealer banks use rehypothecated collateral to provide “money market funding for money market lending” to other shadow banking institutions.

Banks re-use the same collateral for several runs of lending simultaneously. This is true money creation, which filters down through domestic "faces" of banks.

Just as traditional banking dominated by depository institutions can be usefully characterized by the money multiplier, the shadow banking system can be character­ized by a collateral multiplier.

Traditional banking is barely the money creation engine anymore (and really hasn't been since the 1960s). Collateral is the source of money creation for the global banking system. Not the Fed, not one Central Bank.. and not commercial banks holding a deposit and lending against it. Money creation is global, and wholesale.

Perhaps nothing better symbolizes the transition from the traditional bank-cen­tered credit system to shadow banking than the Federal Reserve’s decision to com­pile and publish prevailing rates in the three most visible segments of the repo market (tri-party, bilateral, and GCF). These repo rates, including the Secured Overnight Funding Rate (SOFR) that has been selected to become a reference rate in place of LIBOR, are closely watched as became appar­ent during the money market turbulence of September 2019. The fed funds market, once the center of attention, is now only one of several money markets competing for the attention of monetary policy makers.

Fractional reserve was left behind. Fed Funds is not an effective control of the monetary system. The Fed is a proponent of creating new rates (SOFR) to better track real money creation activity... but is largely mistaken in their approach. Much of repo is bilateral and not centrally cleared (not visible), with less traceability. SOFR as a rate (based on visible secured transactions) does not communicate as much information as LIBOR did.

Not going further at the moment (will get too long)... Fractional Reserve Banking, while still present, is a thing of the past.

Most media that laments the disfunction of the monetary system.. and lays the blame at the feet of governments and Central Banks... gets it wrong.

They describe a system we started to leave behind at the turn of the century.

Central Banks still perform a useful PR role though... appearing powerful (because they say they are), and absorbing/diverting blame... yet have little to no ability to govern the modern system.

Additional quotes to ponder:

The Central Bank's Central Bank (The BIS):

The dollar reigns supreme in FX swaps and forwards. Its share is no less than 90% and 96% among dealers. Both exceed its share in denominating global trade (about half) or in holdings of official FX reserves (two thirds). In fact, the dollar is the main currency in swaps/forwards against every currency.

The dollar is global, created and extended globally.. intermediating most trade around the world. The Fed lacks the ability to fully measure this, let alone issue the units required.

Every day, trillions of dollars are borrowed and lent in various currencies. Many deals take place in the cash market, through loans and securities. But foreign exchange (FX) derivatives, mainly FX swaps, currency swaps and the closely related forwards, also create debt-like obligations. For the US dollar alone, contracts worth tens of trillions of dollars stand open and trillions change hands daily. And yet one cannot find these amounts on balance sheets. This debt is, in effect, missing.

Tens of trillions... trillions of dollars daily. These are not "Fed units" moving around. These are global dollars. It's not missing... It's the wholesale banking system doing what it does, with no need for a Central Bank.

Econ Talk 2006 - Milton Friedman approx 5:30 in:

The difficulty people have with understanding monetary theory is simple; the central banks are good at press relations. Central Banks employ a large fraction of all economists so there is a bias to tell the case, the story, in a way that is favorable to the central banks.

...and they did a very good job. Ever since the 1930s, many people have been convinced that central banks are central, powerful... in reality, they have a record of questionable competence at best. This ain't apologetics.