Krugman: We are in a depression, and it could be a long one

[Kshartle]

Kshartle,

The bank had that asset before the loan.  It was called "reserves."

When they paid it to you (assuming you took the withdrawal (few do)), they lost that asset, but replaced it with a loan receivable.

Ok so I have the cash (which I didn't have before) and I have the obligation to pay it back (which I didn't have before.

The bank has an asset (the receivable which used to be "reserves") right? What is the other liability? Is there one?

To the federal reserve, reserves are liabilities.

You're saying the federal reserve had the liability and the bank had the asset. So if I don't pay back the loan the bank loses it's asset...I lose my liability....but the Federal reserve still has a liability? Who do they owe?

What if the bank is not part of the federal reserve system? Where are their "reserves"?

[Kshartle]

Maybe this one will be easier:

The government needs money. It sells a bond to a bank for $100. Bam...they swap assets.

The FED prints an equal amount and buys the bond from the bank for $100. Bam...they swap assets.

The government says they aren't going to pay. Rates are too high, they don't have the tax revenue, the people will revolt if inflation gets higher....whatever.  (I know I know.....impossible right).

The government's liability is gone, maybe the government is gone...who knows. The FED's "asset" is worthless. What was their liability and who do they owe?

At the end of the day.....the government ended up with $100 it didn't have to start, the 1st bank is whole because they got $100 from the FED (same as they had before they bought the bond).

The FED had nothing to start and still has nothing. If they actually have a liability at this point.....what is it and who do they owe?

[moda0306]

Ok so I have the cash (which I didn't have before) and I have the obligation to pay it back (which I didn't have before.

The bank has an asset (the receivable which used to be "reserves") right? What is the other liability? Is there one?

To the federal reserve, reserves are liabilities.

You're saying the federal reserve had the liability and the bank had the asset. So if I don't pay back the loan the bank loses it's asset...I lose my liability....but the Federal reserve still has a liability? Who do they owe?

They don't really "owe" anything other than relatively stable prices .  It's just a liability on their balance sheet.  There are no real "terms" to it, other than their promise to balance price-stability with full employment.  Normally, they WOULD have owed you some gold.

This is why this is so odd to talk about treasury or fed liabilities as true liabilities... they control the system and the paper they play with is just assets on our balance sheet one way or another, and those assets allow us to transact with others as well as save in this currency.

[Gumby]

So if I don't pay back the loan the bank loses it's asset...I lose my liability....but the Federal reserve still has a liability? Who do they owe?

The bungled loan is between you and the bank. But, keep in mind that banks cannot and do not lend out reserves. (And even FRNs are liabilities of the Fed.)

See: Standard & Poor's: Repeat After Me: Banks Cannot And Do Not "Lend Out" Reserves

Now, obviously, you can transfer the reserves when you make a withdrawal, but those reserves still exist in the "system". They are just owned by another bank now.

What if the bank is not part of the federal reserve system? Where are their "reserves"?

All banks that operate with US currency are part of the Federal Reserve "System." That's the main role of the Fed, to act as a clearing house for all inter-bank transactions. There are "member" banks and "non-menber" banks, but they all have access to the "system". If a non-member bank has limited access to the Fed's discount window, they can always borrow reserves from other banks. Or the non-member banks can, of course, receive reserves when customers transfer/receive payments from other banks. That's what reserves are really used for — interbank payments.

In any case, a non-member bank can hold reserves at the Federal Reserve or as Vault cash (just like member banks do).

See: http://www.frbsf.org/education/publicat ... quirements

Either way, those reserves are traced back to liabilities of the Fed, since that's where the reserves came from.

[Kshartle]

So if I don't pay back the loan the bank loses it's asset...I lose my liability....but the Federal reserve still has a liability? Who do they owe?

The bungled loan is between you and the bank. But, keep in mind that banks cannot and do not lend out reserves. (And even FRNs are liabilities of the Fed.)

I guess the point is if I borrow $100 from the bank and buy $100 worth of scratch off tickets......and never pay the bank back but instead go through bankruptcy, I have the tickets (I'll scratch them on a rainy day), the gas station has the $100 instead of the tickets and the bank has nothing. Now who do they owe? If you say they owe the FED, what was the asset that was created to offset that liability? The one that I have (in the form of tickets or the USD at the gas station?) Who owes on the $100?

My point is.....if the banks and FED can create money out of thin air......who do they owe it to?

[moda0306]

Kshartle,

That question is exactly why I assert that the government doesn't have liabilities in the truest sense.  They "owe" society proper management of the monetary system and facilitating growing the economy.  It's not a liability of payment of any real value, other than the promise that they'll facilitate keeping the bonds/currency valuable within the economy.

[Gumby]

the gas station has the $100

Well, technically the gas station has a $100 FRN (a liability of the Fed). If they deposit that FRN in their own bank, the gas station's bank has the reserves now.

the bank has nothing

The bank's liability was the deposit (the asset was the loan). Didn't your bank fulfill their liability when you successfully withdrew the cash from them?

Now who do they owe?

No one.. I believe they fulfilled the liability when they coughed up the reserves/cash.

If you say they owe the FED, what was the asset that was created to offset that liability?

The Fed created an asset for the bank by creating reserves (a liability).

My point is.....if the banks and FED can create money out of thin air......who do they owe it to?

Banks don't create reserves out of thin air — the Fed does. Banks create deposits (their liabilities) by making loans (assets). Loans and deposits precede reserves (i.e. a bank will make the loan, and corresponding deposit, and then find the reserves for transfers and withdrawals, when necessary).

[Gumby]

Also, keep in mind that Treasury deficit spending adds reserves to the private and foreign sector — another example of government liabilities and non-government assets. The Fed monetizes that debt, much in the way the Fed used to "monetize" gold into dollars.

[Kshartle]

I appreciate the efforts guys. I'll look through and re-read.

[Gumby]

I appreciate the efforts guys. I'll look through and re-read.

Our pleasure!

Tom Brown (a Monetary Realist) does the best job of explaining the technical balances of banking, in excruciating detail.

He covers all the basics:

Tom Brown: Loans & Deposits
Tom Brown: Balance of Money & Debt
Tom Brown: Reserve Requirements
Tom Brown: How Banks Buy & Sell
Tom Brown: Quantitative Easing (QE)
Tom Brown: Capital Requirements
Tom Brown: The Three Places Reserves Can Go
Tom Brown: List of Ways Reserves Leave the Banking System

More technical explanations to come on his to do list.