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Author Topic:   "Completely false and misleading financial intermediation theory"
Member (Idle past 218 days)
Posts: 167
From: Australia
Joined: 08-15-2016

Message 1 of 8 (815622)
07-21-2017 9:58 PM

So I have done quite a bit of research since I first barged in here demanding answers to my questions regarding what I now know to be the 'half-truth' of fractional reserve banking. I linked to this study in another thread, in its own words -

This paper presents the first empirical evidence in the history of banking on the question of whether banks can create money out of nothing. The banking crisis has revived interest in this issue, but it had remained unsettled. Three hypotheses are recognised in the literature. According to the financial intermediation theory of banking, banks are merely intermediaries like other non-bank financial institutions, collecting deposits that are then lent out. According to the fractional reserve theory of banking, individual banks are mere financial intermediaries that cannot create money, but collectively they end up creating money through systemic interaction. A third theory maintains that each individual bank has the power to create money ‘out of nothing’ and does so when it extends credit (the credit creation theory of banking). The question which of the theories is correct has far-reaching implications for research and policy. Surprisingly, despite the longstanding controversy, until now no empirical study has tested the theories. This is the contribution of the present paper. An empirical test is conducted, whereby money is borrowed from a cooperating bank, while its internal records are being monitored, to establish whether in the process of making the loan available to the borrower, the bank transfers these funds from other accounts within or outside the bank, or whether they are newly created.

In other words, until now all our economic theories of money have been based on the musings of economists as opposed to evidence. A quick google search on financial intermediary theory reveals it to be the dominant and unquestioned 'theory' regarding what banks do. It is the theory repeated in all economics discussions in the MSM.

The study first looks at the financial literature of the 20th century, it then conducts an experiment with a small bank to determine whether money is created by the loan(credit creation), whether reserves are multiplied(fractional reserve) or whether depositors funds are reallocated to fund loans(financial intermediary). Here's what they found.

The empirical evidence shows that of the three theories of banking, it is the one that today has the least influence and that is being belittled in the literature that is supported by the empirical evidence. Furthermore, it is the theory which was widely held at the end of the 19th century and in the first three decades of the twentieth. It is sobering to realise that since the 1930s, economists have moved further and further away from the truth, instead of coming closer to it. This happened first via the half-truth of the fractional reserve theory and then reached the completely false and misleading financial intermediation theory that today is so dominant. Thus this paper has found evidence that there has been no progress in scientific knowledge in economics, finance and banking in the 20th century concerning one of the most important and fundamental facts for these disciplines. Instead, there has been a regressive development. The known facts were unlearned and have become unknown. This phenomenon deserves further research.

Sobering? That is an understatement! Man on moon, check. Nuclear weapons, check. Heavier-than-air flight, check. Almost instant global communication, check. Unlimited information at everyone's fingertips, check. Mastery of the invention which we use to organise and allow us to achieve those things? Nope! Not only have we regressed from the truth but the truth is ridiculed!

Note the bolded part, the author suggests the phenomena of regressive development itself deserves further research. Since this is the first study of its kind and science has been around for hundreds of years it is hard not to assume interference of some kind. Why did it take this long? Why have we been taught and continue to this day to be taught a completely false theory?

I have emailed many financial organisations displaying the financial intermediation theory as fact questioning why they present empirically refuted ideas as fact. I cite both this study and the money creation paper released by The Bank of England as evidence. I have yet to receive a response or see any of them remove the innacurate information from their websites.

I have been banned from finance forums for talking about the 'perpetual debt conspiracy'. Perpetual debt is a direct logical conclusion of our monetary/economic system. It is not a conspiracy. I have since made an observation that led me to the inference that the interest is created, however.

Say I just signed a mortgage for $300k at 6%pa. The bank deposits the funds into my/the sellers account and creates a corresponding -$300k loan account. Ignoring repayments and other fees for simplicities sake, at the end of the first month I am charged $1500 dollars interest. My loan account now looks like this -$301,500. I know empirically that the bank created $300k when it created the -$300k, I therefore infer that when the bank adds the -$1500 to my loan account it is simultaneously creating the interest and paying itself. My negative value account is simply anti-money, repayments simply vanish. This doesn't change the ponzi-scheme nature of the sytem though.

Economic activity occurs either due to new money being created and spent or existing money being spent. The creation of money and the velocity of money. Since all our money is borrowed into existence and owed back to banks(where it is destroyed), we need either the velocity of money to increase as debt is repaid and money is destroyed or we must continue to borrow money into existence. Failing to do either will result in economic collapse. Since the velocity of money cannot be increased indefinitely in a money supply that would shrink to nothing if people stopped taking on debt, our economic system is fundamentally a Ponzi scheme.

A ponzi-scheme that is considered sacrosanct by governments of both sides. Why?
One argument I've come across is that our retirement funds depend largely on banks and interest, therefore we should accept the system. I have been unable to find data on the net amount of interest paid/received by income bracket but I find it hard to believe however, that a majority of people ever get into the positive. I find it hard to believe that I couldn't do a better job investing the interest I pay for my own future and end up with more than I'll get back from my retirement fund, if I even live to collect it!

Given the system, every dollar accumulated at the top is also someone's loss down the chain. A fundamentally dog eat dog system. Debt slavery is an entirely rational assessment of the situation. The author of the study seems to agree with me that money should be not for profit and we need a means of issuing debt free currency.

The Bank of England's recent intervention has triggered a public debate about whether the privilege of banks to create money should in fact be revoked (Wolf, 2014). The reality of banks as creators of the money supply does raise the question of the ideal type of monetary system. Much research is needed on this account. Among the many different monetary system designs tried over the past 5000 years, very few have met the requirement for a fair, effective, accountable, stable, sustainable and democratic creation and allocation of money. The view of the author, based on more than twenty-three years of research on this topic, is that it is the safest bet to ensure that the awesome power to create money is returned directly to those to whom it belongs: ordinary people, not technocrats. This can be ensured by the introduction of a network of small, not-for-profit local banks across the nation. Most countries do not currently possess such a system. However, it is at the heart of the successful German economic performance in the past 200 years. It is the very Raiffeisen, Volksbank or Sparkasse banks – the smaller the better – that were helpful in the implementation of this empirical study that should serve as the role model for future policies concerning our monetary system. In addition, one can complement such local public bank money with money issued by local authorities that is accepted to pay local taxes, namely a local public money that has not come about by creating debt, but that is created for services rendered to local authorities or the community. Both forms of local money creation together would create a decentralised and more accountable monetary system that should perform better (based on the empirical evidence from Germany) than the unholy alliance of central banks and big banks, which have done much to create unsustainable asset bubbles and banking crises.

We all know that vested interests will pay to maintain the status quo. I find it hard to believe that we have this system as a result of governement looking out for our best interests. The central banking system certainly did add stability to the system we had but it did not fix the inherent problems, nor did it make life better for the majority. It did however provide a more stable system of wealth redistribution from poor to rich.

I don't care what you think is the most important issue, from climate change to inequality, standard of living or enviornmental destruction, immigration or war/terrorism. Every single one of those things would be helped by a better monetary system. Until we change the system we will never be able to meaningfully address them all.

Edited by Riggamortis, : No reason given.

Edited by Riggamortis, : No reason given.

Replies to this message:
 Message 3 by Phat, posted 07-22-2017 11:54 AM Riggamortis has responded
 Message 4 by NoNukes, posted 07-22-2017 1:59 PM Riggamortis has responded

Posts: 3864
Joined: 09-26-2002

Message 2 of 8 (815624)
07-21-2017 10:24 PM

Thread Copied from Proposed New Topics Forum
Thread copied here from the "Completely false and misleading financial intermediation theory" thread in the Proposed New Topics forum.
Posts: 10872
From: Denver,Colorado USA
Joined: 12-30-2003
Member Rating: 1.2

Message 3 of 8 (815653)
07-22-2017 11:54 AM
Reply to: Message 1 by Riggamortis
07-21-2017 9:58 PM

Money From Nothing
I too have studied this system, though perhaps not as obsessively as you have. I am curious as to what you think the solution to it all is? Also would be curious as to your political ideology.
Until we change the system we will never be able to meaningfully address them all.
One question is whether we the people will ever reach enough of a consensus to change anything and what we would change it to.

Chance as a real force is a myth. It has no basis in reality and no place in scientific inquiry. For science and philosophy to continue to advance in knowledge, chance must be demythologized once and for all. –RC Sproul
"A lie can travel half way around the world while the truth is putting on its shoes." –Mark Twain "
~"If that's not sufficient for you go soak your head."~Faith
"as long as chance rules, God is an anachronism."~Arthur Koestler

This message is a reply to:
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Replies to this message:
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Posts: 10728
From: Central NC USA
Joined: 08-13-2010
Member Rating: 2.0

Message 4 of 8 (815659)
07-22-2017 1:59 PM
Reply to: Message 1 by Riggamortis
07-21-2017 9:58 PM

I know empirically that the bank created $300k when it created the -$300k,

The bank or whoever holds your mortgage, is on the hook for that money, albeit at a lower rate of interest that you are paying, so as far as BoA or Wells Fargo is concerned, they did not create the money. The feds did that.

As for you, well you are holding the house, and are no worse off than if you were paying rent. What is your beef, exactly?

Under a government which imprisons any unjustly, the true place for a just man is also in prison. Thoreau: Civil Disobedience (1846)

I was thinking as long as I have my hands up … they’re not going to shoot me. This is what I’m thinking — they’re not going to shoot me. Wow, was I wrong. -- Charles Kinsey

I never considered a difference of opinion in politics, in religion, in philosophy, as cause for withdrawing from a friend. Thomas Jefferson

Worrying about the "browning of America" is not racism. -- Faith

I hate you all, you hate me -- Faith

This message is a reply to:
 Message 1 by Riggamortis, posted 07-21-2017 9:58 PM Riggamortis has responded

Replies to this message:
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Member (Idle past 218 days)
Posts: 167
From: Australia
Joined: 08-15-2016

Message 5 of 8 (815672)
07-22-2017 9:52 PM
Reply to: Message 3 by Phat
07-22-2017 11:54 AM

Re: Money From Nothing
I am curious as to what you think the solution to it all is? Also would be curious as to your political ideology.

Blind ideology is dangerous. I'm not a (insert label) I'm a -let's use logic, evidence, reason and our alleged intelligence to come up with the best solution, all things considered-ist. As for the solution, if I said I knew for sure I'd be lying. All things considered, I think the best move from here is a hybrid socialist/capitalist system which is what we have now. Just add a little more socialism and a little less faith in the profit motive to deliver positive outcomes for all.

I think having a socialist system covering the basics of life standing alongside a capitalist free market in non-basics is the best solution to ensure freedom and basic living standards etc for all. Of course the capitalists will be free to compete with the socialist market for basics. The difference being that people will always have a socialist cost-price option for the basics so the capitalists will have to genuinely offer cheaper or better quality goods and services. Currently they are allowed to profiteer from the demand created by people just existing and I find the system that allows them to do so immoral. People need to eat, drink, have warmth and shelter etc. People need to cover their costs. People like and want profit. More on possible detailed solutions later, I still have to bring the government and fed into the discussion.

One question is whether we the people will ever reach enough of a consensus to change anything and what we would change it to.

In the US? I can't see a consensus being formed on anything for quite a while, it is so polarised. In Australia, our major parties haven't formed majority governments without coalitions and deals for quite some time. Instead of arguing about whether or not to have single payer health and it being a divisive issue, Australians are pretty well universally against the privatisation of services and sale of public assets. We vote governments out, rather than in. I think there is sufficient underlying political angst for a good person with an entrepreneurial spirit to capitalise and really make a difference. Possible in any country but I think Australia is ripe for it.

I'm actually in the early stages of implementing an idea. So far I have a name sorted, an informally written charter outlining the goals and means of achieving them, funding model, remuneration structure. I'm learning 3D modelling so I can make the logo exactly how I've pictured it and it will come in handy for other things. I'm just waiting to free up some cash to pay the setup costs and fingers crossed I'll be on my way!

This message is a reply to:
 Message 3 by Phat, posted 07-22-2017 11:54 AM Phat has acknowledged this reply

Member (Idle past 218 days)
Posts: 167
From: Australia
Joined: 08-15-2016

Message 6 of 8 (815674)
07-23-2017 12:08 AM
Reply to: Message 4 by NoNukes
07-22-2017 1:59 PM

The fed.
The bank or whoever holds your mortgage, is on the hook for that money, albeit at a lower rate of interest that you are paying, so as far as BoA or Wells Fargo is concerned, they did not create the money. The feds did that.

That they are. They aren't on the hook to the fed for all the money they create however, nor does the fed create the money. The Bank of England revealed that when they said

In reality, neither are reserves a binding constraint on lending, nor does the central bank fix the amount of reserves that are available. As with the relationship between deposits and loans, the relationship between reserves and loans typically operates in the reverse way to that described in some economics textbooks. Banks first decide how much to lend depending on the profitable lending opportunities available to them — which will, crucially, depend on the interest rate set by the Bank of England. It is these lending decisions that determine how many bank deposits are created by the banking system. The amount of bank deposits in turn influences how much central bank money banks want to hold in reserve (to meet withdrawals by the public, make payments to other banks, or meet regulatory liquidity requirements), which is then, in normal times, supplied on demand by the Bank of England. The rest of this article discusses these practices in more detail.

The fed creates money only for banks to conduct interbank transactions and money created by the fed is created post hoc to maintain reserve/day-to-day transaction requirements. In Australia, from memory, these checks are conducted only every two weeks(ABE) They are conducted daily but two weeks behind(ABE). None of the digital money you or I ever borrow or earn or spend is created by the fed, it is all created by the commercial banks. They must only hold a portion of the amount they lend out in their reserve account. If they had to borrow an amount equal to loans issued from the reserve bank all the time, the reserve bank would make more than any bank, they don't.

The bank is liable to pay interest to the recipient of my loan money or transfer its reserve funds to the recipient institution should it leave the bank as opposed to being deposited with someone else within the bank. The truth about the relationship between interest collector and interest payer has been distorted. Why is 'well the bank is still liable somewhere' any excuse?

As for you, well you are holding the house, and are no worse off than if you were paying rent. What is your beef, exactly?

Well the part you took issue with isn't really even part of the 'beef'. That observation served only to answer my own question from last time. The beef is all about the lies/misinformation and the fundamental macroeconomic consequences for society as a whole. Don't get me wrong, I'm playing the system as it stands but I still know that it isn't good for society overall and as a father and member of a democratic nation it is my duty and right to stand up and speak out.

To summarise the actual beef;
- the ponzi-scheme nature of debt based economies and the fact that debt is 100% necessary in our economies yet is treated as a boogieman by politicians.
- the reallocation of wealth from the poor and middle class to the wealthy that results based on the lie that the wealthy are lending us money. It is a completely arbitrary system which benefits the few to the detriment of the many.
- we in fact borrow the money into existence and it is backed by our future labour and promise to repay, the banking system exploits the necessity of having money. Private banks create all the money we actually use, reserve banks just add stability to the system.
- you either accumulate someone else's debt money or go into debt yourself to start a business. Either way you're reliant on debt. If the majority of the supply chain is in debt and paying compound interest, interest is going to add up to a decent chunk of the cost of the final products and services we pay for.
- a socialised monetary system could work very similarly to what we have now, retaining the freedom to borrow money via identical T&C's but under a cost recovery fee structure. The addition of debt free money will allow the economy to function in the absence of debt growth, resolving the debt Ponzi.
- finally and most importantly, a socialised monetary system would allow governments to spend without imposing an interest burden on future generations. They will only have to pay for what is built and what they've inherited. No more whining about the cost of renewables regarding debt and interest. No more arbitrary barriers to making useful things from natural resources.

Edited by Riggamortis, : No reason given.

This message is a reply to:
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Member (Idle past 218 days)
Posts: 167
From: Australia
Joined: 08-15-2016

Message 7 of 8 (815680)
07-23-2017 4:17 AM

Reserve banks, QE and government spending and debt.
The issue of how government debt and spending actually works is laughably also contentious. Do we now need a scientist to tell us? Are they really that daft? Again my emails to various institutions have proved fruitless and so I'm left trying to make sense of the information freely available.

Sanders economic campaign advisor Stephanie Kelton is an adherent of Modern Monetary Theory which holds that governements with their own sovereign currency can always meet their financial obligations via the power to issue currency. Further, that the only constraints they face are real physical ones, available workers and resources. This leads to the conclusion that governments should spend what is necessary to make use of the unused resources and generate full employment.

The problem is that the current setup would cause us to pay vast amounts of interest (way beyond now) if we were to implement MMT because we borrow from the private sector any money the govt needs in excess of its tax receipts. So we need to start selling interest free bonds directly to the reserve bank to be able to make it happen. Then a method of introducing a limited amount of debt free currency would allow some to hold a surplus without denying someone else the ability to break even.

Here is an Australia-centric discussion on MMT and a quote from it.

3) The government’s financial deficit is everybody else’s financial surplus.

For every lender, there must be a borrower. That means that across our financial system, surpluses and deficits always add up to zero.

This is clear in the following chart, which shows the financial balances of the Australian private sector, the rest of the world, and the Australian government sector, since 1994.

For every saver who earns more than they spend, there must somebody or some institution which spends more than it takes in. If we want the private sector as a whole to save rather than go further into debt, the government will probably have to spend more than it taxes (depending on what the rest of the world is doing).

It works the other way around too. The Howard government was only able to run fiscal surpluses because the private sector went heavily into deficit.

Household debt trebled during the Howard years. Since then, we have been in a tie with a couple of other countries for the highest household debt to income ratios in the world.

We have a system that has all of us in debt either privately or publicly. This forms the basis of my claim that debt slavery is a rational description of the situation. Our governments push austerity when the empirical data suggests that the opposite is in fact the answer, in the short term at least. Longer term we should free ourselves from the stupidity of imposing interest bearing debt on ourselves.

Quantative easing from the Bank of England paper.

Why the extra reserves are not ‘free money’ for banks.
While the central bank’s asset purchases involve — and affect — commercial banks’ balance sheets, the primary role of those banks is as an intermediary to facilitate the transaction between the central bank and the pension fund. The additional reserves shown in Figure 3 are simply a by-product of this transaction. It is sometimes argued that, because they are assets held by commercial banks that earn interest, these reserves represent ‘free money’ for banks. While banks do earn interest on the newly created reserves, QE also creates an accompanying liability for the bank in the form of the pension fund’s deposit, which the bank will itself typically have to pay interest on. In other words, QE leaves banks with both a new IOU from the central bank but also a new, equally sized IOU to consumers (in this case, the pension fund), and the interest rates on both of these depend on Bank Rate.

Before the quoted part the paper stated that QE generally targets non-bank holders of bonds and the example of a pension fund had been established. Could also be a trust fund, investment firm or multinational company that decided to invest in bonds but pension fund sounds better. Now to refute the claim that this doesn't represent free money for the bank.

Banks always pay a lower rate on deposits than the official rate so regardless of the liability of the pension fund deposit it will always be generating a profit from the difference. Free money for the banks near enough directly. In addition to this, the banks liabilities and reserve account just rose in equal measure. The bank now has more capacity to lend without having to borrow more reserves.

Ultimately, QE represents the pinnacle of trickle down economics, grant a direct benefit to the banks and corporations with the promise of benefits to all. Benefits that never come while company profits and CEO salaries soar. I'm a production systems engineer and I'd never thought to apply my trade to the system we live under until last year. Now that I have it repulses me.

Member (Idle past 218 days)
Posts: 167
From: Australia
Joined: 08-15-2016

Message 8 of 8 (816092)
07-29-2017 5:37 AM

Thought Experiment - Fiat or Gold-backed
Many people claim that abandoning the gold standard is the problem with our financial system and that a return to it would somehow make everything better, generally by stopping inflation. I am not in that camp. If inflation is kept low and wages rise with it, it is effectively irrelevant. People shouldn't have to pay interest to counter the deflation in value of idle money. Especially when most people only benefit from it via pension accounts while a few get it both ways.

The following thought experiment is intended to demonstrate several fundamental aspects of the way I think regarding the financial system and why an interest free, debt based, fiat monetary system is the -
• Most able system to serve the needs of the people.
• Fairest way to run a fiat monetary system.
• Best outcome we could lobby for now.

To begin our look at the fundamentals of money we will imagine a 'fundamental' economy. The setting is a small ancient tribe in which everyone co-operates solely for the common defence but otherwise sustain only theirselves and their families. In other words, everyone provides their own housing, food, tools, water and so on. There is no trade.

One day, a man particularly talented at making fishing spears but not particularly good at using them approaches a man his opposite. They agree to become specialists and work together, trading spears made for fish caught. Barter trade is born. Pretty soon the rest of the tribe start to notice the arrangement and begin to ponder their own possible specialisations. Shortly thereafter a barter trade market is established. Everyone agrees is good but they start having trouble trading efficiently as the number of goods and services offered increases the complexity of the system. A new invention is needed, money.

The tribal council meet to discuss the issue and settle on using gold as a currency. Everyone is to accept gold as payment in order to make trade more efficient. This works for a time, the populations grows, people prosper. Then they reach a point where they cannot find enough new gold to mine, in addition, some people are now creating jewelry from their gold and/or hoarding it, reducing its availability further.

The council meets again and decides that on account of golds new use and lack of availability, it is no longer a viable currency. They observe that ultimately, gold was simply used as a method of keeping track of who had produced things and traded them. The amount of gold someone had reflected the amount of things they had produced and sold without cashing in by trading the gold on for further goods/services. They observe that some people have been 'lending' gold to others and demanding it back plus more in the future, or else.

The council finally settles on a plan. It will use the new writing invention and tools to create official paper money. Anyone can sell their goods/services to the central market for new money or sell to others privately for existing money. Anyone eligible, can borrow new money into existence in order to fulfill their own goals with the provision that it is repaid. A small fee to cover the cost of producing the money and keeping the accounts will be charged to borrowers.

The benefits of this system include;
• Anyone who can make the case that they will repay money can access it with for a minimal fee. This is the freedom to change your life for the better.
• No one is forced to put more back in than they take out. When people are forced to do it is inevitably reflected in the price of the goods/services they offer.
• The private sector is free to act as it pleases but the people always have the option of selling goods/services to the central market and also purchasing from them.

Now instead consider a situation analogous to our own. Instead of the not for profit system, the council hands the power of currency creation over to the same people who made predatory gold loans. The newly formed private 'banks' control the accounting and issue the money. They implement a similar plan with the key difference being the addition of compound interest charges. Now anyone who lends money into existence must repay a percentage fee on the loan amount regularly, so long it is outstanding. They justify this by offering interest payments on money held in their institutions. By altering the interest rate, they claim to be able to exert control over growth and inflation in the cost of goods/services.

Now consider the following points;
• This system forces those who need money to pay a tax on access to that money to those who have money. Arbitrarily.
• People are forced to repay substantially more than they initially loan. Well beyond the cost of providing the service. This is effectively the theft of their labour.
• Raising interest rates in boom time simply causes the system to transfer more wealth to those who already hold the most.
• Alternatively, raising the minimum percentage of principal repayable per payment would achieve the same effect as raising interest rates. It would still put some people under financial strain but at least they'd be benefiting from paying down debt faster.
• The not-for-profit central bank/market, being benevolent would endeavour to minimise negative consequences in the event of a failure to repay, the private bankers seek to repossess assets.

The case is clear to me, I hope this thought experiment helps some people to understand it the way I see at least.

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