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Money creation in the modern economy (2014) [pdf] (bankofengland.co.uk)
227 points by adamnemecek on Mar 16, 2018 | hide | past | web | favorite | 123 comments

Most people are unaware of the true mechanism of money creation, therefore don't understand how the current mechanism and its (lack of) constraints affect society, therefore don't see the potential for societal improvement through systemic change around money creation and allocation.

Prof Richard Werner is worth listening to on this topic. [1]

I'd also recommend Steve Baker's heroic speech in UK parliament. [2]

[1] https://youtu.be/9bQkfN_pe44

[2] https://youtu.be/bXOkmD8Eozs

>I'd also recommend Steve Baker's heroic speech in UK parliament.

What's astonishing is that 85% of MPs do not know how money is created. 70% believe that only the government can create money!

That's like the CEO of GM not knowing what powers a car...

You can't miss the accompanying videos that they recorded down in the basement:

1) https://www.youtube.com/watch?v=ziTE32hiWdk (beginner)

2) https://www.youtube.com/watch?v=CvRAqR2pAgw (advanced)

Highly recommend this article for a dose of reality (he also covers the theory of money creation)


Can't recommend "The end of alchemy" by Mervyn King former CEO of Bank of England enough.

It seems like leverage has shifted from the central banks to commercial banks over recent decades, and indeed there has been massive consolidation of power in the commercial sector. The central bank seems more like an insurance proxy for the tax payer to the commercial bank, as evidenced by the 2008 rescue packages.

An aspect of this I wonder about is that many years ago a bank account is what you opened when you explicitly wanted to lend money to the bank to earn interest. But these days a bank account is pretty much mandatory for any sort of normal existence.

One thing that is astonishingly glossed over again and again is energy. There is no activity, no economy of any sort without energy. Energy availability therefore is absolutely central to any economic activity. Energy availability is not infinite, or infinitely elastic to demand. You cannot either infinitely yield more output from a given amount of energy. In last resort, we could say that all money is an energy debt (every dollar amounts to some energy quantity that varies). Making untenable promises by printing large amounts of money doesn't change this (promising that in 20 years, we'll have x% more energy than today doesn't help making this actually happen).

In a finite world, you can't grow economy infinitely, period. Frigging laws of physics.

See for instance


Or start here for more


Grantham on finite growth: https://www.zerohedge.com/sites/default/files/images/user5/i...

Grantham on finite resources: http://www.theravinaproject.org/JGLetterALL_1Q11.pdf

There was a nifty quote in Green Mars. Think it went something like "need to shift from sustainable development to sustainable prosperity".

And just for giggles: https://www.youtube.com/watch?v=PTUY16CkS-k

Steve Keen is doing some interesting stuff incorporating energy into economics - here's some of his older stuff - http://www.debtdeflation.com/blogs/2016/08/19/incorporating-... - if you google a bit I think he's developed that further (probably some of his lectures which are available on YouTube are where the newer stuff would be - I'm not sure if he's published much of it yet)

Energy availability is effectively infinite if you can plan for what you need and invest in the necessary infrastructure.

Total insolation for the Earth is around 170 petawatts. If you need more than 1% of that, space-based solar will be cost-effective.

The long-term problem with energy is getting rid of your waste.

Apparently you didn't make the effort to read the article I linked to. You're talking the usual, wishful-thinking nonsense that'll bring us into the entropy wall full speed, real soon now.

Yep, this is exactly the point economist Julian Simon made in his essay, "Can the Supply of Natural Resources - Especially Energy - Really Be Infinite? Yes!" [1]

This exert from the conclusion sums up his argument well:

> Incredible as it may seem at first, the term "finite" is not only inappropriate but is downright misleading when applied to natural resources, from both the practical and philosophical points of view. As with many important arguments, the finiteness issue is "just semantic." Yet the semantics of resource scarcity muddle public discussion and bring about wrongheaded policy decisions.

[1] http://www.juliansimon.com/writings/Ultimate_Resource/TCHAR0...

This is utter BS. It relies on bad analogies and not physical reality. The example given (copper) is absurd; recycling implies using energy (and disposal of waste heat), therefore you substitute a resource (copper ore) for another (used copper and energy). The analysis supposes that every resource is substitutable (they aren't), and that energy is infinite (it isn't).

We don't know for sure that the universe isn't infinite, but we do know that it is at least tens of billions of light years across. We aren't going to run into actual laws of physics making growth impossible for a long fucking time.

Only provided we leave earth and we harvest energy in a more efficient way. One of the reasons I'm supportive of renewable energy is not for environmental reasons; rather, that it's energy that would otherwise have been lost. Extracting hydrocarbons removes the total amount left, but extracting energy from sunlight doesn't lower the amount of sunlight that'll be emitted. Renewables are a responsible long-term energy play, and not just for the planet's health.

Yeah sure, if we suppose that we have nearly infinite resources (energy and material and science to propel billions of humans off the Earth and across the galaxy), we have no short-term resource problem. However we're already constrained (average OECD countries energy availability has been falling since 2006), so you can't exactly hand-wave the problem away.

> Frigging laws of physics

I seem to remember something about nothing being created or destroyed and only transformed but maybe I am wrong.

You’re right, but the transformation is subject to the 2nd law of thermodynamics. The useful work you can do is diminished, and you’re left with entropy. Energy is neither created nor destroyed, but we don’t care about how much waste heat we have available, because nothing can be done with it.

This should not come at a surprise as money really is debt.

Say you get a loan of 100$: now you have 100$ more to spend...but your creditor can still factor his/her credit (sell it at a discount) and spend that sum.

That initial 100$ can be spent twice (minus discounting factor).

Of course that loan needs to be repaid at one point. But what if you keep on making new debt to repay the previous debt? And what if the credits you generate have a particular utility for your creditors (eg. government-bonds for banks) so that you get 0 or even negative interest rate?

You got really close to creating money. The difference between different types of debts and money is rather quantitative (interest rate) than qualitative: https://en.wikipedia.org/wiki/Near_money.

Yes, learning how banks create money for me was a huge turning point in realising most of what people think they know (and what I thought) about money, debt and economics is actually wrong. That the money supply grows when banks lend and contracts when people pay the debt down is a big point to get your head around.

The other big one is the national accounts and sectoral balances - see [1] for a much more detailed run-down.

To summarise, take the definition of GDP:

(1) GDP ≡ C + I + G + (X – M)

where C is household final consumption, I is private investment including inventory, G is Government spending, and (X-M) are net exports.

Add net external income flows (FNI) to (1) and you get GNP:

(2) GNP = C + I + G + (X – M) + FNI

Subtract total transfers and taxes from each side:

(3) GNP – T = C + I + G + (X – M) + FNI – T

Collect terms by sector (private, Government and External)

(4) (GNP – C – T) – I = (G – T) + (X – M + FNI)

Then we can simplify - (GNP - consumption - taxes) is equilivalent to private saving (we’ll call that S), and (X - M - FNI) is called the Current Account Balance (CAD):

(5) (S – I) – (G – T) – CAD = 0

or (6) (S – I) = (G – T) + CAD

What this means is that by definition, if your external sector is balanced, a Government budget surplus must reduce the net assets of the private sector by exactly the same amount as it is in surplus. With a trade deficit and a Government surplus, the private sector’s net assets are reduced by the sum of those.

This is quite clear graphically too [2].

So the end result is that you can only have economic growth when the Government is running a surplus and the private sector is in balance or deficit through money creation from banks. Is relies on people borrowing more and more money - but because equal amounts of debt are also created (no higher net wealth), eventually the sector in aggregate can’t borrow any more, and the system falls apart (the second derivative of credit growth dropped a little while before the GFC, which is how some non-mainstream economists predicted that it was coming).

But at the end of the day, this means a balanced or surplus Government budget is actually bad for the economy by definition unless you have a big trade surplus (like Germany for instance), because it’s sapping the private sector of wealth.

Do you have to start taking a more nuanced view of Government debt, when Government debt actually represents the net actual savings of the private sector!

1. http://bilbo.economicoutlook.net/blog/?p=32396

2. https://skeltonphd.files.wordpress.com/2013/06/slide1.jpg

> But at the end of the day, this means a balanced or surplus Government budget is actually bad for the economy by definition

Not necessarily. You're thinking in nominal terms. There could be the same money supply but nothings prevents producing more and consuming more. Also beware the trap of equating fiat money with wealth: Zimbabwe government's deficits are also private assets...

There needs to be enough money to purchase the goods and services produced. Yes, there is some multiplier from monetary velocity (one persons expenditure is another’s income, so the same money can be spent multiple times), but the supply still needs to grow to not experience deflation, and that can only come from a trade surplus, bank created money (private debt) or Government deficit spending, by the definitions above. And since lending in the private sector must create debt too, the private sector cannot increase its own net financial assets.

Zimbabwe is well understood by modern monetary theory. If you look at what actually happened, it’s not an argument against the mathematical fact that a Government must spend somewhat more than it taxes to have a stable economy in the presence of a trade deficit (don’t make the mistake that many do when confronted with the fact that a currency issuing Governmment is not fiscally limited - of course that doesn’t mean that the Government should spend unlimited money. Of course if its spending pushes aggregate demand enough above the supply of goods and services produced in the economy you’ll have inflation, and even hyperinflation if you push enough - but on the other side, some of the most successful Government surpluses (apparently ‘responsible’ Government budgeting) without trade surpluses have preceded many financial crises).

Zimbawbe’s economic woes started when farms were confiscated, leading to huge unemployment (80%!) and a huge supply shock with food production reduced by a massive 35%. The Government then depleted foreign reserves by using it to import food. In response, the Government overspent domestically, partially in an attempt to buy political favours - and not investing in productive capacity. Of course hyperinflation happened!

Venezuela has similar issues (big supply shock due to Government policy), as well as the added problem of attempting to keep up a fixed exchange rate to the US dollar (fixed exchange rates always fail eventually).

> And since lending in the private sector must create debt too, the private sector cannot increase its own net financial assets.

In this respect it is identical to the logic of real world deficit spending in the developed world, where (ceteris paribus) each and every dollar spent is matched by the issue of government debt (with the "net financial asset" monetary base being adjusted independently of current period G by a separate institution in order to hit a target interest rate).

But the wealth of a nation is not a growth in what MMT calls "net financial assets" (i.e. currency with no debt obligation attached), the wealth of a nation is a growth in goods and services sold. The fact I have to repay a loan with interest in ten years time does not mean that I am less likely to generate goods and services with it this year (if anything, it encourages me to do so, because I need to generate a profit to repay the loan). Provided lending continues to grow, the amount of currency available to purchase the goods can continue to grow even in trade deficit and budget surplus (which might in some circumstances represent a useful counterbalance to excess lending growth) whilst holding monetary velocity constant.

What actually matters is not whether the money pumped into the economy has debt attached, but whether it's spent creating new assets/services which the public wishes to purchase or spent bidding up the price of existing assets or production processes. In theory (but not always in practice) money which is in aggregate lent into the economy is more likely to be invested in production to meet repayments than money spent into the economy.

    but the supply still needs to grow to not experience deflation
What's wrong with that ? Seems like an obsession to some people

We all do think in nominal terms.

Spending stops when you run out of things to buy at a price worth paying.

Zimbabwe was caused by destruction of production power - giving land to people that can't farm.

productive assets have nothing to do with nominal stock market entries or gold bars either.

> So the end result is that you can only have economic growth when the Government is running a surplus and the private sector is in balance or deficit through money creation from banks.

Not that fast. The catch is that all those equations are nominal, and they have an incredibly complex interaction with the real economy.

>Government debt actually represents the net actual savings of the private sector!

Excuse me, but when Federal Reserve conducts QE and buys 1 trillion of freshly issued government debt, what does it have in common with actual savings of the private sector? Who saved that paltry trillion? :)

Nothing. QE is just a swap, the net assets for each involved party doesn't change, only the type of assets they happen to posses.

The government get a trillion of debt but also a trillion worth of assets that pay their cost back, eventually.

Can you look here -- https://news.ycombinator.com/item?id=16606140 for my counter-argument?

That is not really a counter argument - I am not claiming QE has no effect on the economy.

I claimed that it isn't inflationary, and your example doesn't show any clear inflationary pressure.

QE isn't inflationary?! Please explain this alchemy?

I already did, a few steps up. It is a swap, not a printing press.

That is not an explanation. Where do the debt and assets come from in this example?

Yes, QE is interesting. Definitey goes against the “Government must tax before it can spend” idea. Remember the Fed is part of the US Government sector, so spending as a result of QE should go into the private sector, minus what is taxed back later.

Government securities generally represent savings because the Governments are generally legally required to match deficit spending with bonds, etc. QE was a bit of a departure from the norm (perhaps only temporarily though) and shows what modern monetary theory says - that it isn’t really necessary, not is it necessarily inflationary (this is because all spending carries inflationary risk, and inflation has to do more with aggregate demand than money supply etc. - and the most generally anti-inflationary force is actually taxation)

I have a different view. Unfortunately it's not possible to make a real scientific experiment to validate your or my assumption.

My thinking is that QE is quite inflationary.I think that after 2008 crisis we were expected to have a long period of strong deflation (let's say, with prices falling 4% each year, for 8 years straight), but QE reverted that and we had 1% of inflation or something like that instead. So, formally we are in "mild inflation" ground, but in fact the QE effect was quite dramatic. We just can't observe it because we don't have a "control group economy".

Well, all spending carries inflation risk - what really matters is what aggregate demand is like and how much spending and taxing alters that. Certainly QE could be inflationary, but as it was it was mostly just buying back securities it was mostly asset neutral so shouldn’t have done much (just like issuing Government securities to match deficit spending (just in reverse) - it doesn’t actually alter whether deficit spending is inflationary or not since there is a quite liquid market for those assets so they’re very similar to cash).

It is considered to have inflated prices of certain financial assets though (shares etc.)

stephen_g, if you are interested, then I wrote a very simple scenario of how QE could (and IMHO did) spill over into "real economy" here -- https://news.ycombinator.com/item?id=16606140

Preventing deflation was one of the main goals of QE, so, I don't think your view is so weird :)

You do know the Federal Reserve is not actually federal and is owned by private banks right? Perhaps there is some definition of US government sector I'm not aware of.

That's a common misconception. It's technically a soft of public-private hybrid, but the "ownership" by private banks is purely symbolic. The system is considered "independent within the Government", not independent of the Government.

The Federal Reserve's governors are appointed by the President and confirmed by the US Senate, and it derives all its authority only from the Federal Reserve Act. The organisation is accountable to the Government Accountability Office as well.

Most central banks though are just directly owned by the Government of the country, even if they are meant to operate independently.

The "independence" of central banks is generally a bad thing though - the point is supposedly to "depoliticise" them but really it's just an attempt to remove any democratic control of them.

Your first paragraph is just flat wrong. I know quite a bit about the Fed, and I'd like you to cite your source on both the "public-private hybrid" part and the "purely symbolic" part. Neither are true, unless you consider 6% of trillions and trillions (after expenses) "purely symbolic". I have no idea where you get the hybrid part. No government owns shares of the fed.

Also, for your information, the GAO audits are anything but accountability. After finally getting the GAO audit part passed in 78 there were so many limitations on thier audits as to make them so piecemeal they are more of a rubber stamp than anything. (Not to mention a few times when it got out the Fed destroyed source documents)

Don't call something a common misconception when you don't have a more solid understanding of the subject please. The common misconception is that they are federal, not the other way around.

QE is just repricing risk. It doesn't really have any real economic impact. But when you're in a severe depression people will try anything.

BTW it's not true at all that economic growth requires a surplus. In fact often the case is the opposite. I strongly recommend people who want to understand this read up on Modern Monetary Theory. Once you understand how this stuff really works (yes Banks create money they are not dumb intermediaries sand fractional reserve banking is a myth) it will help a lot to understand much of what is not reported on the news.

>QE is just repricing risk. It doesn't really have any real economic impact.

That's where things get interesting.

Let's imagine, for a simplicity sake, that there are 3 types of assets -- government debt, apple stocks and tesla debt.

If I'm sitting on my 1 trillion of government debt and I want actually switch to apple stocks (or maybe just get dollars and eat pizza and drink margaritas), I need to sell it to someone who will put his trillion into government debt. So, for me to "untie" my 1 trillion in government bonds and free it for consumption, someone has to "tie" his trillion dollars into it.

Now, fed enters the market and buys that 1 trillion from me as a part of QE. It does not need to sell his apple stocks or delay consumption and save that 1 trillion.

I now have dollars in my account, and can use it to buy, say, trillion of tesla debt, because I love Elon Musk.

Musk, in turn, can look at the market and observe that it has a huge appetite for tesla debt, and it was not the case one year ago. So maybe it make sense to issue one trillion dollars worth of bonds and build Gigafactory-2 and another car factory, and he does exactly that.

Are we still sure that when Gigafactory-2 is being erected and people are hired for a second car factory, "QE have no real economic impact"? It's not obvious to me.

The only thing that changed here is you swapped one type of money-like asset for another. Previously you owned bonds and now you have cash. Anything you could do before you can still do. (You can pay for stuff like factories with bonds.) I don't see why you think you're suddenly richer. QE has no impact on your wealth because you're just swapping similar assets. Now you can argue that it does send a message to the animal spirits leading to your risk preferences to change (seeing the Fed act so boldly makes you more likely to invest) which leads to a rising stock market and eventually a general "wealth effect" ... But this is kinda voodoo magic and no longer a quantitative analysis even if it's real.

(BTW in reality the market for government debt is very liquid. What you're really describing hate it's liquidation risk. It becomes an issue for more think traded instruments but not for bonds.)

Well, yes. Since Fed is not making pizzas and margaritas, it can only swap one asset for another, it can't mix you a decent margarita.

And if Fed will go out and just buy the whole outstanding float of GOOG, AAPL, TSLA, FB and NFLX with freshly minted money, it would be, bingo, "swap of one asset for another".

Don't you think that asset swap like that will somehow affect the general economy?

EDIT: damn, let's go _really_ extreme. Fed can basically swap all the government debt with dollars. All the 21 trillion of it, in a single asset swap. Click-click and boom, USA is debt free, no more interest payments, hooray. Dont you think such swap will have some real-life repercussions? If it will, how it's different from QE?

> Are we still sure that when Gigafactory-2 is being erected and people are hired for a second car factory, "QE have no real economic impact"?

I'm pretty sure it does have an economic impact on growth. The argument according to which it wouldn't make sense when you're at or near potential GDP, but when you fall enough below that - as in a big recession - increasing the money supply definitely has an impact. Then, it can be argued if the impact is good or bad in the long term - eg: will people create useful Gigafactories, or will they build unsustainable McMansions? But the impact is there.

While informative I think that this article is somewhat misleading as it omits any discussion that the reserves described are, in fact, fractional reserves.

Well no, because the whole point of the article is that fractional reserve banking doesn't actually exist and that there is no money multiplier.

https://en.m.wikipedia.org/wiki/Chiemgauer is a good experiment on local currency

It seems quiet ironic that Bitcoin/Cryptocoin advocates claim the minting and production using algorithms like Satoshi's BTC will be better than fiat when it just creates a new oligarchy... easier to co-opt due to the consolidation of control within the cryptocoin ecosystems.

Banks and the finance sector took note of BTC prior to 2014, and with the way BTC is produced anyone with enough capital entering into BTC - especially during the first few years would be in a position to take vast amounts of BTC at low cost and simply wait and attempt to convince other people to exchange their wealth for BTC which due to how the supply begins to be cut off, serves to enrich the minority of oligarchial squatter-speculators.

Bitcoin is often misunderstood as "deflationary" yet checking the math under the hood and we see that's a half truth. The supply inflates every 10 minutes, and for the first few years Bitcoin was hyperinflationary, granting a small group of users the majority of the supply.

  Satoshi Nakamoto
  Thu Jan 8 14:27:40 EST 2009
  I made the proof-of-work difficulty ridiculously easy to 
  start with, so for a little while in the beginning a 
  typical PC will be able to generate coins in just a few 
  hours. It'll get a lot harder when competition makes the 
  automatic adjustment drive up the difficulty.

  first 4 years: 10,500,000 coins
  next 4 years: 5,250,000 coins
  next 4 years: 2,625,000 coins
  next 4 years: 1,312,500 coins
https://medium.com/@balajis/quantifying-decentralization-e39... :

  One important point: if we actually include all 7 billion 
  people on the earth, most of whom have zero BTC or 
  Ethereum, the Gini coefficient is essentially 0.99+. And  
  if we just include all balances, we include many dust 
  balances which would again put the Gini coefficient at 
  0.99+. Thus, we need some kind of threshold here. The 
  imperfect threshold we picked was the Gini coefficient 
  among accounts with ≥185 BTC per address, and ≥2477 ETH 
  per address. So this is the distribution of ownership 
  among the Bitcoin and Ethereum rich with $500k as of July 

  In what kind of situation would a thresholded metric like 
  this be interesting? Perhaps in a scenario similar to the 
  ongoing IRS Coinbase issue, where the IRS is seeking 
  information on all holders with balances >$20,000. 
  Conceptualized in terms of an attack, a high Gini 
  coefficient would mean that a government would only need 
  to round up a few large holders in order to acquire a 
  large percentage of outstanding cryptocurrency — and with 
  it the ability to tank the price.

  With that said, two points. First, while one would not 
  want a Gini coefficient of exactly 1.0 for BTC or ETH (as 
  then only one person would have all of the digital 
  currency, and no one would have an incentive to help boost 
  the network), in practice it appears that a very high 
  level of wealth centralization is still compatible with 
  the operation of a decentralized protocol. Second, as we 
  show below, we think the Nakamoto coefficient is a better 
  metric than the Gini coefficient for measuring holder 
  concentration in particular as it obviates the issue of 
  arbitrarily choosing a threshold.

  ...However, the maximum Gini coefficient has one obvious 
  issue: while a high value tracks with our intuitive notion 
  of a “more centralized” system, the fact that each Gini 
  coefficient is restricted to a 0–1 scale means that it 
  does not directly measure the number of individuals or 
  entities required to compromise a system.

  Specifically, for a given blockchain suppose you have a 
  subsystem of exchanges with 1000 actors with a Gini 
  coefficient of 0.8, and another subsystem of 10 miners 
  with a Gini coefficient of 0.7. It may turn out that 
  compromising only 3 miners rather than 57 exchanges may be 
  sufficient to compromise this system, which would mean the 
  maximum Gini coefficient would have pointed to exchanges 
  rather than miners as the decentralization bottleneck.

  Conversely, if one considers “number of distinct countries 
  with substantial mining capacity” an essential subsystem, 
  then the minimum Nakamoto coefficient for Bitcoin would 
  again be 1, as the compromise of China (in the sense of a 
  Chinese government crackdown on mining) would result in 
  >51% of mining being compromised.

Anyone can mine. Anyone can earn bitcoin. Early adopters have been rewarded, sure, but the distribution of bitcoin has been steadily increasing. The vast majority of the world is able to exchange their local currency for bitcoin should they decide to take that risk.

How exactly do you propose a decentralized currency controlled by no one bootstrap itself?

The reasonable choice would be to mine a fixed amount of coins per year over ~100+ years not have a perimid scheme designed to artificially reward early adopters, and simulate a pyramid scheme.

And that's sidestepping the issue with ~1/5 of all possible coins already being lost.

It's likely that there won't ever be a single cryptocurrency that solves all the messy and complex problems of our global financial systems. Bitcoin is certainly far from delivering on that promise at the moment. It has however delivered a significant improvement in providing a trustless, secure, fault tolerant and immutable environment in which to implement a clean slate in monetary policy. Ethereum evolved this from a ledger of transactions to a ledger of computational states, and off to the races we've gone in using these as inspirations toward improving the broken qualities of our modern financial services industry. Factom offered a different take on inflation and deflation, dozens more tinker and toil to get it right. Transparency has improved, regulations have begun to take shape, and its just the first inning.

>The reasonable choice would be to mine a fixed amount of coins per year over ~100+ years

But that doesn't fix the underlying problem which is that early adopters can get the coins for pennies, whereas late adopters have to pay thousands.

That presumes there's a pressing reason to pay thousands of dollars for a bitcoin. Which seems absurd to me. If it ceased to exist, my life wouldn't be affected in the least.

You’ve chosen an arbitrary amount of Bitcoin and said “1000$ for this arbitrary amount is absurd!!1”

Would you feel better if I told you one satoshi is worth $0.00008?

Completely missed the point.

The work required to acquire 50 Bitcoins every 10 minutes was trivial for a small group of users.

Imagine some guy pressing a button and receiving a 50 Bitcoins. Now imagine you pressing a button 700 times to receive .0001 Bitcoins.

I understand how proof of work functions, thanks.

The person I was replying to claimed $1000 was an absurd amount for a bitcoin. I was merely pointing that 1 btc is an arbitrary amount of satoshis.

Anyways, my point stands: how do you expect a grassroots currency to bootstrap itself? Of course the first miners had it easy, no one took the currency seriously back then.

Regardless of the numbers, the other posters on this subthread are making an important point: too much wealth concentration deters new adopters.

Think of it in terms of the Ultimatum Game [1]: when faced with a new system of wealth distribution, potential new participants not currently within the system have two choices. They can choose to trade something they possess that would be of value to the existing participants (labor, wampum, or $USD, for example) for the new currency. Or they can say "Fuck you, I'm not playing in your sandbox."

The challenge for Bitcoin is that only ~0.3% of the population is involved in it, but the amount of money you have to spend to get a tiny fraction of the wealth that early adopters got just for showing up early is ridiculous. Under those conditions, the incentives for the remaining 99.7% is to say "Fuck you, I'll stick with my dollars". Or, alternatively, to create new currencies with their own pyramid schemes in the hopes of replicating Bitcoin's success.

Too little reward for early adopters and the new currency never gets adoption. Too much, and its adoption stalls out before it reaches a critical mass of the population. Ramp up the inflation rate later, and you can get continued growth after adoption, but at the expense of overall trust in the currency. It seems like you need a steady stream of broken promises, buried history, and disaffected outsiders to both gain adoption of a new currency and continue its growth.

(Interestingly, fiat has the same problem now: a significant number of people believe their chance of amassing significant wealth is near-zero within the current system, which is one of the major factors driving adoption of Bitcoin. They're effectively saying "Fuck you, I'm not playing in your sandbox" to the financial system of the developed world. But the other posters in this thread are pointing out that this problem is not unique to fiat, and that Bitcoin itself has this problem too, as does every other attempt to coordinate a new store of value.)

[1] https://en.wikipedia.org/wiki/Ultimatum_game

So I take it you will leave the fiat game then?

No, because the scale is the same. You can't just move the goalposts, so to speak, of the scale is reference after the fact.

(scale of reference, sorry, too late to edit)

Or even further, keep the internal economic work:payment model consistent. All work pays equal tokens.

Computational work = constant payment.

Unfortunately no one has been able to create an algorithm which creates valuable compute work.

Satoshi's Proof-Of-Work is more like

  ÷ time passed 
  ÷ sum of all users and capital burning in network

PoW is effectively guessing a random number.


>Computational work = constant payment.

With moore's law, that would result in hyperinflation. Who wants gold if the amount that is mined doubles every 2 years?


Computational work is not Gold.

Database tokens acquired though a software game of number guessing (Satoshi's PoW algorithm), rewarding less and less as the number grows larger would be more akin to fools gold.

Here is a simple way to demonstrate the point of the article. If I deposit $100 in a bank, the bank can lend out around $90 to someone else (fractional reserve banking). That person now deposits the money at another bank, and the "money supply" is $190 instead of $100.

On the other hand when a central bank "prints money", they use it to buy assets with an equivalent value, so there is no net transfer of wealth done by the central bank. That assumes they don't affect asset prices, which not a great assumption.

The way central banks affect the money supply is through interest rates to change the supply and demand of private loans that banks make, which indirectly affects the money supply.

> If I deposit $100 in a bank, the bank can lend out around $90 to someone else (fractional reserve banking)

This is the textbook explanation which the article strongly rejects. In practice the bank will lend out as much as possible - it is not effectively constrained by reserve requirements since it can and will simply borrow the difference. What constrains it is market forces (the demand for loans, and their profitability), and financial regulations, and finally the interest rates set by the central bank.

If a retail bank believes it can turn a profit by lending money borrowed from the central bank, in compliance with the law, it will do so until it exhausts the opportunity. Consumer deposits are irrelevant.

Exactly. There is no reserve limit: any pretense of that was washed away once sweep accounts became standard.

Banks lend as much as they possibly can, and then a bit more, and then expect the taxpayers to pick up the pieces when it all falls apart.

The irony is that there need not be a reserve ratio: if we just adopted duration-matched banking, where a bank had to demonstrate it had ownership of a given dollar it was lending for the duration it loaned that dollar (e.g. via a CD) it would be fine.

This is the fundamental problem with banking, and I don't understand why no one talks about it. Banks are lying about having money they don't have (i.e. they are promising the same dollar to more than one person at the same time). If we forced them to just stop lying it would all work out, and there wouldn't be any need for a reserve ratio.

You do realise that the loans banks take are liabilities, right? Banks are risk averse regardless of whether bailouts exist or not.

> whether bail-outs exist or not


As others have said, that is a textbook model of banks that describes how banks haven’t worked for at least a century (if ever?). That’s called the ‘money multiplier’ model, and it’s a myth. Even ‘fractional banking’ isn’t really a valid explanation. How banks work is called ‘endogenous money’, but one economist is trying to change that to the more friendly and self explanatory “bank-originated money and debt.”

The most amazing thing about how banks actually work (see the article) is that they don’t need any deposits to lend. Thus, how much a bank can lend is utterly independent of the amount of deposits they have. (Of course, deposits are useful for liquidity for interbank transfers, but the bank can just borrow reserves from other banks or the CB if it needs). But lending creates deposits with an equal amount of debt.

The other thing to remember is that deposits are a liability to the bank. A bank couldn’t lend out deposits because it wouldn’t balance out in double entry bookkeeping - even if it created the debt as an asset, it needs to create the matching deposit, so now you have two liabilities (deposit lent from, deposit for the person lent to) and one asset (the debt), which doesn’t sum to zero. Whereas creating the asset (mortgage / debt) and a matching liability (deposit) does.

Banks are factories for money not warehouses.

Reserves are not even required for banks to function.

A loan creates a deposit and that deposit then moves between people as they pay each other.

Banks can do that until they run out of creditworthy borrowers.

All so callled constraints on banks do nothing other than try to increase the price of lending so there are fewer creditworthy borrowers.

There is no quantity restriction that binds. The payment system would collapse if you tried.

Apparently my answer is worse than the guy who thinks "The fed is literally giving asset holders free money" and the guy who makes a pitch for Bitcoin. Whatever. Utilize your downvote cartel however you see fit I guess.

Regardless of whether the loans are linked to individual deposits or borrowed from other banks, I was just trying to communicate how commercial banks could increase the money supply without input from the central bank. Nowhere did I claim the reserve requirement and monetary base were the limiting factor of the money supply (in fact the last sentence says supply of loans is influenced by interest rates). This is just what figure 1 depicts in the paper. The direct quote from the conclusion of the paper is "Most of the money in circulation is created, not by the printing presses of the Bank of England, but by the commercial banks themselves."

Furthermore I claimed that central banks affect the money supply via rates, which is supported via the conclusion as well: "The Bank of England is nevertheless still able to influence the amount of money in the economy. It does so in normal times by setting monetary policy — through the interest rate that it pays on reserves held by commercial banks with the Bank of England. "

“QE involves a shift in the focus of monetary policy to the quantity of money: the central bank purchases a quantity of assets, financed by the creation of broad money and a corresponding increase in the amount of central bank reserves. The sellers of the assets will be left holding the newly created deposits in place of government bonds. They will be likely to be holding more money than they would like, relative to other assets that they wish to hold. They will therefore want to rebalance their portfolios, for example by using the new deposits to buy higher-yielding assets such as bonds and shares issued by companies — leading to the ‘hot potato’ effect discussed earlier. This will raise the value of those assets and lower the cost to companies of raising funds in these markets.”

The fed is literally giving asset holders free money at the expense of people trying to save in traditional ways (savings accounts). They buys whichever bonds they decide which then enables the holders of those bonds to collect free money. All the new money slowly works it’s way into the rest of the economy, inflating away the value of our savings.

Crap like this is precisely why bitcoin will succeed. Eventually people will realize what the Central Banks are doing and will decide they’ve had enough.

It's not "free money". Investors get the money by selling assets. But it might be at a better price than they could have gotten elsewhere.

One lesson is not to use a savings account as the only place to keep your money. Anyone who has looked at interest rates in the last few decades already knows this.

Another lesson is that it would be a lot more fair if the Fed had a way to boost the economy that involved giving money to normal people. This gets talked about as "helicopter drops" but never happens. (It probably requires an act of Congress.)

> Another lesson is that it would be a lot more fair if the Fed had a way to boost the economy that involved giving money to normal people

Like Kevin Rudd's stimulus package in Australia?

It is free money. If you bought a bond for 30 years today, and the fed came along and said they’d give you what you paid for the bond plus 20 years of interest payments, how is that anything other than free money?!

Without conflating savings with investment, how would you propose an individual save money?

> It is free money. If you bought a bond for 30 years today, and the fed came along and said they’d give you what you paid for the bond plus 20 years of interest payments, how is that anything other than free money?!

If you had to put it away and couldn't use it for 30 years, it's not really free, is it? It cost you 30 years of not being able to use it. Plus you're taking inflation risk, default risk, depending on the bond you might also be taking liquidity risk, etc. You're talking out of your ass dude.

Ummmmm, you’ve got it around the wrong way friend. The central banks are buying the bonds. You had already taken on the risk of buying the bond. The fed then came and said, “I’d like to buy your bond and give you 20 years of interest payments on top of your principal.”

If you have a 30 year bond and hold it for 10 years then you get 10 years worth of interest payments. When the fed (or anyone else) comes, they buy it at the market price of a 20 year bond (30 year bond after 10 years is a 20 year bond). You don't get any interest payment on top of that. It's still not free money, you took the risk of holding a 30 year bond for 10 years. And it's not "on top of the principal". They don't give you the principal for your 20 year bond, they give you the market price. Which fluctuates, and hence you're taking a risk and being rewarded for it.

Suppose there is a new issue zero-coupon 10 year bond with par value of $1000. The price for that bond is roughly $750 which gives me a 6%/yr return at maturity.

I buy it, and the fed comes around 1 month later and decides they want to do QE. They decide the 10 year yield is what they want to target so they go on the market and start buying bonds. The price goes from $750 to $900 in a short time.

I can now take my bond I purchased for $750 and sell it for $900 if I desired — this is the same as returning my principal plus a few years of interest payments after having held the bond for just a few months.

The fed printed money and I directly benefited.

What..? Where do you even get that $900 from? If it's at 6% annual then that's 0.4867% monthly, which would then be priced at $753.65.

What? I said the initial price of the bond was roughly 750$ which represented a 6% yield.

900 comes from QE. If the fed wants a 10 year interest rate of 1%, they would buy bonds on the market until the price rose from 750$ to 900$. And that is exactly what they did with QE 1-3.

No wonder they got away with it... no one here even understands how QE worked.

> no one here even understands how QE worked

You clearly don't.

If you buy a 10 year bond for $750 and wait for 1 month, now you have a 9year,11months bond, which will have a price slightly below $750, and that's what the fed will give you for it. YOU made up that they will pay $900, but they won't.

You’re assuming there’s a coupon. I explicitly said these were zero coupon. In this case the price at 9 year 11 month is higher than 750$, dumbass.

The entire point of QE is to increase the bond price, thereby reducing the yield. You don’t have a clue.

But.... you're the one who's complaining that you missed out of assets booming due to QE. So surely if anyone doesn't have a clue it's you, right? I did quite well over the past decade.

Oh look, the guy who doesn’t understand how bonds work is still here! Let’s all listen to his uninformed opinion!

I’ve been buying bitcoin since 2014 since I did understand what the fed was doing. I did pretty alright.


> (...) I did understand what the fed was doing.

Earlier (https://news.ycombinator.com/item?id=16604736)

> (...) had I realized what the fed was doing when QE was happening I would have definitely done that.

You wanted to pretend you're a victim from the evil FED while at the same time pretending you're smart enough to understand what's going on.

You're full of shit. Don't waste my time.

By your definition, any price rise in any asset is free money for whoever holds the asset. That's... kind of true, in a way, I suppose, but not a very useful way to look at it.

What you seem to be either missing or sweeping under the rug is that the holder has to sell the bond in order to get the money. Your description is therefore rather odd for the reality of the situation. It looks like you wanted to find the most outrage-inducing description that had some faint correspondence to the situation.

Um, I thought I was pretty clear: when the fed prints money to buy a specific asset, then it’s free money for the asset holders.

> The fed is literally giving asset holders free money at the expense of people trying to save in traditional ways (savings accounts).

If you believe this, isn't the rational thing to use your dollars to buy assets?

I think you're betraying a deep mis-understading of how money works. QE has been raging for 10 years, but inflation is incredibly low (2.5% US, 1.5% EU). In other words, even though you claim that the FED "gives asset holders free money", when you hold cash you're not really losing purchasing power. How do you square the two things?

>How do you square the two things?

Very simple. For everything that could be produced in China or, say, Vietnam, you have, essentially, a deflationary backstop. No matter how many mp3 players you want to buy, chinese will deliver without rising prices, since they have a capacity and happy to utilize it.

For stuff like real estate, or stocks... bloomerg reported yesterday that "FANG Rally Is Outpacing the Heyday of the Tech Frenzy" [0]. Stock market was and still is a good place to be for last 9 years, and while economic recovery was slowest since Great Depression [1], stock market roared for some reason. Hmmmmm..

[0] https://www.bloomberg.com/news/articles/2018-03-15/looking-l... [1] http://money.cnn.com/2016/10/05/news/economy/us-recovery-slo...

It's not that simple. The word "assets" is the wrong word (and I know, you didn't pick it). What actually happened was that there were two kinds of assets, safe and... not so safe. And when the bottom fell out on housing, people got out of the stock market too. Where did the money go? Some evaporated, as people found out that their assets weren't worth as much as they thought they were. A bunch of the rest went into bonds, especially US Treasuries, which were regarded as the safest asset out there.

The Fed responded by buying a bunch of treasuries (QE). That drove the price up. If you happened to hold treasuries when the Fed did this, you made money. On the other hand, everyone else on the planet was also buying treasuries, so the price was going up anyway - the Fed just made it go up more.

So some people sold, because the price was high. Some did it to cash in the price rise. Others did it because, going forward, the rate of return was dismal for the next X years. Those who sold had to put their money somewhere. Where would they put it. Not in treasuries - that was what they were selling. So they were getting out of treasuries, and had money to buy other things. That's what the Fed intended.

But it's not just QE. It has always been a good strategy to hold bonds when interest rates fall, because the price of the bond moves in the opposite direction of interest rates, and the longer the bond duration, the further the price moves.

Why did the Fed do this? A few paragraphs ago, I said that some money just evaporated. Well, "some" here means four trillion dollars. So the Fed used QE to create four trillion dollars and pump it back into the economy, which kept the whole thing from seizing up in a real Great Depression. Whether people holding treasuries at the time made a bit more money than they would have is beside the point.

So freejulian is wrong in what he's implying, that there was some conspiracy of evil bankers to transfer money to the rich. But he's right that, when this came down, holding bonds was the right move. (But by the time QE started, the big gains had already happened.)

> If you believe this, isn't the rational thing to use your dollars to buy assets?

If you have leftover capital after consumption, then yes.

>I think you're betraying a deep mis-understading of how money works. QE has been raging for 10 years, but inflation is incredibly low (2.5% US, 1.5% EU). In other words, even though you claim that the FED "gives asset holders free money", when you hold cash you're not really losing purchasing power. How do you square the two things?

Housing affordability crisis in nearly every urban centre.

In my view, QE's inflation happened before QE started. A significant purpose of QE was to prop up the loans made before the financial crisis. The inflation happened with the creation of trillions of dollars of securitized sub-prime housing loans. Rather than allowing those loans to default, the Fed is acting as a buyer of last resort through QE MBS purchases [0]. Without the Fed, much less money would be available for housing loans, and their prices would return to historical ratios to income [1, 2].

[0] https://fred.stlouisfed.org/series/MBST

[1] https://archive.nytimes.com/www.nytimes.com/imagepages/2006/...

[2] Blue line in http://www.econ.yale.edu/~shiller/data/Fig3-1.xls

Absolutely, had I realized what the fed was doing when QE was happening I would have definitely done that. And a lot of people smarter than myself did do precisely that! Inflation is only “incredibly low” if you cherry pick the basket of goods used to measure it.

So. No need for bitcoin.

You're just running away from a complex thing you don't understand but has a lot of traction, to a simple thing which you understand but has no traction. My strategy is stick with the former and educate myself more. Different strategies.

I think an alternate money system that works alongside government issued currencies would be a huge boon to society.

Long term, you will either have government as we know it now, or an alternate currency, but not both. The monopoly on currency is closely related to the monopoly on force.

I generally think a lot of anarcho-capitalist theory to be obvious nonsense, but on that, they have a point.

I agree that governments will try but there are already plenty of countries where merchants will accept USD as well as their local currency.

It already exists


The reason why you've never heard of it it's because it's not a huge boon to society. In the vast majority of cases it's an entirely pointless thing that you do just because you can.

I think that's a weak argument. All of the currencies listed in the article are limited to local purchases. At first glance they all seem to be paper money as well. They clearly solve none of the problems that concern crypto-enthusiasts/non-keynesians.

No, the reason I never hear about them is because they are limited in scope and simply defer power to another authority.

It's amazing that you are being downvoted for explaining exactly what Ben Bernanke himself said back in 2010. [0].

"This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate this additional action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion".

[0] https://www.federalreserve.gov/newsevents/other/o_bernanke20...

I downvoted him for the conspiracy claim that the inflation numbers are intentionally kept lower than they should.

I have noticed a great overlap between crypto-fundamentalists and conspiracy theorists.

Why do you think they aren’t?

Pretty common for me to get downvotes for making a statement that goes against the hackernews groupthink. Then their comment throttle kicks in and I can’t post for a few hours and the groupthink can continue without interruption.

Right after the part you quoted:

"That, in turn, should lead to higher spending in the economy.(1) The way in which QE works therefore differs from two common misconceptions about central bank asset purchases: that QE involves giving banks ‘free money’; and that the key aim of QE is to increase bank lending by providing more reserves to the banking system, as might be described by the money multiplier theory. This section explains the relationship between money and QE and dispels these misconceptions.


Two misconceptions about how QE works

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"

I think maybe that is beside the point.

If new money is created, and the new money is not distributed evenly among all citizens, all those citizens who receive less than an equal share are harmed while those who receive more than an equal share benfit.

It seems like the central bank, in this way, harms most people on a regular basis.

I am not prepared, however, to argue that Bitcoin is any better in this respect.

> Crap like this is precisely why bitcoin will succeed

"Indeed it has been said that democ­ra­cy is the worst form of Gov­ern­ment except for all those oth­er forms that have been tried from time to time"

I'll believe you when the entire world economy has run on non-Keynesian cryptocurrency economics through a couple of recessions...

Well, I mean, the greatest economic booms in American history happened when our money was backed by gold. When the dollar came off the gold standard in the 70s, we saw wages decouple from productivity. This is not a coincidence.

Yes, and when there was free land available, and when the economy was small so growth was easier to achieve as a percentage, and when immigration was at levels that would be politically unthinkable today. So "This is not a coincidence" seems to be rather overstating the certainty of what the cause was.

Most people who claim that fiat money is essential for a growing economy are unable to explain the US economy from 1800-1914.

The real purpose of fiat money systems is so the government can spend more than it takes in by printing the difference (or the more modern variation of just creating it with accounting gimmicks).

The real point of fiat money is that it affords a government the option to increase the money supply at will.

Whether they do that for good (e.g. to attempt to combat a recession) or for evil (e.g. to invalidate government debt / inflate their way out of deficits) is a political exercise.

And knowing that, I actually think the US Fed is a pretty decent system. I shudder to think what would happen if Congress controlled monetary supply.

An 1800 dollar is worth the same as a 1914 dollar. A 2018 dollar is worth about 4 cents.

That is wrong in multiple dimensions.

First, that the dollar in 1800 had the same worth as in 1914 is pure coincidence. Relative to 1800, it was

- 20% less in 1798

- 60% more in 1814

- 40% less in 1840s

- 50% more in the 1850s and so on. source: http://liberalarts.oregonstate.edu/sites/liberalarts.oregons...

Second: incomes changed. The dollar worth alone is meaningless without lookiing at the purchasing power of the population. In 1800, a farm worker earned 12$ a month, which are $300 in 2018 dollars, so today's farm workers obviously earn more, regardless of the dollar's value. (source: https://babel.hathitrust.org/cgi/pt?id=wu.89071501472;view=1...)

I don’t think anyone claimed the value of a dollar was constant. Even on the gold standard there were periods of inflation and deflation. The average value over time was stable though.

That's right, it averaged out to net zero over more than a century. Afterwards, it steadily declined in value to 4 cents.

It's a fundamentally different behavior, both in direction and magnitude.

> That's right, it averaged out to net zero over more than a century.

It just averages out because you selected an arbitrary period, which makes the point essentially meaningless. Id didn't average out from 1800 to 1900, from 1814 to 1914, from 1800 to 1850 and so on.

> It's a fundamentally different behavior, both in direction and magnitude.

Again, this is not correct. If you look at the actual data, you can see that the the inflationary periods in the 20th century actually have smaller inflation per year than those in the 19th century. The fundamental difference is the absence of severe deflationary crises, of which there were plenty in the 19th century. The top ten highest inflation rates of the last 200 years were all in the 19th century. Have a look at the data: http://www.in2013dollars.com/1800-dollars-in-2016

No, it wasn't stable. I have linked the actual data, please have a look. It was only stable if you select arbitrary time periods to make it look stable.

Looks to me like it fluctuates around a specific level... which is pretty much what I said: periods of inflation and deflation.

I'm flabbergasted how you can call 25% inflation in a single year stable.

For context, you should look at the specific dates of the actual crises. Those were severe economic shocks. Incredibly high human costs.

And those types of crisis are all gone. The 2008 crisis was a tiny blip in comparison.

Is there any kind of data that can shake your view on economics? Or is that more akin to faith for you?

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