I didnt quite understand this "There are of course regulations about how banks can lend out (e.g. can’t just lend out money to itself, must meet capital requirements, etc.) but these don’t limit how much the bank can create/lend.
The whole reserve multiplier thing that we are taught about how banks take our deposits and then lend out 90% of them and so on is a myth. Money creation is endogenous. "
My understanding is that Central Bank require bank statements from banks and penalise bamks that go beyond certain thresholds of lending. Hence controling the amount of money banks create...
I don’t think I’ve come across that dynamic. The main regulation on banks is about liquidity, for which post-2008 there are rules about what asset mix banks must hold (e.g. high quality liquid assets - HQLA). But those don’t translate into any real limits per se since bank reserves count as HQLA. Would be interesting see if you can share some resources I can dig into!
It could be the case that in some countries bank lending is more controlled. For example, in China, 1980s Japan & Korea, etc., the ministry of finance directs banks which sectors to lend to and how much (“window guidance”). So yeah there are definitely variations globally.
In the current situation, meaning post 2008, governments in the Global North have actually been trying to push banks to lend more (this is what erroneously drove QE) but banks have been skeptical because of poor economic growth conditions & financial assets being an easier avenue.
Wait, so reserve requirements and resulting reserve ratios do not effect a bank's lending?
What about all the indirect regulations, such as KYC requirements, Cooling periods, Sanctions lists, Consumer protections laws, etc? Do they not also affect their ability to lend?
These are all monitored by a bank's complaince departments. I guess I am a little shocked that bank's have such a freehand in lending to consumers.
Reserve requirements not in the way we’re taught. We are taught that banks can lend more if customers save more. But that’s the part that’s wrong. There are reserve requirements but reserves are a different form of money and don’t constrain lending in the way we’re taught (eg banks can get more reserves from the central bank).
All the indirect ones you mention are totally right! All are applicable and all limit who can be lent too. There’s also an additional regulation about how much a bank can lend to a specific customer. That’s what I meant by saying banks do have to make money, do need to maintain positive equity, and do need to comply to AML and other laws.
However, banks are not constrained by savings. Money creation is endogenous, such that they can create money to lend whenever all these above conditions are met. Banks are not merely intermediaries and have this special money creation power, which then opens the door to questioning privatization, financialization, etc.
Hello Taimur, thanks for this article. Super new to finance and found this to be a fascinating read!
One question I have is about the government debasement of currency chart. Why is the chart meaningless? Why is it that it used to cost $1 to buy a 30 Hershey's bars but now you can't? Or that it used to cost .99 for a gallon of gas and now that's not the case? Isn't that inflation? And that's what Bitcoin is protecting against. It certainly feels like prices are rising and in all of history, prices have never decreased for any significant amount of time (in the Global North).
You’re totally right that prices consistently increase. The reason I think that chart is useless is because it doesn’t measure affordability. It doesn’t make sense in finance to only look at only side of the balance sheet — in this case, only looking at prices without looking at income.
So a more accurate, although still imperfect, measure is to look at real wages. And there the trend varies a lot more: in the US, it rose from 1940s-70s, then stagnated more or less, and now has been up over the last 3 years.
Anyways, just conceptually it’s mot sufficient to look at prices alone to tell you anything about well-being or prosperity.
On BTC, it’s complicated. For now, until proven otherwise, it is just a risk-on asset as opposed to an inflation hedge. It’s not analytically different than having bought Tesla stock for example.
I think it’s the other way around actually. The GRC status is somewhat maintained till the US can run deficits. The problem will mostly come domestically, with industrial policy and onshoring and domestic investment -- that’s when the US deficits will come under pressure, and that ultimately will incentivize the US itself to move away from the USD as the GRC.
One could argue that that is what Nixon already tried to do in 1971. He wanted to rid the US of the GRV responsibility.
Interesting question! It depends on who’s point of view you look at it from.
Pricing oil in US$ means that, since oil is a global commodity and every country needs it, everyone needs US$ to buy oil. It’s basically network effects (more things priced in $ —> more people use it —> more things priced in it). For the US, this gives them geopolitical power as all countries need their currency. For Saudi, they get US support and protection in exchange for this.
Now, if Saudi actually starts accepting non-$ payments then it’s more complicated because whatever that other form of money is will lack the network effects (at least to begin with). For example:
— What will Saudi do with that other money (say the Yuan) if other global markets still use US$?
— For China it might help that they pay for something as imp as oil in its own currency, but does it want to also deal with the responsibility of managing a global currency (because there are domestic trade offs)
— How will other countries get their hands on this other money (since it’ll still be external for them)?
— Right now oil is priced globally. Will there be different prices for oil depending on who’s exporting and in what currency?
I think there’s no easy way of out because of how entrenched the system is.
But isn’t that a catch-22? If US moves away from GRC due to on-shoring then demand for US debt will decrease. Won’t that result in higher interest rates simply to fund the interest on the debt, debt spiral, etc.
Demand for US debt isn’t a problem. Japan isn’t the GRC and yet doesn’t have any debt issues, despite having a v high debt gdp ratio.
The key is to understand that governments don’t finance themselves by issuing debt (as long as they’re financing in their own currency). The sale of bonds to private or foreign buyers is a specific design choice for the system, it’s not an inherent constraint.
For example, the US continues to have a budget deficit. What happens? The govt spends money first, then taxes later. That deficit money is already gone. Why does it now need to sell a bond?
This is of course me super simplifying it but conceptually this is true.
Also, bonds are needed by financial investors as a safe form of collateral (again, a system design choice). This is why Japanese, European bonds etc don’t have a demand problem per se, even in their CBs aren’t stepping in to backstop.
Great one Taimur.
I didnt quite understand this "There are of course regulations about how banks can lend out (e.g. can’t just lend out money to itself, must meet capital requirements, etc.) but these don’t limit how much the bank can create/lend.
The whole reserve multiplier thing that we are taught about how banks take our deposits and then lend out 90% of them and so on is a myth. Money creation is endogenous. "
My understanding is that Central Bank require bank statements from banks and penalise bamks that go beyond certain thresholds of lending. Hence controling the amount of money banks create...
Thanks!!
I don’t think I’ve come across that dynamic. The main regulation on banks is about liquidity, for which post-2008 there are rules about what asset mix banks must hold (e.g. high quality liquid assets - HQLA). But those don’t translate into any real limits per se since bank reserves count as HQLA. Would be interesting see if you can share some resources I can dig into!
It could be the case that in some countries bank lending is more controlled. For example, in China, 1980s Japan & Korea, etc., the ministry of finance directs banks which sectors to lend to and how much (“window guidance”). So yeah there are definitely variations globally.
In the current situation, meaning post 2008, governments in the Global North have actually been trying to push banks to lend more (this is what erroneously drove QE) but banks have been skeptical because of poor economic growth conditions & financial assets being an easier avenue.
Wait, so reserve requirements and resulting reserve ratios do not effect a bank's lending?
What about all the indirect regulations, such as KYC requirements, Cooling periods, Sanctions lists, Consumer protections laws, etc? Do they not also affect their ability to lend?
These are all monitored by a bank's complaince departments. I guess I am a little shocked that bank's have such a freehand in lending to consumers.
Reserve requirements not in the way we’re taught. We are taught that banks can lend more if customers save more. But that’s the part that’s wrong. There are reserve requirements but reserves are a different form of money and don’t constrain lending in the way we’re taught (eg banks can get more reserves from the central bank).
All the indirect ones you mention are totally right! All are applicable and all limit who can be lent too. There’s also an additional regulation about how much a bank can lend to a specific customer. That’s what I meant by saying banks do have to make money, do need to maintain positive equity, and do need to comply to AML and other laws.
However, banks are not constrained by savings. Money creation is endogenous, such that they can create money to lend whenever all these above conditions are met. Banks are not merely intermediaries and have this special money creation power, which then opens the door to questioning privatization, financialization, etc.
I see, i think I get your point. This was definitely something new for me to realise. Thanks man 🤍
Thank you, much appreciated! 🙏🏽
Hello Taimur, thanks for this article. Super new to finance and found this to be a fascinating read!
One question I have is about the government debasement of currency chart. Why is the chart meaningless? Why is it that it used to cost $1 to buy a 30 Hershey's bars but now you can't? Or that it used to cost .99 for a gallon of gas and now that's not the case? Isn't that inflation? And that's what Bitcoin is protecting against. It certainly feels like prices are rising and in all of history, prices have never decreased for any significant amount of time (in the Global North).
Glad you found it useful!
You’re totally right that prices consistently increase. The reason I think that chart is useless is because it doesn’t measure affordability. It doesn’t make sense in finance to only look at only side of the balance sheet — in this case, only looking at prices without looking at income.
So a more accurate, although still imperfect, measure is to look at real wages. And there the trend varies a lot more: in the US, it rose from 1940s-70s, then stagnated more or less, and now has been up over the last 3 years.
Anyways, just conceptually it’s mot sufficient to look at prices alone to tell you anything about well-being or prosperity.
On BTC, it’s complicated. For now, until proven otherwise, it is just a risk-on asset as opposed to an inflation hedge. It’s not analytically different than having bought Tesla stock for example.
I wrote about BTC & inflation specifically in more detail here: https://bitcoinmagazine.com/markets/criticism-of-bitcoin-as-money-narrative
Is your view that the US can run perpetual deficits with no consequences as long as it maintains its global reserve currency status?
I think it’s the other way around actually. The GRC status is somewhat maintained till the US can run deficits. The problem will mostly come domestically, with industrial policy and onshoring and domestic investment -- that’s when the US deficits will come under pressure, and that ultimately will incentivize the US itself to move away from the USD as the GRC.
One could argue that that is what Nixon already tried to do in 1971. He wanted to rid the US of the GRV responsibility.
“Remember, the agreement to price global commodities, particularly oil, is critical to the US$ dominance (petrodollar)”
Can you expand a bit on this? What are the pros/cons of Saudi accepting non usd for oil?
Interesting question! It depends on who’s point of view you look at it from.
Pricing oil in US$ means that, since oil is a global commodity and every country needs it, everyone needs US$ to buy oil. It’s basically network effects (more things priced in $ —> more people use it —> more things priced in it). For the US, this gives them geopolitical power as all countries need their currency. For Saudi, they get US support and protection in exchange for this.
Now, if Saudi actually starts accepting non-$ payments then it’s more complicated because whatever that other form of money is will lack the network effects (at least to begin with). For example:
— What will Saudi do with that other money (say the Yuan) if other global markets still use US$?
— For China it might help that they pay for something as imp as oil in its own currency, but does it want to also deal with the responsibility of managing a global currency (because there are domestic trade offs)
— How will other countries get their hands on this other money (since it’ll still be external for them)?
— Right now oil is priced globally. Will there be different prices for oil depending on who’s exporting and in what currency?
I think there’s no easy way of out because of how entrenched the system is.
Hope that’s helpful!
But isn’t that a catch-22? If US moves away from GRC due to on-shoring then demand for US debt will decrease. Won’t that result in higher interest rates simply to fund the interest on the debt, debt spiral, etc.
Demand for US debt isn’t a problem. Japan isn’t the GRC and yet doesn’t have any debt issues, despite having a v high debt gdp ratio.
The key is to understand that governments don’t finance themselves by issuing debt (as long as they’re financing in their own currency). The sale of bonds to private or foreign buyers is a specific design choice for the system, it’s not an inherent constraint.
For example, the US continues to have a budget deficit. What happens? The govt spends money first, then taxes later. That deficit money is already gone. Why does it now need to sell a bond?
This is of course me super simplifying it but conceptually this is true.
Also, bonds are needed by financial investors as a safe form of collateral (again, a system design choice). This is why Japanese, European bonds etc don’t have a demand problem per se, even in their CBs aren’t stepping in to backstop.