Are all of you up for a challenge?  I hope so, because I have a favor to ask all of you.  I am blessed to have among my readers many people of varied backgrounds that might know the answer to the problem that I am about to pose – or maybe be able to research it.  Some of the aspiring younger adults might even want to call a few banks as a homework assignment.

Here’s the issue:

Most all of us have been taught that our nation’s money supply is based on the “Fractional Reserve System”.  We have further been taught that it operates somewhat like this:

“Joe” goes to the bank and deposits $1,000.

The bank sets aside 10% of the money as “reserve requirements” and is free to loan out the other $900 to somebody else at interest.  The person receiving the $900 loan (“Sam”) can then deposit that money into a bank, and that bank will set aside $90 as reserves and loan out the other $810.  And so it goes – with the loan amounts getting smaller each iteration, until the total loans plus the original deposit can equal $10,000.

Under this scenario, it looks like it is Joe’s “wealth” that is being lent out by the bank.  What if this is wrong?  What if this isn’t how banks work at all?

You see, the Federal Reserve rules never state that a “reserve requirement” means that a bank has to set aside 10% of each deposit.  Instead, it says that banks cannot have “transaction accounts” (demand accounts) greater than 10 times their deposits.  This may seem like it’s saying the same thing as our example, but it’s not.

Here’s scenario #2:

“Joe” goes to the bank and deposits $1,000.

The bank treats Joe’s deposit as its reserve requirement, so it has a reserve of $1,000.  According to Federal Reserve rules, this means that the bank cannot have more than $10,000 of “transaction accounts”.  They already have one transaction account from Joe’s $1,000 deposit.  This leaves the bank free to create another $9,000 of “transaction accounts”.

“Sam” walks into the bank wanting to borrow $5,000.  The bank says “Sure!”.  So the bank creates a $5,000 loan as an asset on their balance sheet and creates a $5,000 checking account as a liability.  The balance sheet is still in good order – but new money has now been added to the nation’s money supply.  “Sam” can take this money out of the bank, which would then make that $5,000 show up as Federal Reserve Notes Outstanding on the balance sheet.

The money supply would shrink again as the loan gets paid off over time.

Can anybody find a rule stating that a bank must have less in outstanding loans than their deposits?  Or that a bank can only directly lend from the money that depositors deposit?

Enjoy the challenge, and please email me back with any thoughts and/or findings.
_______________________________________________________

Watch for these indexes to drop:

Chinese Shanghai Composite Index: 3,224.15 (change of 1.31% from July 20, 2009 base value of 3,266.92)
Shenzhen Stock Exchange Component Stock Index (SSE): 13,264.37 (change of 0.87% from July 20, 2009 base value of 13,381.22)
________________________________________________________

Here are today’s numbers for the economic indicator:

1) Gold = $1,130.00
2) Silver = $18.39
3) Dollar Index = 77.32
4) Oil = $78.00
5) S&P 500 Index = 1,136.03
6) 3-month Treasury Bill yield = 0.05
7) 3-month OIS = 0.14

HEI = 30.53

(A value of under 100 indicates deflation, while over 100 indicates inflation – as referenced to Sept. 12, 2008…the day before Lehman Brothers collapsed)



__________________________________________________________

Here are the numbers for the day:

Dollar Index adjusted indexes:
Dow = (10,609.65) x (0.7732) = 8,203.38
S&P 500 = (1,136.03) x (0.7732) = 878.38
Nasdaq = (2,287.99) x (0.7732) = 1,769.07

3-month Treasury: 0.05

2-year Treasury: 0.86

10-year Treasury: 3.67

30-year Treasury: 4.58

2-yr vs. 10-yr Spread (Target > 273): 281 basis points – (Danger Zone)

2-yr vs. 30-yr Spread (Target > 369): 372 basis points – (Danger Zone)

3-month LIBOR: 0.25

3-month EURIBOR: 0.68

3-month OIS: 0.14

TED Spread: 20 basis points

LIBOR/OIS Spread: 11 basis points

Dollar Index: 77.32

Volatility Index: 17.91

JPY-EUR Exchange Rate (Target < 115): 130.5908

JPY-GBP Exchange Rate (Target < 145): 147.6292

JPY-USD Exchange Rate (Target < 90): 90.77

USD-EUR Exchange Rate (Target < 1.25): 1.4387

USD-CNY Exchange Rate (Target > 7.0): 6.8270

Warmly,

Brad

Comments or questions?  brhamill@hamill.com

If you are not currently on the Economic Update email list you can email me at: economics@datatogo.com to be added.