Extremely simplified:

When I deposit a dollar, the bank records a $1 deposit liability. If the bank makes a $1 loan, it creates a new $1 deposit for the borrower.

If that dollar is spent and redeposited, deposits increase even though the amount of base money has not. It looks like multiplication, but what’s really happening is that loans and deposits are expanding together on the balance sheet.

The bank is not creating wealth out of nothing. It now has matching assets (loans owed to it) and liabilities (deposits owed to customers), backed by capital that absorbs risk.

With reserve ratios effectively zero, lending is constrained by capital requirements and risk management, not by reserves. Banks cannot recirculate a single dollar endlessly without sufficient capital.

> It can be difficult to figure out whether the theoretical limit is 10x or 100x in my mind because there isn't a reserve ratio federally (well, there is one, but it's zero)

I know what you're thinking of here, but it doesn't mean anything like what you think it means.

So the US used to have a rule that every bank hand to have a certain percentage of its assets stored in its account at a Federal Reserve bank; it is this percentage which was gradually reduced to 0 by I think 2020. Note that only the funds in that account meet the requirement; a literal pile of cash contributes not a single cent.

The way banks are primarily limited nowadays is via capital adequacy ratio, which is essentially that you need to set aside a particular pile of capital that can be raided to guard against assets falling in value to 0. It's complicated because this pile of capital doesn't come from the money a customer deposits in their account (which needs to be held as an asset to offset the liability a depositor represents), but rather from income the bank makes in other ways. If a bank sells $1 million worth of shares, they get to issue ~$20 million more loans.

If a bank gets $1 million worth of new deposits, they get to issue... $0 more loans. Well, maybe less: if a bank gets $1 million worth of new bitcoin deposits, that probably reduces its capital ratio because bitcoin is such a risky asset.

Lots of places, eg Canada, never had a legally mandated reserve ratio.

Fractional reserve banking has economic limits, even when there are no legal limits.

> IIRC the fed said that narrow banking threatens the stability of the banking system since private credit expansion (and ultimately, the risks that come with that) is in their estimation desirable. Regulators want nothing but to crush the idea.

But why? I don't understand, I feel like certain exceptions like (credit cards?) or house loans can be built or some personal loans but we all see a disaster which will be billed by govt. thus impacting everybody

The govt itself can then buy ETF's once again / invest money from one way or other via pension funds or other funds (sovereign funds?) to the stock markets themselves or other avenues.

banks basically arbitrage the fact that they are FDIC insured and loans. Nothing wrong with it except the fact that most banks would keep most of the money with themselves and only give chump change to average person or even 0%. If that's the case, why isn't there a bank which can just provide 3% treasury funds or similar or (gold?) and then just help the average person.

I saw a lot of points I agreed upon the narrow banking website on and I'd love to discuss more about the harms of narrow banking compared to fractional and why regulators shot it down/just comparing the two of them.

I wouldn't call it blind faith similar to how it isn't blind faith to get usd stable coins

I think paxos and xaut have audits etc. from what I know/ I have heard.

Although having more audits is always a neat idea but I was just proposing that there are ways to invest in things like gold and have things like liquid gold perhaps via stablecoin or some other means too basically allowing you to instantly sell gold and gold is a pretty good hedge against stablecoin imo.

I actually once wrote about this idea of narrow banking discovering it accidentally where I wanted a bank which could invest in treasury bonds for inflation protected money or gold.

https://gist.github.com/SerJaimeLannister/c3db4eb84da96decfc...

Hey, so does gold-backed currency!

How do you know how much gold the government is holding? Ask them!

How do you know the government isn't lying? Ask this question loudly enough and meet people with guns!

Stable coins are stable relative to their backing asset, not necessarily US dollars or any other currency.

On a long timescale gold is way more stable than the dollar. Dollar is nonvolatile on a long timescale in the sense the expected returns are negative and it does it reliably at usually anywhere from a return around negative 2-10%. But in terms of price stability gold would be far far far far more stable on anything but the most short-sighted of timescales.

Thank you for your detailed response. I find the idea of wise's being able to store even liquid cash into stocks.

How does the taxation aspect of it work? Would I have to pay short term capital gains on each transaction that I then make?

They also provide daily interests which seem interesting and about on par with treasury rates so it technically sort of can act as the end result of narrow banking for what I wanted (instead of banks borrowing and spending and containing huge chunks of profit in between, it invests into a safe investment)

> In what sense would America benefit? On an inflation adjusted basis, foreigners often get a negative real interest payment, ie they lose money, for the privilege of lending to the US. That seems like an extremely good deal for America.

Ah it seems that you are right but also that there are some inflation protected treasury but you might be right and I thought about it and doesn't it also bring a new set of problems that America faces.

Basically US can get real goods by giving debts and the real value of what US pays actually lessens over time because of inflation so in a sense, US is able to offset some costs by debt itself but it still has a vicious loop where you start borrowing money just to pay your debt and this starts cutting into your infrastructure hurting the poor the most but also reducing the ability of care etc. effectively making things private if govt cant fund it for many (healthcare) which would impact the poor the most

And this is really tricky as the current model really favours overconsumption and that makes more goods be easily sold and this is why other countries are willing to do this in the first place.

From what I could observe, the biggest winners would be corporations as US pays corporations get funding or the stock market looks more lucrative etc. Low real rates inflate asset values and this would disproportionately benefit the rich

It also starts to overconsume from other countries and just make it financially unable to operate at the same level combined with globalization to compete globally at everything but the software (doubtful, we will see what happens in the near future) and at the financial level.

So basically from my understanding, it increases inequality, increases overconsumption, benefits the rich and hurts the poor.

Also, basically US loses all major exports for this financial hack of sorts. Doesn't it fundamentally weaken the reality of US?

Another aspect is that since it favours the stock market or overvaluates them, these help vc funds and these vc funds trickle down to startups who can only compete at the software level so they end up subsidizing all costs (mostly human software engineering) plus hardware costs and make them able to offset/run at losses.

Now VC funds end up enshittening most solutions in order to extract maximum profit down the line usually basically impacting the end consumer and thus hurting the reputation of VC companies (and sometimes for good measure)

Theoretically this also subsidizes open source in a very minute way. Software engineers get rich and are able to enjoy the craft and there are subsidies of free storage and server access from basically github aka microsoft and others to basically streamline the whole process as well since these cloud/others also extract some values of open source.

But open source ends up creating better alternatives to VC funded solutions if those solutions exist in the most human-friendly way where profits arent even thought of usually and are run via donations.

Combine this with the fact that in India and China,developers are cheaper and they are having a boom in their VC industry/startup culture as well and they are willing to undercut America because they are simply leaner and usually pick less VC funding overall as well imo

So in a way US's software success can only be relied upon on full monopolies support considering open source and cheaper alternatives and also moral focuses where EU companies would prefer to support EU as US wreckballs into political disaster.

Also in my opinion, most of US software success recently aside from the monopolies or maybe even including them is so reliant on including "AI" and AI fundamentally lacks any moat most of the times and they are actively losing/making 0 profit while spending billions in hopes of beating the competition.

US's export of financial products basically loops this cycle back to probably an over-reliance on AI itself.

So US economy is so damn reliant on AI which is fundamentally unstable partially due to it "earning profit in the middle" or taking this lucrative deal.

Y'know what I feel the issue with this is? that in other countries there is a cap of the amount of destruction/reliance. Usually most countries suffer from the other side of spectrum but America has removed this cap because of it and this weird blend of hyper capitalism just converted into late stage capitalism.

So (when) the AI financial bubble explodes, How would America even rebuild itself?

I don't think there is a free lunch. Not even in this case, what ended up happening was that America took short term profits in long term structural losses and this hyper capitalism lured companies as well to outsource or build factories in china and other countries actively increasing the extent of the loss and there just wasnt any cap.

Something which is lucrative but not sustainable and now its starting to bite back.

A lot of issues I felt that were in America are now starting to feel intentional.

I mean one of my questions is that how can America even be optimistic at this state considering that everyone I talk to admits that AI is an bubble, so yea AI companies still make profits but long term everyone sees an impending doom. It's like a time bomb and I already feel at unease and I observe the same feeling of unease as well from other people.

Another point was that America helped foreigners into the American dream (by exporting a story) or perhaps the silicon valley dream (a lot of S&P companies are built by people who came to america) as it losses even that.

In a way America just incentivized a new form of grifting called financial innovation in this AI bubble era in my opinion by this decision. I am genuinely not sure what America can do at this stage.

I am sorry to say but the future seems bleak. I hope I am wrong but I wish the average american the best of luck and hope in a better future for the whole world combined but being honest, the future doesn't feel good for America.

The best way to understand a loan is as the right to a future income stream (principal repayments and interest). The original debtor (the person/entity taking out the loan) establishes the credibility of that future income stream (based on income, expected returns on a project, etc) and sells it to the lender (usually a bank) for cash up front. Thus the loan is an asset on the bank's balance sheet, that is generating returns (assuming all goes to plan). Banks can and usually do sell on that asset to other parties.

Conversely, when you deposit cash to a bank, you are actually creating a liability on the bank's balance sheet - as you might want your money back one day!

For every debt there's a debtor and a debtee. For the first debt is a liability, while it's an asset for the second.

>The constraint for the bank comes when you start spending that money. Most people take loans to spend the money, eg a company might invest in some new machinery or you might buy a house. The Mr Wagner in your story stopped his investigation too early.

No, you don't get it. Imagine if there was a single bank and no cash withdrawals. The bank can't run out of liquidity, ever. If you buy something from a company, the money lands in the bank account of the company, which is managed by the same bank. This means as long as there is no cross bank transfer, there is no limit to how much money can be created.

Now you might argue that this is a bit unrealistic, but at least in principle you could artificially engineer a situation like that even in the current system by having large corporations agree to use the same bank for money created by a specific loan.

But here is where it gets weirder. Imagine if there are two banks now. Surely now the idea presented above breaks down the moment there is a cross bank transfer, right? Except it's not that simple. There is merely a limit to how much of the created money can leave the bank in one direction. If the cross bank transfers are balanced so that for every transfer from bank one to bank two, there is a transfer from bank two to bank one, then you are back in unlimited money territory.

This means there is no static limit to the amount of money that can be created. The limit is dynamic and depends on the interactions between banks. Specifically, it depends on the liquidity/solvency of a given bank. This means this limit is purely practical and more akin to friction, rather than a fundamental restriction in the math of banking/accounting. It's like how computers aren't turing machines because they have finite amounts of memory. There is no limit to how much memory a computer can have as long as you can manage to build a computer with that much memory.

>What's that supposed to mean?

The misconception is that if a bank has a capital X, the law gives them power to create loans up to 10X.

What I'm saying is that without the law, the bank could create loans without a constraint, so say 20X, 100X 1000X.

The fractional reserve policy is actually a limit, not the source of lending in excess of capital.

Loans are money creation, and this creation is organic, it doesn't need a charter from the government.

Another misconception is that this money creation is monetary emission or that it somehow causes inflation. It doesn't, because it is gross money creation, not net money creation.

There are many Christians very fervent opponents of listening to such authorities and stick to the Bible itself. Nowhere in the Bible for example it is written that one can pay off sins by giving money to some authority. But someone had to pay for the Saint Peter’s Basilica so there was an incentive to adjust scripture.

Canada is not an exception and operates via the same mechanism https://lop.parl.ca/sites/PublicWebsite/default/en_CA/Resear...

Fractional reserve is a model only for textbooks, it is not an accurate model of how the banking system works in most western economies with a central bank and sovereign currency today.

>> The more useful limitation in economic terms and in legal terms is on the amount of capital banks need to hold

Well this is usually the biggest of several limitations which impact whether a loan would be profitable to make for a bank or not so i don't entirely disagree but this is a legislative control, there's no "economic terms" here because in general no school of economics understands this or has anything to say about this control which you correctly point out exists and is central to loan decision making. People can argue about the degree of centrality because it's not the only factor so let me put it this way: it's central in a way which any notion of "fractional reserve" is simply not.