From: Thomas Grant Edwards <tedwards@Glue.umd.edu>
Date: Wed, 17 Apr 1996 05:28:30 +0800
To: "Perry E. Metzger" <perry@piermont.com>
Subject: Re: Money supply is fake anyway
In-Reply-To: <199604121257.IAA24747@jekyll.piermont.com>
Message-ID: <Pine.SUN.3.91.960416114925.6156C-100000@kolo.isr.umd.edu>
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[only relevant in terms of ecash lending and counterfeiting effect on the 
money supply]

On Fri, 12 Apr 1996, Perry E. Metzger wrote:

> You are correct that the fed creates and destroys money. You are not
> correct that ordinary banks do, or in your assertion that the fed
> substantially controls the expansion of the money supply through the
> discount rate.

We may be talking about different definitions of "making money."

I'll quote from "Secrets of the Temple" by Wiliam Greider... 

"New money was created not only by the Federal Reserve but also by private
commercial banks.  They did it by new lending, by expanding the
outstanding loans on their books.  Routinely, a bank borrowed money from
one group, the depositors, and lent it to someone else, the borrowers, a
straightforward function as intermediary.  But, if that was all that 
occurred, then credit would be frozen in size, unable to expand with new 
economic growth.  On the margins, therefore, bankers expanded their 
lending on their own and the overall pool of credit grew - and the bank 
turned credit into money."

If the Fed was the only organization that create or destroyed money
(through sales and purchases of federal securities), then the money supply
could be finely controlled.  The reality is that the money supply can only
be slightly controled by the Fed. 

The challenge of the Fed, though, is that banks create money with 
credit.  If the Fed makes $1 billion through the purchase of securities, 
that $1 billion injection will be multiplied by bank lending and credit 
up to $5 billion of new deposits, which would now be counted in the M1 
money supply.  

The banks would loan out $840 million of new loans (keeping 16% for
reserves), creating $840 in new deposits.  Those new deposits would enable
banks to loan out $706 million, and so on, and so on, until around $5
billion would be created.

-Thomas