greekfire, you are a saint for providing this. I am far too lazy to find this sort of thing. Allow me to dissect Griffin’s math and expose him for the charlatan he is. (As I’ve acknowledged previously, I haven’t read Griffin, so I had no idea how poor his understanding of banking was.)
[quote=greekfire][quote=davelj]
Anyhow, it took me all of 30 seconds to find this criticism of Jekyll Island, specifically, and Fed conspiratorialists in general (see “Myths” at the bottom):
My point is an obvious one (and applies to BOTH sides of any issue): Just because it’s in writing don’t make it so. Lots of legitimate thinkers clearly think Griffin’s a quack and his book is toilet paper. (Doesn’t make them right, but it’s a data point to consider when deciding whether to hang your hat on some specific author’s views.)[/quote]
In the spirit of presenting both sides, here’s Griffin’s response to Ed Flaherty:
(Sorry this is so long! I tried posting just the link but it got rejected.)
[snip]
Flaherty: Hypothesis: Through fractional reserve banking and double-entry accounting, banks are able to create new money with the stroke of a pen (or a computer keystroke). The money they lend costs them nothing to produce, yet they charge interest on it. Facts: The banking system is indeed able to create money with a mere computer keystroke. However, a bank’s ability to create money is tied directly to the amount of reserves customers have deposited there. A bank must pay a competitive interest rate on those deposits to keep them from leaving to other banks. This interest expense alone is a substantial portion of a bank’s operating costs and is de facto proof a bank cannot costlessly create money.
My [Griffin’s] reply: Flaherty presents facts that in no way contradict what I said in my book. I speak of rotten apples, and he speaks of sweet oranges. My book makes it clear that the bank’s ability to create money is tied to its reserves. The current average ratio (it varies depending on the bank) is about ten-to-one. In other words, for every one dollar on deposit and held in reserve, the bank can create up to an additional nine dollars out of nothing for the purpose of lending. The statement that the banks must pay a competitive interest rate on those deposits is humorous when one considers the math. For example, let us assume for the sake of illustration that the bank pays 1.5% interest. Then it turns around and charges, let’s say 6.5% interest. That’s a spread of 5%. Although that’s a pretty good brokerage commission, it doesn’t sound exorbitant. But, here is another of those half-truths. Don’t forget that the bank uses each deposited dollar as a so-called reserve for creating up to an additional nine dollars in loans. It collects interest on these loans as well. Let us assume that the bank is not fully loaned up, as they call it, and has an average of only eight dollars in magic-money loans for every one dollar on deposit. In that case, it will collect 6.5% interest on all eight of those dollars. That means, based on each dollar placed on deposit, the bank will collect 52% in interest. After paying the original depositor the generous “competitive” amount of 1.5%, the bank actually receives a brokerage fee of approximately 50%. When Flaherty says that “This interest expense alone is a substantial portion of a bank’s operating costs and is de facto proof a bank cannot costlessly create money,” one can only wonder what banking system he is describing. It certainly is not the one in the United States.
[/quote]
Houston, we have a problem. And that problem is that Griffin doesn’t understand basic bank balance sheet accounting. [As a side note, this is why microeconomics is taught before macroeconomics. If you don’t understand what’s happening at the micro (re: bank) level, then you’re not going to understand what’s happening at the macro (re: Federal Reserve) level.]
[quote=greekfire]
Griffin states: “Don’t forget that the bank uses each deposited dollar as a so-called reserve for creating up to an additional nine dollars in loans. It collects interest on these loans as well. Let us assume that the bank is not fully loaned up, as they call it, and has an average of only eight dollars in magic-money loans for every one dollar on deposit. In that case, it will collect 6.5% interest on all eight of those dollars. That means, based on each dollar placed on deposit, the bank will collect 52% in interest. After paying the original depositor the generous “competitive” amount of 1.5%, the bank actually receives a brokerage fee of approximately 50%.”
[/quote]
What Griffin is saying here is that the bank’s “real” spread (its “brokerage fee”) is 50% because the fractional reserve nature of banking allows the bank to loan out nine of its “deposit dollars in so-called reserve” and earn an interest rate on those nine dollars of loans while only paying interest on the one dollar of deposit in reserves. The only problem here is that it’s wrong and violates the accounting identity: Assets = Liabilities + Equity.
Allow me to explain using a simple example:
Davelj Bank (DBank) is going to start up with $10 million in equity (and receives a charter from the FDIC).
Day 1: Assets = Liabilities + Equity
$10 million Cash = 0 Deposits + $10 million Equity
DBank gathers some deposits and makes some loans (but let’s assume no profits to keep things simple)…
End of Year 1: Assets = Liabilities + Equity
$5 million Cash + $35 million Loans = $30 million Deposits + $10 million Equity
So, what’s happened here is that DBank is “leveraging” its original $10 million in capital and using deposits to “fund” its loan growth. So far, $10 million in capital has turned into $35 million in loans. Thus, money/debt is being created within the system.
DBank becomes fully leveraged:
End of Year 5: Assets = Liabilities + Equity
$10 million Cash + $90 million Loans = $90 million Deposits + $10 million Equity
So, $10 million of original capital has given birth to $90 million in loans – that’s fractional reserve money/debt creation.
Now, where’s that 50% brokerage commission of which Griffin speaks? It doesn’t exist. Because, you see, as DBank was generating its loans, it ALSO had to bring in deposits to FUND those loans (that’s how the accounting works, folks). And it has to pay INTEREST on (essentially) ALL of those deposits, NOT just the “original deposits,” as he suggests. (Technically, commercial DDA accounts don’t collect interest, but that’s not what Griffin’s talking about here. 90% of the country’s bank deposits collect interest, however minimal.)
So, using current figures, if DBank is really well run and has no credit quality issues, DBank’s asset yield is about 5.5%, its overall cost of funds (including deposit costs) is about 1.5%, for a “spread” of around 4%. But after taking into account operating costs (SG&A, etc.) of about 2.25% of assets and credit costs, you’re probably down to a 1.5% pre-tax return on assets, under 1% after-tax ROA, and maybe a 10% return on equity. That’s if you’re well run today. In normal times the industry as a whole earns maybe a 13% ROE. Right now, it’s barely positive (and arguably negative).
Griffin wants you to believe that every bank charter comes with a license to print money on behalf of the OWNERS (the “50% brokerage commission”) and that this activity is COSTLESS. In fact, nothing could be further from the truth. Yes, each charter does come with a license to print money (via fractional reserve banking) – but that money goes into the economy in the form of loans… and must be MATCHED with deposits, which also COST MONEY (which is what Flaherty points out). Once you get outside of the largest 100 banks in the country (there are almost 8,000 total), you don’t find a lot of really wealthy managers/owners. Community banking is not where folks go to make a fortune. (The Big Banks are a different story because of all of their non-banking activities – which is a separate discussion entirely.)
So, there are all sorts of legitimate arguments that one can make against a fractional reserve system (and the Fed). But one of them is NOT that every bank charter essentially comes with a “50% brokerage commission” to the owners. (When someone finds a bank making this magical “50% brokerage commission” please let me know. We can definitely do business.) That’s completely absurd and betrays a complete lack of understanding as to how a bank actually operates. (Based on his response above, I’d be willing to bet that Certified Financial Planner Griffin has never worked at a bank, sat on a bank’s board, or understands a bank’s financial statements.) Which, of course, begs the question: Who in their right mind can claim to be an expert on the Fed (macro level) if that same person doesn’t even understand the basics of how the system works at the operating (micro) level? Answer: A charlatan.
[Also, on a side note, I see that in several different instances, Griffin refers to Flaherty’s “half-truths.” Do you know what the definition of a “half-truth” is? It’s a “whole-truth” in which you simply disagree with the other person’s interpretation.]
