To be more specific, though, the author is right that there are a lot of dollars out there being hoarded because the USD is the global standard currency, and that its fall from that status will have some interesting consequences. Pretty much every other factual claim of the article is nonsense. His explanation of fractional reserve banking is upside-down. He pulled the conjecture "if the interest rate is 4%, then 4% of all credit will default" from the deepest recesses of his rectum. The assumption that the economy will revert to the state it was in just before the end of Bretton Woods reads more like the lazy premise of a short story than an economic theory.
Yep. I actually was somewhat credulous until he got fractional reserve banking backwards (getting a $1000 deposit with a 10% reserve requirement means you can lend out $900 of it, not that you can magically lend out $9000 that you don't have), and then it was all downhill from there.
There are a lot of relatively decent arguments that the US economy is in for a prolonged recession, but I would group the article with the crazy goldbug paulites rather than with legitimate, usually fairly well-reasoned economic criticism with which I disagree (Krugman, etc).
That actually isn't strictly true; you could loan out that 900, which gets spent by the person you loaned it to, and can then could be redeposited by the person who sold him something, in the same bank. And this can be repeated up until it asymptotes off, which (from memory), with a 20% reserve requirement, would occur at $5000. You can do the math on your own for a 10% reserve (I'm guessing it happens at $10,000, which minus the original $1000 is the author's $9,000).
What's really fun is that you can do this with anything, e.g. lawnmowers. I might own one, I lend it to Bob. Now how many lawnmowers are in circulation? Certainly I own one, I have an IOU for one lawnmower. And of course Bob owns one, he's mowing his lawn. If I swap out my lawnmower IOU for some cheesecake and a Tijuana Brass LP, now I'm creating currency and inflating the money supply, since really anything can be currency, ask all those people swapping around cell phone minutes.
I think this is confusing for currency because the IOUs look so much like the real thing.
sorry for the meta comment: but the above comment thread is why I think news.YC is the greatest at the moment. Compare this sort of conversation to reddit, or anything really. Doesn't compare.
Its a geometric series. In math: Let r=(1-reserve requirement) and Total = 1000 * sum(1-r^n,n=0,infinity) = 1000 * 1/(1-r)
Now I'm probably wrong with my indices because I'm a little confused about connecting my infinite sum to people running around at the bank. If I plut in .8 for r (the same as the comment above used, I get 1/(1-.8)=5, or $5,000 so I'm right that far. For 10% its: 1/(1-.9) = 10 or $10,000. So the author is right in numbers, but arguing against this would be ridiculous. How could any bank guard against this? Why would they want to?
Right, that assumes the proceeds of the loan are redeposited into the banking system. If instead the money remains in circulation or is otherwise kept in physical form, the multiplication stops.
The author has since added an italicized paragraph explaining that this is what he meant to write, but I think the original wording crosses the line from shortcut into misleading, because by the time it will have "the right to lend $9,000 to other people", the bank will have had $10,000 in deposits, not $1000.
Although it's a big house of cards, but since in today's age of almost everyone using the debit, credit & gift card instead of cold hard cash, it's very true reality. Also, it's the not the same bank, but the entire banking system as a whole that allows the money to "multiply". And todays reserve ratios are ridiculously small, in the 1% area.
First off, only idiots loan money without requiring the borrower to put up some collateral to cover most of the sum in the event of a default. Not even the Federal Reserve.
Second, reserve requirements are there to insure the institution can cover defaults at a modeled rate. The requirement is not to cover the entire amount of the loan in the event of a default, but ONLY the difference between the market value of the collateral against the loan and the principal of the loan.
So a bank with a $1000 deposit and a 1:9 capital ratio can, indeed, directly lend $9000 if their risk modeling and lending standards predict a sufficiently low default rate.
This is why accurate (and conservative??) modeling and subsequent pricing of risk is so very important to a fractional reserve banking system. Mis-priced risk => actual losses are greater than projected losses => insufficient capital to cover actual losses => bankruptcy.
Sprinkle in some 32:1 hedge fund leverage using crap mortgage paper as collateral and you have yourself a financial weapon with a very short fuse.
The most recent incarnation of mis-priced risk has been "houses ALWAYS go up in value", leading to AAA-rated mortgage-backed securities (MBS). Which is bullshit and we all know it. The institutions that bought this crap only held enough capital to cover their modeled default rate of AAA-rated bonds, rather than the (much larger) capital to cover defaults on the junk bonds this trash is really composed of.
The situation is actually worse than the author says. Those banks turn around and use the mis-priced MBS paper as collateral for even larger loans, and now the problem has REALLY been magnified. This goes 3 or more levels deep with some of the credit derivatives out there.
Edit: P.S. I think the pirate author guy is kind of a doomsday nutjob. I do not think the U.S. will collapse in a poof of logic.
If you believe that all money is just loans, then that 4% interest has to either to be defaulted on, or another loan has to be created to cover the original interest on a global scale. If you take out another loan to cover interest, then money will balloon to infinity. It's internal logic is consistent.
