The total amount of bank deposits has nothing to do with the saving attitude, or with the spending decisions, of bank accounts’ holders. A new bank deposit can only be created through two main channels. In one, deposits are born twins with bank loans to the non-bank private sector (households or firms). In the other, deposits are born twins with bank reserves as a result of payments made by the public sector (Treasury or Central bank) to the non-bank private sector. A third process, yet smaller in importance, is when the banking sector makes net payments to the non-bank private sector.

The bank loan channel: This is when a bank makes a new loan.

Once the new balance is made available to the client-borrower, this will increase the total deposits in the banking system. By the end of the day, the banking system has more loans in its portfolio (assets) and more deposits to honor (liabilities), while the non-bank private sector has more deposits (assets) and more loans due (liabilities). In the process, the total amount of reserves held by the banking system has not changed.

Conversely, the total amount of deposits declines when the non-bank private sector makes any payments to a bank (such as interest payments, loan principals, or a purchase of a bank product).

Thus, for any time period, the net creation of deposits through this channel equals the amount of bank loans made to the non-bank private sector net of principals and interests payments received.

Public sector’s payment channel: This is when the public sector sends a check to the non-bank private sector.

If the check is issued by a national state with monetary sovereignty (i.e., the unit of money issued is a national state liability not pegged to any other asset the nation state must hold as guarantee), than the check will never bounce. When the non-bank private sector’s recipient deposits the check, the banking system acquires an equivalent amount of reserves via a credit entered by the central bank. By the end of the day, the banking system has more reserves (assets) and more deposits to honor (liabilities), while the non-bank private sector has more deposits (assets).

Conversely, the total amount of deposits declines when the non-bank private sector makes any payments to the public sector (such as taxes, or purchases). Thus, for any time period, the net creation of deposits through this channel equals the amount of all government and central bank net payments.

The banking system net factor: This is when a bank makes a payment to the non-bank private sector for reasons other than making loans, such as payments of salaries to bank employees, rents paid to landlords, interests paid to depositors, dividends paid to shareholders, and any other outlays (for current output, existing real assets, or outstanding financial assets). By the end of the day, the banking system has settled a number of its liabilities by creating deposits in the name of the payees, and the non-bank public has more deposits (assets).

Conversely, the total amount of deposits declines when the non-bank private sector makes any payments to the banking system (such as fees).

Thus, for any time period, the effect of this channel equals the outflow of funds of total banks’ expenses net of total banks’ receipts.

You may think that the Fed, the central bank of the U.S., has complete control, or at least some control of how many banknotes circulate in the economy. The fact is that the Fed has no power in this.

Banknotes enter in circulation anytime you request a teller machine to supply cash.  The machine debits your bank account and gives you cash.  Banknotes will disappear from circulation anytime someone decides to get rid of cash and deposits it in a bank.

Banks make sure they have an inventory of banknotes to accommodate any net withdrawals of banknotes. When they feel their inventory is excessive they send some banknotes back to the central bank (that will shred them). When they feel their inventory is short of their clients’ needs, banks have extra banknotes sent by the central bank (that will debit the bank’s account at the Fed—If the bank’s account balance is zero, the bank will borrow reserves and then have its account debited). Banknotes could completely disappear from the economy if only everyone felt that all payments could be handled through bank (or credit card) payments. This way, the amount of banknotes in the economy would endogenously go to zero with no decision of the Fed. On the other end of the spectrum, how large the amount of banknotes could go if only everyone decided to increase the use of cash? Very high indeed. But with a limit: when the willingness to hold banknotes is driven by a generalized loss of confidence in bank accounts, the process of conversion from accounts to banknotes could either a) continue until all bank accounts are converted into cash if the central bank decides to lend reserves to all banks (and if the central bank printing press is fast enough to keep pace with the requests) until people calm down and deposit their banknotes back into the banking system; or b) stop when banks fail and lose access to reserves; or c) stop when banks decide to refuse conversion to protect their liquidity; or d) stop when the central bank declares a bank holiday awaiting to restore confidence in the banking system. In no way, it is the Fed that decides the amount of banknotes in circulation.

The first Mecpoc Symposium was held on April 8, 2008, at Franklin College Switzerland. The proceedings consist of papers submitted by the guest speakers and transcripts of the speakers’ remarks.

To download the full symposium proceedings, click here. Segments of the proceedings can be found below.

Program Contents

• Symposium Participants
• Welcome and Introduction
• Korkut A. Ertürk – University of Utah and Levy Economics Institute
  Where Are We in the Crisis and What to Expect Next?
• Jérôme Creel – ESCP-EAP and OFCE
  Monetary policy: What Can Be Learned from Recent History?
• Benoît Mojon – Federal Reserve Bank of Chicago and European Central Bank
  Globalization and Inflation Dynamics
• Christian de Boissieu – Université Paris 1 Panthéon-Sorbonne
  Has Globalization Turned Inflationary?
• Panel Discussion with Antonio Foglia – Banca del Ceresio, Giacomo Vaciago – Università Cattolica del Sacro Cuore, Christian de Boissieu – Université Paris 1 Panthéon-Sorbonne

There are no ’scarce resources’ causing the financial crisis and the global recession! And yet, no self-correcting force is likely to operate soon. In a “money crisis”, only political authorities (who are the ultimate monopolists of money) can provide effective answers. And to be effective, these should be based on out-of-the-box thinking.

Bank deposits are based on depositors’ confidence, and nothing else: banks’ liqudity is (always) only a fraction of deposits.

Unconventional idea #1: The US Fed should remove the self-imposed $100,000 cap on insured bank deposits. Make insurance unlimited!

Banks can’t find enough liquidity, and when they can’t, they declare bankruptcy even when their balance sheet is sound!

Unconventional idea #2: The US Fed should provide unlimited, unsecured lending at the Federal Funds rate. Banks should be able to borrow all they need.

Demand, incomes, and employment are diving. Lowering interest rates is completely ineffective now.

Unconventional idea #3: A fast and very substantial fiscal package is needed with no consideration to deficit caps! A fast action is to declare a payroll tax holiday.

The euro system is at risk of more and larger insolvencies. In addition, because of Euro rules governments cannot guarantee the checks they write! It is hard to change this structure during emergency. The above proposed measures may mend the Euro mess too, for the moment… and if we are lucky!