Mohamed Ibrahim’s Blog

I’ve been reading more lately about financing. I mean the core of money, where it comes from and how it gets killed, not just real estate financing. I’m surprised by a lot of what I read, and actually hope that others take the time and understand the pillars of our economy in order to know how to plan for his or her future.

I watched some videos on Google video: Money As Debt , Money banking and the federal reserve . Although sometimes those videos generalize their talk, yet after doing some research I found that a lot of it is actually true. The fact is we are dealing with non-existent money.

So today, I real in the New York times that the federal reserve cheif is hinting on rate cuts. Now there are two forces in the equation, lowering rates to ease the credit crunch, and more debt that people will assume as a result of lowering the rates and which in turn will create more cash infusion in the system - as much as 10 times that debt.

Remember that banks can lend 90% of deposits (the fractional reserve). Assuming that person p1 gets a loan of $1000, and then buys a merchandise from p2 and p2 deposits it in bank b1, then bank b1 can lend $900 due to this deposit to person p3. As this goes on, the initial $1000 can create almost $10,000 in the system. This new money leads to inflation, which leads to the increase in the price of goods or equivelantly the devaluation of the money you and I have.

So basically banks represented by the feds tries to manage the willingness of people to take on debts by lowering the rate by which the federal reserve lends money to banks. Lowering that rate too much will cause inflation, which people hate as it will increase the price of goods.

However, if all the people are doing OK and start paying their loans the money created out of thin air due to the fractional reserve will get killed in the same manner it was created. When loans get repaid the amount of money in the system decreases and causes deflation, which is the increase in the value of dollar - Who will ever hate that the value of the dollar increase? - BANKS

Banks hate deflation. If all of us are doing well and we repay our loans the banking business will do bad, since banks make money out of interest on loans of non-existent money made through fractional reserves.

So again, we haven’t made the tie between the federal reserve rate and the rate by which you take you loan from the bank yet. Banks are like me and you, they all have bank accounts in the central banks. There are 12 central banks, and one main federal reserve bank. You can imagine those central banks as the local branches of the federal reserve bank. When you get a loan to buy a car from bank X, bank X will give you a check or make the money readily available to you. When you pay the car dealer the check, the bank of the car dealer (Bank Y) will request the money from your bank in a process called clearing. So your bank Bank X, needs to come up with the cash to pay for Bank Y. Good if they had it - but if they don’t, they will either get it from their depositors or take a loan from the federal reserve bank. The federal reserve has been blessed by congress by passing the most trusted power given by the people - coining of money. The federal reserve does not print the money, by can type in the loan money in the bank’s federal account. So here you go - money out of thin air without the need for fractional reserve.

So what happens when the feds hint towards lowering the rate? people instantly bet that gold price will increase. If the value of gold is constant - so what just happened to the dollar in your hand ? it shrank. Investors know the gold price will increase because more people will take loans and more money will be created in the system.

So how can we avoid been sucked in in the banking system?

1. Pay off your debts. Now you removed your hidden hand from causing inflation, although you didn’t stop the government from borrowing more money, and that’s the biggest borrower of all.

2. Elect and support officials with good understanding of economics, and good monetary policies. Elect official who will try to pay off debts rather than take more debts.

3. Store your valuable money as commodities like gold and silver rather than notes. Now your savings cannot be inflated.

4. Try to be a partner in a project rather than a lender. You will benefit by getting dividends, and you will benefit more by not being a factor in devaluating your own money.

I don’t have any more ideas that might be helpful other than those - at least for now. But I will update this post as soon as I know better ways.

So the real estate market has been going deep down the toilet for a while now, and it looks like there’s more down to go in 2008.

Technorati Tags: money, inflation, rate, federal, reserve, lending, loans, credit, deflation, money value, notes

Tags: credit, deflation, federal, inflation, lending, loans, money, money value, notes, rate, reserve

This entry was posted on Thursday, January 10th, 2008 at 12:53 pm and is filed under Real estate, financing. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.