# Where has all the investment money gone?



## PostTiger (13 Oct 2008)

Just a quick question to help my understanding of the current financial crisis.

Most asset classes have taken a hammering in recent weeks. Equities, commodities and for a longer time frame property prices.

My understanding is that many investors are pulling out of other asset classes and placing their money in "cash" at least until the current volitility passes.

My question is does putting your money in "cash" mean on deposit in a bank?

Also many banks are offering attractive interst rates eg. 8% over 18 months. What asset classes are the banks investing in to earn such high returns. Or are they simply lending to other financial institutions caught in the credit squeeze?

Surely there is trillions of dollars of investment searching for a more permanent home at the moment and it is only a matter of time before some asset class comes into vogue and is driven up by sovereign funds, pension funds, individual investors etc.

My own thoughts are that we may see a bubble in the green energy and clean technology sector over the coming years as both US presedential candidates are making noises about energy supply being integral to US national security and for the countries who signed up to Kyoto, Ireland included carbon levies will start to bite.


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## darag (13 Oct 2008)

Most of the money in circulation is created by lending by banks.  For example, imagine a bank with 1 billion of deposits.  It's balance sheet has 1 billion of assets (cash) and 1 billion of liabilities (debt to customers).  The same bank now lends out 1 billion.  It's equity hasn't changed - it's zero; now it has 1 billion assets (loans) and 1 billion liabilities (debt to customers).  However there is now an extra billion floating around the economy.  In fact banks can lend out more than they have in deposits which is the point of fractional reserve banking.

Conversely when lending slows or when banks (or businesses or individual) try to collect debts, money is taken out of circulation.  Thus a "credit crunch" causes a reduction in the money supply.  So no, I don't see asset price bubbles arising from the current situation.


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## Duke of Marmalade (13 Oct 2008)

darag said:


> In fact banks can lend out more than they have in deposits which is the point of fractional reserve banking.


 
Probably a difference in interpretation, but my read is that isn't true:

Deposits = Loans + Safety Margin

That is the identity of the banking system. Deposits must exceed loans. But deposits (the money supply) can greatly exceed the Safety Margin(cash at the Central Bank).

Deposits here includes interbank deposits.


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## darag (14 Oct 2008)

I don't believe that's the case, Duke.

Bank's do not solely rely on deposits for funding their lending; they also borrow from other banks, central banks and issue commercial paper.

For example, IL&P have a loan to deposit ration of 281% (!) according to .


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## Maximus152 (15 Oct 2008)

Deposits must exceed loans, that does not make sense to me, in a perfect world maybe. The banks are always chomping at the bit to hand out loans to every one and there dog this is because they know that they can reep a fruitful harvest from your constant pandering to their interest rates over the 2-3 years or what ever the term.So it would be in their interest (excuse pun) to have more money lent then actaully on deposit because they will not only get it back but with substantial interest me thinks, as long as there is a nice consistent flow on money comming in they are happy, or so I imagine, but hey what do I know.



You have to latch on to the afirmatice relay on the negative excentuate the positive and never mis with Mr in between.


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## Duke of Marmalade (15 Oct 2008)

darag said:


> For example, imagine a bank with 1 billion of deposits. It's balance sheet has 1 billion of assets (cash) and 1 billion of liabilities (debt to customers). The same bank now lends out 1 billion. It's equity hasn't changed - it's zero; now it has 1 billion assets (loans) and 1 billion liabilities (debt to customers). However there is now an extra billion floating around the economy. In fact banks can lend out more than they have in deposits which is the point of fractional reserve banking.


 
"floating around the economy" You mean in used notes? In fact those loans finish up precisely as extra deposits, okay maybe deposits in other banks. Reserve banking means the creation of *deposits *(aka the money supply) by creating credit. The total deposits in the banking system will exceed loans as an accounting truism. Even your example does not show a bank lending more than it has on deposit.  The excess of deposits over loans are the prudential reserves held with the Central Bank. 

The total of inter-bank deposits is zero, by definition. However, individual banks can be very heavily reliant on inter-bank deposits as in your example and indeed whole economies, like Ireland, can be massive inter-bank borrowers.


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## darag (21 Oct 2008)

> "floating around the economy" You mean in used notes?


As I suspect you understood, my point had nothing to do with where the money ends up, what matters is that it is being used in the economy not being stored in a safe which is what would happen if people did not have access to banks who take in deposits and recycle the money as loans.  Or maybe you didn't understand and thought it would make you sound clever.  

I can't even make sense of what point you're trying to make except to be antagonistic.  Even if you misunderstood the fairly simple claim that "banks can lend out more than they have in deposits" as being some sort of claim about total aggregates in the entire banking system which it patently was not, you'd be wrong.  If you'd even superficially studied what has being happening in recent times, you'd know that banks have increasingly resorted to the money markets to fund lending and/or derivative and bond markets to raise funds or resell debt instead of relying on deposits.


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## extopia (21 Oct 2008)

Jeez, guys, get a room!

But to answer the original question...



PostTiger said:


> My question is does putting your money in "cash" mean on deposit in a bank?



... basically, yes, it does.


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## Duke of Marmalade (21 Oct 2008)

extopia said:


> Jeez, guys, get a room!


Yes _Darag_, let's chill out. 

I still think your terminology was a tad defective, I am not saying I am cleverer than you. 

Consider the following definition:


			
				 Wikipedia said:
			
		

> *Fractional-reserve banking* is a banking practice in which banks are required to keep only a fraction of their deposits in reserve with the choice of lending out the remainder while maintaining the obligation to redeem all deposits upon demand. This practice is prevalent worldwide and is considered to be the customary form of banking system.


 You will note from this definition that banks do *not* lend out more than they have on *deposit*, but they do lend out more than they have on *reserve*.

Of course with an inter bank market some banks' deposits are made up of net interbank borrowing, and as we have seen it is thus very possible for a particular bank to lend out more than its *retail* deposits. Overall, this is not possible.

So in summary, Ireland's problem stems not from *Fractional Reserve Banking* but from being over borrowed on the inter bank markets.


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## PostTiger (21 Oct 2008)

Thanks Extopia.


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