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Flow of Money - Payment System

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How the Domestic & International payment system works. Revised from original version. *Challenge Question:* 1) Is it possible for banks to "lend out" reserves? *Terms:* Fedwire - a wire transfer service offered by the US Federal Reserve that debits and credits member bank accounts. Clearinghouse Interbank Payments System (CHIPS) - a private clearinghouse that accumulates daily transactions from member banks and settles at the end of 24 Hours. As much as 95% of all dollar transaction use the CHIPS service, this includes international transactions also. Society for Worldwide Interbank Financial Telecommunication (SWIFT) - A private company headquartered in Belgium. SWIFT maintains a network of international wire transfer protocols. Most international wire transfer communication occurs in the SWIFT format.
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Text Comments (50)
SCIFIaction (2 months ago)
wow thank you... hard to find a good explainer for this
joe bongiovanni (4 months ago)
Wayne, Enjoyed finding your comments, your site and your vids. Please be in touch. joebhed ATT verizon DOT net joe B
Ray Adams (6 months ago)
Well done! Thank You.
Frost qwerty (7 months ago)
Hello Wayne. I was wondering, can banks create a loan in other currencies(while they don't have it in its reserves). I am from the country where is the foreign currency reserves deficit, and no one can exchange their money to foreign currencies. Because there is no foreign currency in reserves of banks(As i know). So I was wondering can our banks create a loan which is, for example, is denominated in USD? If it can, I think also can send this money (USD) to another country by using correspondents account in foreign countries bank(by just debiting my deposit and credit this amount to correspondents account of a foreign bank which is held in my bank. Am I right or wrong in my thoughts? Could you please explain me about this? And also thanks for your great videos!
beterhans (8 months ago)
This is the best video that make me understand payment system
Clayton Fry (8 months ago)
Great videos! I'm wondering if there is a good textbook that you could recommend for additional information regarding these topics. thanks!
Wayne Vernon (8 months ago)
Hey Clayton, Im glad you enjoyed the video :) For introductory macroeconomics textbook try: Blanchard / Fischer “Lectures on Macroeconomics” Or Krugman / Wells “Macroeconomics” If you interested in modeling try: De la Fuente “Mathematical Methods and Models for Economists” For statistics: Hogg / Craig “Introduction to Mathematical Statistics” For some less formal reading: Keen “Debunking Economics” Fox “The Myth of the Rational Market” Mosler “the Seven Deadly Innocent Frauds of Economic Policy” Thanks for watching! -Wayne
Kc12345 (9 months ago)
Thanks ,this is good stuff, I am just curious, in the case of international clearing, does ICBC summarize multiple transactions into one at the end of the day to get cleared in the US or each transaction get cleared individually? If a person has two US dollar accounts in beijing with ICBC and another Chinese bank say CCB and he made a USD transfer of 1M, does it have to go through the US for clearing?
Wayne Vernon (9 months ago)
Hi Kc, International Banks operate in a very similar fashion to domestic banks, so yes, they accumulate transactions in the CHIPS system before clearing . Some international banks will hold deposits at a domestic correspondence bank, so instead of dealing directly with US Reserves they use an intermediary to clear transactions. In this case, the foreign bank's private deposits are instantly credited/debited, unless they have a special arrangement with the domestic bank (which is often the case). Do foreign banks use US clearing systems to exchange US dollars? Yes, whenever US dollar reserves are transferred between banks, foreign or domestic, it is recorded on the ledger of the The Federal Reserve. (there may be some marginal exceptions where foreign banks have special arrangements, but these are few). If you want some more material on international clearing, I have a video on foreign exchange that you might enjoy. https://www.youtube.com/watch?v=ghHnZADyRQw&t=2s Thanks for watching! Wayne
Nina Liu (10 months ago)
http://bigpicture.typepad.com/comments/images/m3_110205.jpg M1 hovers below 2 trillion. It might be more now. Who knows. But m2 m3 etc are over 10 trillion. This is money supply that exists well beyond whatever the govt has printed in fiat cash. This extra money is money created out of thin air by private markets.
Wayne Vernon (10 months ago)
Hi Nina, In my opinion, measures like M1, M2 tell us very little because we don't know how that stock of money is being used. If monetary aggregates are entirely held by savers, and dedicated to investment, then you would not see broad-inflation, but may see inflated financial asset prices. On the other hand, if the deposits are being held by consumers, then you _are_ likely to see inflation. The metric I track study the expansion and contraction of the money supply is 'net change in aggregate debt.' I then dis-aggregate the totals by dividing them into three categories, 1) Debt created for productive investment, 2) Debt created for direct consumption, and 3) Debt created to purchase financial assets. Type 1 is the highest quality money creation. Type 2 is fairly neutral, it may or may not cause inflation depending on the business cycle. Type 3 money creation is very dangerous, causes asset price inflation, and should probably be illegal. You're right! Most money is created out of thin air when people make contracts or agreements. All financial assets are created this way. Here is the accounting of an endogenous money transaction, if you're interested. :) https://www.youtube.com/watch?v=vUHsIZRhQQI ...and this one is a similar example, but shows how banks avoid settling in US dollars. https://www.youtube.com/watch?v=2b4oBcD_nQw Cheers!
Nina Liu (10 months ago)
ICBC doesnt hoard us dollars. They hoard us debt. China is America's biggest creditor once again - Aug. 16, 2017money.cnn.com/2017/08/16/investing/china-us-debt-treasuries/index.htmlAug 16, 2017 - China's vast holdings of U.S. government debt jumped $44 billion to $1.15 trillion in June, according to U.S. Treasury Department data. They cant use us dollars and holding onto it would only mean the value of those dollars would continue to drop at an annual rate of 4 percent due to inflation. Instead, they buy american financial assets such as debt. Hoping it will lead to profits from interest rate payments. China doesnt buy us dollars out of thin air however. China gets it from its massive trade surplus from americans. Otherwise. Every dollar the Chinese received in exchange for Yuan would mean an equal amount of Yuan would be received by americans. And in reality. americans have no reserves because they only post trade deficits.
Wayne Vernon (10 months ago)
*_"ICBC doesnt hoard us dollars. They hoard us debt. "_* Domestic banks and the Central Bank of China hold both US Treasuries and US Reserves. Private banks hold enough US reserves to clear dollar denominated transactions, and convert the rest to US Treasuries, or sell them to the Central Bank. The Chinese central bank determines its ratio of Reserves to Treasuries by maintaining a peg in exchange markets with the US Dollar...if the Yuan is strengthening too much, they will buy US Treasuries, dumping dollars in forex. If the Yuan is weakening too much, they will sell US Treasuries, effectively removing US Dollars from forex. *_"They cant use us dollars"_* Yes, they can, just like American banks can use Yuan to settle Yuan denominated transactions. It is true that a lot of dollar denominated foreign savings ends up purchasing US financial assets, but a large portion of foreign dollar holdings are also used to settle international transactions. Consider the role of the US dollar as the global reserve currency...countries can spend their US Dollar reserves to purchase goods and services from nearly any country on the planet...no other currency has such utility. The role as reserve currency also nearly guarantees that countries will run a trade surplus against us...it is the only way for foreign countries to acquire net dollar savings (without devaluing their currency). Indeed, if the US began to run consistent trade surpluses against foreign nations, the Dollar would likely decline as a reserve currency. Thanks for the comments! :)
Tarun Juneja (1 year ago)
nice explanation of payment system..Can you please explain this in term of nostro vostro relationship.
Wayne Vernon (1 year ago)
Hmm, i've only heard those terms a few times, but sure, i'll explain. A common point of confusion when talking about "money" comes from changes in language that occur when speaking from different points of view. If I am a bank, a deposit belongs to the "them" [the customer], if I am the customer, the deposit belongs to "me". In this case, the pronouns "them" and "me" are describing the same entity, the customer. Sometimes accountants will use the terms "Nostro" and "Vostro" to help eliminate the confusion. If i understand correctly, a "Nostro" account will appear as an asset on the balance sheet of the entity. A "Vostro" account will appear on the liability side of the balance sheet. Examples of Nostro and Vostro: BANK DEPOSITS... ...are a Vostro account of the bank. ...are a Nostro account of the depositor. BANK RESERVES... ...are a Vostro account of the Central Bank. ...are a Nostro account of the Private Bank. And, if you want to stretch the meaning a bit further... FEDERAL FUNDS LOAN... ...is a Vostro account of the borrowing bank. ...is a Nostro account of the lending bank. Disclaimer: These are not terms I use on a regular basis, so there may be nuance or context I am missing. Banks often use the terms when describing deposits they have with other banks, but this video doesn't specifically deal with banks having deposits in other banks (except for the central bank). I do have an example of a international correspondence bank in my foreign exchange video...it is the third example: youtube.com/watch?v=ghHnZADyRQw Hope this helps, thanks for watching! :)
David Juarez (1 year ago)
BUY BITCOIN
amit kumar (1 year ago)
Brilliant .
Andriy Betsa (1 year ago)
Thanks. Great explanation
mynamegoeshere (1 year ago)
ahh SPEAK UP. can't hear you! but nice video..
Anurag Mankar (2 years ago)
Amazing way of explaining. You nailed it! Thanks for such a brilliant video book.
Jeremy Bennett (2 years ago)
Good stuff
RGV (2 years ago)
"US dollar as international reserve" In your example of the $100 purchase in which moment does that transaction affects the exchange rate of both currencies? You said ICBC has 2 options to clear that transaction, one being to sell the U$100 in the Forex market to get Yuan (in this moment it would affect the exchange rate, right?), second option would be ICBC New York to transfer those $100 to the China central bank account in the FED and the China Central bank to pay the ICBC branch in China with Yuan. In this case I don't see how the exchange rates should be affected since the Chinese (or any country`s) central bank in this scenario would have to create new money to make that payment (meaning the Yuans wouldn`t be bought with dollars in any currency market), no?
Nina Liu (10 months ago)
ICBC doesnt hoard us dollars. They hoard us debt. China is America's biggest creditor once again - Aug. 16, 2017money.cnn.com/2017/08/16/investing/china-us-debt-treasuries/index.htmlAug 16, 2017 - China's vast holdings of U.S. government debt jumped $44 billion to $1.15 trillion in June, according to U.S. Treasury Department data. They cant use us dollars and holding onto it would only mean the value of those dollars would continue to drop at an annual rate of 4 percent due to inflation. Instead, they buy american financial assets such as debt. Hoping it will lead to profits from interest rate payments.
žiga Mahne (1 year ago)
By hoarding dollar reserves you mean that they make demand for dollars that is pushing the price of dollar up?Because if they were selling those dollars then the supply will be greater than demand but because everbody is trying to buy dollars it means that there are not enough dollars inthe forex market to satisfy demand.
žiga Mahne (1 year ago)
If PBOC gets 100$ in US Dollar Reserves so will the Reserves(china) on the balance sheet of the FEd get credited with 100$?
žiga Mahne (1 year ago)
But US Reserves in PBOC bank are matched with those on the FED balance sheet Reserves(China) right?
Wayne Vernon (1 year ago)
+žiga Mahne Here are some examples of foreign exchange transactions. ;) https://www.youtube.com/watch?v=ghHnZADyRQw&t=2s
RGV (2 years ago)
So when a foreigner Government announces the country currently holds U$ X billions in international reserves in USD, it means the sum of its centrall bank reserves in dollars PLUS the reserves of the banks of that country in dollars in their accounts in the FED? If a country (that not the US) runs out of these international reserves how can they keep importing?
RGV (2 years ago)
"Dollars never leave the United States". How countries like Ecuador (which has the US Dollar as its official currency) get dollars to run their economies?
žiga Mahne (1 year ago)
That is also the case with Montenegro the former Yugoslav republic they use Euro but they are not in the Euro area.
Wayne Vernon (2 years ago)
+RGV _" I assume when you mentioned "dollars never leave the United States" you meant eletronic dollars correct?"_ Yes, electronic dollars, which accounts for 97%+ of dollar transactions. However, because US dollars are a popular savings vehicle, it is not uncommon for entities to ship _physical_ dollars out of the US. In the case of Ecuador, their central bank literally went to the Federal Reserves and withdrew the physical cash notes and shipped them back home. There are great risks associated with transporting physical dollars, but it does happen. Saddam Hussein had stashed away over a billion physical US Dollars, for security...ironic! Ecuador, and a few others are unique because they circulate physical US Dollars...Not a bad idea if the local currency is struggling, although Ecuador basically gave up sovereignty over their currency, which can be good or bad, depending. =P But yes, you are correct, physical notes do get exchanged internationally, but they are a very small part. =)
Wayne Vernon (2 years ago)
+RGV _" I assume when you mentioned "dollars never leave the United States" you meant eletronic dollars correct?"_ Yes, electronic dollars, which accounts for 97%+ of dollar transactions. However, because US dollars are a popular savings vehicle, it is not uncommon for entities to ship _physical_ dollars out of the US. In the case of Ecuador, their central bank literally went to the Federal Reserves and withdrew the physical cash notes and shipped them back home. There are great risks associated with transporting physical dollars, but it does happen. Saddam Hussein had stashed away over a billion physical US Dollars, for security...ironic! Ecuador, and a few others are unique because they circulate physical US Dollars...Not a bad idea if the local currency is struggling, although Ecuador basically gave up sovereignty over their currency, which can be good or bad, depending. =P But yes, you are correct, physical notes do get exchanged internationally, but they are a very small part. =)
RGV (2 years ago)
Hey Wayne, I have been still trying to figure this out but haven't found much about how it works for countries with USD as their official currency. I have only found an article in Russian explaning how cash dollars enter Russia to cover the demand for cash dollars (most Russians save in dollars). The article basicaly says that russian banks transfer eletronic dollars to american banks such as Citibank and Banks of America (I believe they are talking about reserves in their FED accounts according to your class), the american bank takes a percentage up to 2% for their service and then send the cash dollars to russia in airplanes (U$250 million in each airplane maximum due to insurange limitations). The article says in March 2015 (Crimea crises period) this flow reached U$5 billion a DAY (20 airplanes)! So I assume when you mentioned "dollars never leave the United States" you meant eletronic dollars correct? Any guess of how it works for countries who have as USD as their official currency? Ecuador has a negative balance of trade, and their interest rate is 9.15%. How do they manage to get dollars in order to be able to spend more than collected in taxes and to pay interest? By making loan in foreigner markets and increasing their international debt?
RGV (2 years ago)
Why is the Belgium company required, or the swift transaction required between New York and Beijin branches if they are the same bank? Why don`t they keep it as an internal transaction only like it happens when 2 clients of the same bank send money to each other (as shown in the first example of the video). Why when the transfer is international these third party is required? Sorry for so many questions, please take your time :P
Wayne Vernon (2 years ago)
+RGV _"Why is the Belgium company required, or the swift transaction required"_ The Society for Worldwide Interbank Financial Telecommunication maintains standard universal protocols and security that is trusted by banks everywhere. Technically, they don't _have_ to use SWIFT, but other banks would not likely do business with you. Basically, it is a trusted network, not a bank or clearinghouse.   Happy to answer questions! =)
RGV (2 years ago)
Question about the transaction that happens at 13:25. If the international trade is all compensated in the Federal Reserve only, how does trade deficit affects the exchange rates if the dollars don`t ever really enter or leave the foreigner countries?
Wayne Vernon (1 year ago)
+žiga Mahne Yeah, the strong US Dollar is damaging developing countries in the same way that the gold standard damaged economies during the Great Depression. The world abandoned gold during the 1930s because there wasn't enough it, they might do the same to the US dollar. ;) The Eurozone has special problems because there is a disconnect between fiscal and monetary policy - you have one central bank, and 19 treasuries - this creates big problems when one member runs a surplus against another (e.g. Greece & Germany). =/ Thanks for watching! =)
žiga Mahne (1 year ago)
Yes i would also agree on that theory because it is hard to find out what is causing so much problems in developed countries.It is simply not working here in the EU where I live the economy.I think that also euro is part of that problem because it is also high against other currencies.But here in the EU is more the thing of huge debt in countries.You actually answered to my question in the next question of RGV but how does trade deficits affect exchange rates I mean that you said never use them again but that is also the same thing as China that is holding these reserves and not use them.
Wayne Vernon (2 years ago)
+RGV  Even though the dollars are in an account at The Fed, doesn't mean they are being used in the American economy - they are controlled by a foreign entity just like you control your bank deposits. Hypothetically, the foreign bank could just sit on the dollars and never use them again - this is the digital equivalent of mattress-stuffing. =P The US Dollar acts strangely in exchange markets because there is such a huge demand. Our Treasury is recirculating our [huge] trade deficit at near zero percent, and the entire world is still screaming for more dollars. I have a working theory that global deflationary trends in developed economies, and inflationary trends in developing economies is all caused by a massive dollar shortage. This is shown in the rising exchange rate of the dollar, and collapsing dollar denominated commodity prices (oil, gas, etc.).
RGV (2 years ago)
Wayne, how would the transaction mentioned at 12:20 take place? If the Chinese branch of ICBC decides to get its Yuans at the China central bank, would the China central bank get credited by $100 in the Federal Reserve and then increase ICBC reserves by 600 Yuans? Would these 600 Yuans be brand new money created?
Nina Liu (10 months ago)
If China needed Yuan. They dont need to go to a forex market. Since all Yuan originates from China. https://www.youtube.com/watch?v=xsMif5ClbRM&t=16s When a govt needs money. They will simply print it out of thin air.
Nina Liu (10 months ago)
This is how they retain the debtor creditor relationship. China is America's biggest creditor once again - Aug. 16, 2017money.cnn.com/2017/08/16/investing/china-us-debt-treasuries/index.htmlAug 16, 2017 - China's vast holdings of U.S. government debt jumped $44 billion to $1.15 trillion in June, according to U.S. Treasury Department data. They cant use us dollars and holding onto it would only mean the value of those dollars would continue to drop at an annual rate of 4 percent due to inflation. Instead, they buy american financial assets such as debt. Hoping it will lead to profits from interest rate payments.
Wayne Vernon (2 years ago)
+RGV ICBC New York would be transferring $100 to the Chinese Central Bank, who is now holding the US reserves. This transaction eliminates the accounts payable to ICBC Beijing - ICBC New York is back in its original position. Next, The Chinese Central Bank credits the yuan reserve account of ICBC Beijing with _new_ yuan, which eliminates the accounts receivable entry (swaps it for reserves). Not every Central Bank will exchange currency for banks, and this type of thing is frowned on - it is overt currency manipulation. Normally, if ICBC Beijing needed the Yuan, they would need to find another bank who needed dollars, in a forex market. Currencies are suppose to _float_ against eachother in the open forex market. Exchanging dollars for new printed Yuan is how The Chinese central bank maintains their _peg_ with the US dollar.
RGV (2 years ago)
Excellent, as usual!
Wayne Vernon (2 years ago)
0:23 Review of Balance Sheets. 2:02 Single Bank Transaction. 2:51 Bank Deposits settle most transactions. 3:39 Federal Reserve Balance Sheet. 4:56 Two-Bank Transaction with Federal Reserve. 7:05 Fedwire. 7:30 Clearinghouse Interbank Payment System (CHIPS). 9:01 International Transaction. 12:39 Dollar as the Reserve Currency.
Wayne Vernon (2 years ago)
*CHALLENGE QUESTION:* 1) Is it possible for banks to _"lend out"_ reserves?
Frost qwerty (8 months ago)
no, banks do not lend out reserves to customers. but they can lend them to other banks. I hope my answer is correct :)

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