Where Do Banks Get Their Money? Fractional Reserve Banking

Do Banks Create New Money out of Thin Air?

**Re-posted after the events of the credit crunch and 700 bailout packages, enjoy the read and learn how the banks got themselves in this mess.**

Here’s the story. Banks keep on lending money, but where do they get it from? Do they borrow from bigger banks who borrow from bigger banks who borrow from the central bank who then prints the money? Is it as simple as just printing more money?

Turns out money creation sometimes appears out of thin air. All banks lend based on a reserve ratio of their deposit: they must keep a certain % of each deposit at the bank but can lend out the rest. Of course, the whole system is dependent on a) the bank being responsible with lending, b) everyone not defaulting on their loans. If these two things happen eventually the system faces massive losses which is what we’re seeing in the current market.

Let’s observe a fictitious situation to help us understand how the bank gets or ‘creates’ their money. Note: when the term ‘bank’ is used in this article it will refer to your bank and not the central bank (Federal Reserve for the US.)


Let’s build a scenario where there is on bank called National Bank (operating as a monopoly). Suppose a person in another country sends $1000 and they deposit it into the bank. This becomes a NEW deposit for the bank (a PRIMARY deposit).

BANK:

Assets

Liabilities

Cash +1000

Demand Deposit +1000

(Primary Deposit)

(Increase in money supply (Ms))

At this point there is no change in the Ms (money supply), only the composition of it. M1 outside bank to M1 in demand deposits.

The bank will now: A) Keep a little in reserve to meet cash demands, B) Lend the rest out to worthy borrowers.

Let’s assume the Bank has a desired target reserve ratio of .15 (15%) to cover customer cash demands (when you go to the bank and withdraw cash). For $1000 they will keep $150 and lend out $850.

When someone borrows the $850, eventually it will reach the bank again (unless they put it underneath their mattress). Remember we are in a one bank scenario (monopoly).
Bank Now Has:

Assets

Liabilities

Cash +1000

Demand Deposit +1000

Loan +850

850

Total $1850

Total $1850

The total Ms is now $1850.

The Bank holds 15% of 1850 in reserve & lends the rest out. This process repeats itself indefinitely until they can no longer lend out money. This whole concept is called: DEPOSIT CREATION MULTIPLIER.

A quick way to determine the theoretical maximum a bank can lend out is this formula:

New Deposit / Target Reserve Ratio =

ex. $1000 / .15 = $6666.67 in new deposits (Ms increases by this much as well).

The theoretical maximum of course depends on whether the target reserve ratio is correct. Some things that affect the max include: a) number of worthwhile borrowers, b) no currency drain, c) no precautionary balances, d) no clearing drain.

Here are some additional items that may affect how much money the bank can create.

Deposit Creation Multiplier (Modifications)

Base case –> $1000 / .15 = $6,666.67

1) Suppose a 5% currency drain = money supply will only expand to $1000 / .15 + 0.05 = $1000/ .20 = $5000

– Final position of bank –
Assets Liabilities
Cash $750 Deposits $5000
Loans $4250

2) Suppose the banks decide to hold additional precautionary balances of 5%
Ms only expand to = $1000/ .15 + .05 + .05 = $4000

3) Suppose banks have foreign currency deposits and choose to hold additional reserves of .02 (2%)

Ms will (only expand to): $1000 / .15 + .05 + .05 + .02 = $3, 703.70

These are simplistic examples of how banks create money using the scenario of a single Bank acting as a monopoly in the banking industry. It may seem like money is created out of thin air but that’s not exactly the case because behind every loan is an asset. Huge trouble develops when the asset becomes worthless (many homes); someone needs to face all the losses.

Also, this does not highlight how the Federal Reserve creates money, they can actually print more money but, again, it’s not out of ‘thin air’, it’s based on the debt created by a debt note usually in the form of a government bond.

Related deposit creation multiplier equations:

TD = ID / crr

Where: TD=change in Total Deposits ID=Initial change in Deposit ccr=cash reserve ratio

 

?R / ?D = r
or
?D = 1 / r × ?R

Where r = the required reserve ratio. This formula tells us how much deposits increase by the multiple   1 / r  > 1 : Since r < 1, 1 / r > 1

1 / r = simple deposit multiplier. When the central bank supplies the system with an addition $1 in reserves, deposits increase by the multiple $(1/r) > $1.

 

Read another related article to money and banking located here.

101 thoughts on “Where Do Banks Get Their Money? Fractional Reserve Banking

  1. This is a very interesting concept, I’ll use this info to figure out how much $ my employer makes.

  2. Webmaster

    What does your employer do? Loan shark?

  3. No, my employer is a bank but I can’t reveal the name of it because of confidentiality reasons.

  4. cece

    It was either loan shark or bank 😛

  5. Joe

    I have tried to follow your explanation using your example of the one-bank monopoly and am a bit lost. The bank lends the $850, with the money deducted from cash on hand. The person then returns and deposits the money with the same bank, with the resulting balance sheet looking like this:

    Assets: Cash-$1,000 (leftover $150 from out-of-country deposit after loan was made plus $850 deposited by same individual), Loans-$850 (made to individual) TOTAL ASSETS: $1,850

    Liabilities Deposits-$1,850 ($1,000 out-of-country deposit plus $850 deposit from person who obtained the loan)

    However, no new money (cash) has been created. The situation you describe basically has people taking money from the bank and putting it right back in. The balance sheet grows as the amount of loans and deposits rise, but the amount of cash in the system remains the same. Assuming no interest, all subsequent loans and deposits will cancel each other out, leaving you with the original deposit of $1000. Please explain further.

    1. What is missing is the obvious truth that banks DO create money out of thin air. This money is created as debt but don’t expect anyone at the bank to admit it.

  6. Webmaster

    There is an assumption that people won’t demand all their money at the same time (clearing drain) so there’s no danger of having Ms will (only expand to): $1000 / .15 + .05 + .05 + .02 = $3, 703.70 being demanded all at once.

    When money borrowed eventually it makes its way back to the bank then they can lend it out again–assuming that their customers won’t come back and ask for it. It’s a theoretical example to show how far banks can go.

  7. Dorky

    What about Bank A make money by borrowing from Bank B at 1% interest, with Bank A providing 20% of the loan amount as collateral? Say the loan is $100k. Then Bank A lend out all the $100k with interest at 2%. The return will be $2k. Out of $2k, Bank A will pay back $100k + $1k (interest) to Bank B, keeping the other $1k for itself. Since Bank A only spend 20K (collateral to secure the loan) and get $1k return, it actually make 5% return ($1k out of $20k). Webmaster, do you think this tactic is possible.

  8. Bob

    Are we to believe that Banks lend our deposits? I have never seen a Bank ledger Card/Account with a deposit that is then lent to a borrower!! One would suggest it appears fiction ….a Bank lend Deposits. The illusion that a Bank makes only a margin on the difference of the Interest it pays the Depositor & the amount it charges the borrower…. is what it is…..an illusion….if you will …an amazing sleight of hand supported by those who profit by the trickery….which in turn appears supported by legal fiction.(Admiralty Law)

    It is interesting to note explanations of how credit is created. Having scoured many docs & books etc on the subject one comes to the conclusion that the Leaders of Banks, Govenors & Secretaries of Banks……from many parts of the world……have made it so clear in so many of those enquiries & their writings & quotes….the clarity appears lost in the detail of those educating & profitting from the credit creation system. For instance….. in the 1935 Parliament of Tasmania Monetary System: Report of Select Committee many a Leader has been quoted. eg
    Mr.R.G Hawtrey, Assistant-Secretary to the British Treasury, says”When a bank lends, it creates money out of nothing.” Also William Patterson, first Governor of the Bank of England (about 1694 said- “……………(quoted on p15 of the Report) The Bank hath benefit of the interest of whatever credit issued out of nothing.” It is also interesting to note that Beaumont Pearce, Chairman of Lloyds Bank, who said in Melbourne on 13/11/1934 & shown in the National Bank (NAB) Monthly Summary for December 1934 that “NO CAPITAL IS NECCESSARY TO START A BANK” There a many other Parliament Reports showing Banks create money out of thin air & the river of interest flowing back to them (sweat interest) is mind boggling….& the interest & fees they charge appears to be is crippling humanity. One has to only read Prof Joseph Stiglitz’s books & writings freely available on the web to dig deeper into the “System” So we have to come to the conclusion that money is created out of thin air & the System is not good for the people & stifles them…..of course after reading Prof Stiglitz & the Tasmanian Reports & many other books written by famous Legal minds & Bankers you may have a different view……..I think not

  9. barry econ

    Dorky, I’m not sure about your question. Remember the above example is merely theoretical.

    Nice post Bob. Money isn’t created out of thin air but in itself is worthless. It has a perceived value and will lose that value if the people/investors loose confidence in it. Banks DO in fact lend out your savings, where else do they get the money? The whole sub prime mortgage problem is rooted in banks losing their investments because people default on loans.

    There is also an assumption that everyone won’t withdraw money all at once, so banks will always have X amount of money on hand to support cash demands.

  10. Bob

    Thanks for that Barry…….you say money…..as in borrowing money…..is not created out of thin air……then Mr Hawtrey in my posting above is not correct & the 1st Governor of the privately owned bank The Bank of England was pulling our leg or telling lies??? The 1st Gov of the Bank of England also said” The Bank hath benefit of the Interest of whatever credit it issues out of nothing” We don’t think he got it wrong. The Federal Reserve System relies upon in…..credit created (money) out of thin air. The Bankers want the public to think that Deposits are lent & they….the Banks make a margin(profit). They could not run a business on that small amount of margin……this myth of margin has been exposed by many a noted Banker. Why even the former Governor of the privately owned bank (like the fed in USA) Reserve Bank of Australia said in the E.S.& A Bank Research Address at Queensland university on 15the September 1954 ” Any given piece of expenditure can be financed from one of 4 sources: 1,2,3,&
    4. money borrowed from a bank. This last source differs from the 1st three because when the money is lent by a bank it passes into the hands of the person who borrows it without anybody having less. Whenever a bank lends money there is, therefore ,an increase an increase in the total amount of money available”
    R G Hawtrey, of the British Treasury, in the “Art of Control Banking,” says:
    When a bank lends, it creates credit. Against advance which it enters amongst its assets, there is a deposit entered in its liabilities. But other lenders have not this mystical power of creating the means of payment out of nothing. What they lend must be money that they have acquired through their economic activities.”
    Even Sir Josiah Stamp, Director of the Bank of England,1928-41, said…….” The modern banking system manufacturers money out of nothing. The process is perhaps the most astounding piece of sleight of hand ever created. Banking was conceived an iniquity & born in sin. Bankers own the earth……..etc etc etc.
    We don’t think he was telling lies….he was speaking from a position of power & knowledge…maybe some things are bypassed & not the done thing in universities when it comes to banking ……..it to appears students have to follow the dogma required to pass….albeit not the reality….but the line of thinking to perpetuate the blinkered thought patterns required to keep the Wizards of Oz alive & in power.

    The Banks maybe lends the deposits of the depositors….may as well….but please note Government statistic bureaus have shown that in Australia……. 1 year banks lent out 78 times their deposits & another year 48 times their deposits…..What the!! The river of interest flowing back to the banks per hour is unbelievable. And don’t forget all the trumped up fees & charges…another river of money flowing back to the banks.

    Maybe the Bible should be adhered to by folk …Exodus 22.25……be an interesting & we suspect……an uncomfortable debate to discuss that passage for millions of faithfull who work & profit by the western banking system. In any event interest it most certainly fuels inflation… another sin of the system. However the brainwashing continues it seems…..& there are certainly plenty of folk ignorant of how the banking system works in their country & globally who will defend it …..blindly……(& fair enough ….the propagand is very good)…..without opening up their minds & exploring to understand the money system.

  11. OLiver zoum

    How can I create a SMALL bank in US or cash advance? how can I start and were can I get monoey? can sameone help me

  12. ThinkLogical

    Let’s try to focus on the question.

    Assume the following:

    There is a Bank ABXY in a small town with no money. You arrive with $100 of cash in your pocket. You bring $100 in cash to Bank ABXY. The bank keeps $10 of cash in the vault as reserves. The bank lends $90 in cash to Person 22, who uses it to pay Person 33 for some service (e.g. painting a house). Person 33 deposits the $90 of cash in Bank ABXY. The bank keeps an additional $9 of cash in the vault as reserves. The bank advertises that it has $81 available for lending.

    Now the question:

    At the beginning, there was no money.
    Then you arrived, and there was $100 of money (all of it in your pocket).
    After a while there was $190 of money (two deposit accounts in Bank ABXY).

    Money is not only cash, it includes bank balances.
    Banks can create money. Bank ABXY created $90.

  13. barry econ

    You all have to remember that on the balance sheet the bank still only has 1000 assets and 1000 liabilities. See Wiki for an example of that.

  14. gerald

    how can a bank increase it deposit

  15. Bob

    Good post THinklLogicol,

    However according to statistics Bureaus Banks in Aust lent out lots more that 9 times their deposits….try say 78 times etc. etc. that sure means a hell of a lot of income from the artificial high interest rates ….in Aust over he last 20 years! Seems the population are being cooked slowly…….and its legal? Of course the fees & charges….in my opinion & many others…. are outrageous & considered legalised rip off in Australia. Of course the high interest rates …….. in my opinion….are a scam as well. However the people are waking up.

  16. barry econ

    Banks don’t create everything though. Remember, that the asset versus liability position still remains 100 assets and 100 liabilities.

  17. tern

    Money is “destroyed” when bank loans are repaid.

    But what happens to the money when the loan is defaulted on? The loaned money stays in circulation.

    The lending bank records a loss and possibly reduces its lending.
    But no money is “destroyed” in this process. Correct?

  18. barry econ

    No not really, from my understanding money is not ‘destroyed’. Remember that assets and liabilities remain the same. If there is a default, then the bank must find a way to bring that money off its books as a liability. If everyone defaults then the system would collapse.

  19. Bob

    A simple format for lending is as follows……

    When a Bank lends money it can create a debt in the borrowers name…..& credits an account in its own Bank or eslewhere…..or a cheque is written out by the borrower…..paid into payees Bank ….crediting the payees account & the cheque is exchanged by the Bankers & the cheque ends up back at the borrowers Bank creating the new loan account/debt. Thus the debt is created & the new funds are deposited in the payees Bank . New funds have been created without any Banker,Shareholder or depositor short of funds.

    Good sleight of hand. The liabilities & asset thing…..sleight of hand. So you see Banks can lend out funds to there hearts content( if there are parameters they certainly seem to blow it)….or find ways of doing it…& not use prudent lending principles….lend funds to thier subsidiaries of subsidiaries….10 times removed which have no scruples. This is apparent through the history of Banking & appears to more so since 1694. See posting above.

    All the gobbly gook can not change the simple fact……. heads of Banks have given us their words….they have spoken…. that Banks create money out of thin air….. ensuring the river of interest flowing back along with the creative charges & fees would have to lead to unbelievable riches….would it not?

    Sir Josiah Stamp, Director of the Bank of England,1928-41, said…….” The modern banking system manufacturers money out of nothing. The process is perhaps the most astounding piece of sleight of hand ever created. Banking was conceived an iniquity & born in sin. Bankers own the earth……..etc etc etc.

    ceative accounting ensures assets = liablities

  20. JohnD

    My understading is that money does not get destroyed when a loan is repaid. Sure, money is created out of thin air so to speak by banks but as it gets repaid the banks keep that money as well as the interest. My source for this is the fabulous book called “the grip of death” by michael rowbotham. I know that in the video “money as debt” by paul grignon he says that money disapears when a loan is repaid but the book “the grip of death” does not agree with this point. (see page 28 section:the ownership of money) This book is NOT a light read but thorough study will perhaps turn your beliefs on the world financial system on its head. I believe now that the financial systems of the world are the chief evil in the world and the forces that are driving wars, starvaton and environmental disasters.

  21. Bob

    I agree with you JohnD on the matter of financial sytems beign the chief evil in the world driving wars, starvation & envirmental disasters. One only has to read the whistle blowers expose ….e.g. Prof Joseph Stiglitz or John Perkins (Confessions of an Economic Hitman) to get a feel
    from their experiences……the lack of humanity in the systems are evil…..one has to ask “Why are they accepted by Countries?” As John Perkins suggested…it could be to do with Govt Dept Heads, Politicians & health…..it is not healthy to oppose?? There have been many other Books exposing the underbelly of the West’s Banking system & 1 I author am aware of left his country for some time as he was afraid of the consequences…….Politicians & money lenders did not like what he exposed & the remedies he suggested. One could form the opinion that these forces will protect their position as if in a war (no rules)……their house of cards depends on it.

  22. Bob

    It now appears that the Western Banking/monetary system….. house of cards has been exposed…….for what it is. Even some economic commentators interviewed on major TV programs mention corruption & lies & fiat/thin air money…& expect criminal charges to be laid in the USA. Interesting times. The Political leaders appear to have pandered to the money changers for far too long…..& guess who laughs all the way to the Bank!

  23. barry econ

    Regardless of what you may say the money creation ideas are crucial to the development of economies. You just need that one aspect–responsibility. If you over lend you’re going to get screwed. You see now before you what happens when you overlend and everyone defaults. The bank goes bankrupt and you see the government finding ways to dump cash into the market.

  24. Bob

    Seems Politiicians love to let the Foxes run the hen houses. Or is it the case of if you don’t let us have control we concerned for your health??? aka John Perkins book expose”Confessions of an Economic Hitman” Regardless of what learned ones say in brainwashed opinions & who sail in the ocean of boundless cash…there are alternatives to allowing Banks to create thin air money.
    …..but it is not taught in Uni’s it appears (to the changrin of the odd leading Banker & Statesmen & some of those men spoke out & some became no more) ……so we have a certain mind set…..bit like children brought up to believe their parents religious beliefs are the only way. All not normal …..according to folk who deal in healing a brainwashed mind.

    Trillions of dollars has power…one could suspect.

    The cycle of over lending is never ending. It goes around & around. They (the lenders) seem to lend stupidly (& to folk who will default due to not using prudent lending principles on these dudes situations) for a time then the poo hits the fan…..bad risks can’t pay back . Banks scale right back lending & cause the ecomy to falter…..not enough money going back into the economy to pay the river of interest……more defaults……..head to another recession/depression. Of course lack of regulation by Govt’s does not help. The Foxes & their predator mates love to play & get fatter which ever way things go. It’s the game & the public suffer again. Yes……there has to be accountability now & ongoing scrutiny of the Foxes & their leech mates who profit in all sorts of ways by the game. Wonder which Government has the gonads to bring in stingent controls. Do we hear the Foxes squeeling & flexing their muscles??? Which Government Leader has the gonads to tackle the Foxes???? Seems in South America there is a move….interesting times. Guess we have to read between the lines as John Perkins words hit home.

  25. barry econ

    To conclude that all banks overlend and are greedy is an over statement although from the outside they look like piggies (fat ones).

    this is one of the reasons why the US govt should let banks who overlent to go broke (but pay back the creditors first!). The system will remain, tougher rules on borrowing are ths things needed now.

  26. How do the CDO’s work. If the gov’t takes them off the banks books, will the banks look like they have lost a great deal of assets. Does the share price look cheap or expensive at that point.

    Also if the government is buying up all these assets because they have failed to provide liquidy to the market, why is no saying that they are going to make the buying and selling of these types of assets illegal. Is the because the governments wants to try and sell them back to the banks at a another time. That said, how long before we need a buy out for that.

    Interesting article about the senate vote http://www.whybanksfail.com/?p=197

  27. Dave

    My question is in regard to the system of US Govt borrowing from the Fed and securitization of those notes. When the Fed sells US debt securities, is the payable in the foreign currency or US dollars or some neutral currency (gold?) If foreign currency, does that mean a weaker dollar effectively increases the debt? If US dollars, does that mean the security is worth less to the foreign investor?

    Thanks,
    Dave

  28. Steve

    Guy’s, Guy;s. We can all ramble on about this into the next centery, but the thing is, Banks/lender’s off all sorts, not only get there moneys from us/norm on the street, but also from reserve banks/goverments that litery print the stuff/money. The only way the man on the street can get a win is to have a instertute simular to nonprophit super fund or nonprophit orgenizations {most of witch are gov garenteed anyway} that siqures {not banks} your well erned income {there for has a real sause of capital, not just plucked out of thin air}. That can lend back only to it’s members {not investors or buisnesses} for non profit things sutch as buying a house or car, normal house items Ect Ect. Just think how cheap a house would cost if you borrowed from your own, non prophet fund. Ofcause the deposit/amount in your account would have to be a large percentage of the item/items perchasted. Say 75% with a cap on that, compairable to your income. To easy. Then the banks & big buisness can all go to …… were ever.
    Nice dream Ha.

  29. barry econ

    Dave, local Tbills in local currency. There is a correlation between T-bill demand and the demand for dollar if everyone wants Tbills.

    Steve, the govt just doesn`t ‘print’ money, they have to pull it from somewhere. Printing 700 billion notes and giving it all would devalue the entire system and drive inflation sky high. They have to make the money somehow or pull it from reserves.

  30. Steve

    Hi Baza
    No, govenments do print money. Just Google the question & you’ll get the true info from gov sits themselves. & Yes it dose cause major inflation, that’s one of the reasions why we are in the sh– we are in.
    But I’m not conserned with the leachers & fat cats of the financil sector, thay have been doing one another over for centerys & will be for ever in the future. I’m just trying to get the average jo to get off there round about & start supporting them selves. & a supa/personal fund only for non profit & personal use for individual members, can work.
    Cheers
    Steve.

  31. meleagrid

    Very thought provoking posts here. We can agree there is no real value in (fiat) money. The system does not make sense in that it outpaces the ability to perpetuate itself. There is really only one solution and that is complete failure or long term depression that should lead to recaliberating monetary systems.

  32. Q. to Bob: Who was the author that had to flee the country: which country and what book did he write?

    Wrt others: bankers seem to know about the money multiplier effect, yet most that I know say that their banks do NOT lend more than they have on deposit….to me this should be an open and shut fact. Does anyone have a source that can unequivocally clear this up?

    We live in a debt-based system.
    http://www.prosperityuk.com/prosperity/prosperity.html

    If a bank has to balance its books then so must an economy.
    Q. How can a debt be repaid with interest if that money to pay the interest
    does not exist? A. It too must be created out of “thin air”. Eventually this “money that does not exist” has to vanish somewhere – and so it does: as a loss in a ledger.

    This is a high stales game of “pass the parcel” or “musical chairs”: the bank or business that get left holding the debt when the music stops vanishes – and with it the money. And in the blink of an eye everything is in balance again, the scarecrow finds his brain, the tinman his heart and we arrive home – just in time to hear the music start again!!

  33. JohnD

    It has become quite an amazing spectacle to see the daily disaster headlines of more and more major banks and financial headlines and news reports. Just when you think things can’t get any worse something new breaks. It has come to completely dominate the news in nearly every country of the world. The terrible repercussions of the flaws in the financial systems of the world will now hopefully, slowly open itself up to more and more people being bothered to learn about this corrupt, fraudulent and despicable banking system that is at the heart of the mess we are now in. It may be though that some good may come out of this coming total crash of the world economic system. It would be good if we could begin the process now of getting the strategy developed for a fair system that can replace the fraudulent banking system. How say you?

    Some thoughts…
    First off there are no experts in economics. Economic experts have totally failed us for too long. We need to get back down to basics and think about the root of the flaws in the present system and what we can possibly replace them with. I do not put myself forward as an expert or that my opinions are correct but I will put forward what I see as the basic flaws in the system and suggest something that might work instead of what we have now.

    1. Flaw 1 is that all money is created as debt and the debt money is temporary hence there is no permanent money supply in any country (except a small % in notes and coin, less than 3% usually)

    2. Flaw 2 is that banks are permitted to create the money supply in economies and effectively control and own the money supply therein. This they charge interest charges on for money that is effectively counterfeit created out of thin air by simply typing the amount into there computer systems. Gosh I wish I had a computer that could magic money like that.

    3. Since there is insufficient money in the system to pay the principal and the interest due to the fact that only the principal is created into the money supply there is a constant pressure cooker effect in every economy to get growth.

    4. The enormous pressures of insufficient money in the system is responsible for nearly all the ugly news of bad things in our world, from wars to environmental decimation of the planet it is all down to the pressure created by the financial system itself.

    How strange it is that most folks have no clue about the root cause of these big problems in the world. The key missing factor in our economies is a permanent supply of money created by governments at zero interest and remaining in existence. Instead of money being temporary it needs to be permanent and not requiring an interest charge just on existence. Money is like a natural social need within all countries and economies to enable the efficient transfer of value. We need to figure out a method of issuing the money by government into society without the need for private banks to create it as interest bearing debt of temporary money. I’d suggest that one way is for all banking (as we know it now) to be nationalized and run by Governments. Money could be created as loans for home mortgages for example at zero interest. Every £ $ or euro that was repaid would reduce the amount owed by that amount. Thus home owners would not pay twice for the property via principal plus interest and the money repaid would add to the permanent money supply of the country. Instead of money being fiat money, this money would be backed by a real world asset that most people would agree has proper value – a house or dwelling. I know many people that hark back to a gold standard but I can’t really see why gold should be singled out as real value as it has little practical use for ordinary people. Governments could also do away with the massive borrowing from the fraudulent financial system each year and the theft of money from citizens via all kinds of taxes to pay principal and interest to banks. Money being used for physical infrastructure could be flagged as money that stays in the economy as permanent money. Money for paying wages or services would not stay in the economy and would be deleted as money came back in as tax. Over a few years using this system tax burdens would decrease steadily. Then there is the issue of where we are at now. Vast numbers of people have profited to excess by this fraudulent system. The vast disparity in wealth of people in society is unjust and inequitable and governments need to figure out how to re-distribute from those ill- gotten gains back into the people.

    These thoughts and ideas are just crude ideas as regards reforms. Of course changing the world financial system is one of the most challenging things to contemplate. Come on guys, free your conciousness and let the ideas flow.

  34. barry econ

    Again, money is not entirely created out of thin air. The assets and the liabilities at the end of the day should remain balanced. The system works so long as assets don’t depreciate (like houses have) and you don’t overlend. Both have happened in the US.

    If everyone wants to get their deposits back (which they haven’t) we’d have a problem. If everyone defaulted on mortgages and the houses aren’t worth much then we have the problem we have now. It really boils down to the issue in a free market economy and that is GREED.

    If you want an economy equivalent of Bolivia then don’t live in a first world nation. Otherwise, this system is necessary in order to spur growth (which is based on investment) which requires lending.

  35. JohnD

    Why do you say money is not entirely created out of thin air Barry? I heard a radio documentary a short while ago about the sub prime crisis which interviewed a person working in the World Bank that said that between 2001 and 2007 the world money supply doubled and they had never seen such a massive growth before. Where do you think that money came from? How was it created do you think? It is an interesting documentary and is available for download if you’re interested? Money is borrowed into existence in the first instance. This borrowing may be people buying holidays or experiences. It may be to fund a wedding. It may be just to survive and buy food and pay interest payments on existing debt. Increasingly I think a key element of current problems is the % of money requiring to be paid to service all the debt from the new money creation process has spawned. Indeed I know that is a significant feature of personal debt that people are drawing cash from credit cards, making minimum payments and using the cash to pay minimum payments on other cards. Of course this is the path to financial ruin but as you see from the rising bankruptcy rates this is a growing problem. It is also true that a good deal of borrowed money does actually buy houses, cars, furniture, business purchases, government purchases so your idea that some of the loaned money is backed by real world valuable assets is correct. How much real world value exists as a % of loaned money can only be guessed at. The central problem though as far as I can see is that NO economy has any permanent money within the country or region – all money has a temporary existence based on debt based money creation via bank credit. Surely this can’t be right. If all the individual, business and government debt was repaid the money supply in that country would disappear. We’d still have all the fine homes and business assets, fine art, government buildings and gold and natural resources. We’d still have all the valuable land and the labour power of millions of population – yet no money would exist to pay for anything. Even though these vast valuable assets had been bought and paid for by honest labour, no money would exist. This is the system we live in. The system of constantly disappearing money where each new generation has to toil again to earn money to pay new loans to banks to buy. Look at a Victorian house in London and ask yourself how many times that same house has been bought and paid for, each time requiring a new bank loan to bring money into the economy to buy something that has been bought and paid for umpteen times. There is a constant focus in standard (broken) economics that all countries need constant growth. You mention it in the last paragraph of your comment Barry. Why do we constantly need growth? Answer is to pay for the extra debt money on the interest of the current money that is loaned into existence. And next year you need more and so on. It is a system that has limits. And we have reached the mathematical end point of that growth that can be supported by the actual real wealth creators within the economies. The people have been maxed out. Drained of any further ability to support this fraudulent system of banks getting more and more of everything – for nothing. You mention Barry countries like Bolivia. All these so called 3rd world countries are kept in this position by the corrupt IMF and World Bank. This is a despicable act of cruelty that is forced on developing nations by the prosperous nations. But that is another story…

  36. barry econ

    If by money creation you mean the gov’t says, “700 billion coming your way” and all they do is print 700 billion notes then you’re wrong, that’s not how the system works. You can’t just print 700 billion notes without it being accounted somewhere or nobody is really better off (purchasing power). That doesn’t meant they don’t print money, they just don’t print money as the only means of getting it. Basically, there’s only X amount in circulation because the reserve values don’t warrant more. Right now we need more, so they print, however, they still need to pull that ‘money’ from somewhere. Whether it’s issuing bonds or dumping reserve money it comes from SOMEWHERE.

    Money has no value other than what the gov’t suggests it has (legal tender) and what the economy will accept. Tomorrow it could be worth nothing then we move to another system of banking such as value of goods (barter). We won’t, and the value of items are again perceptions, but going back to your printing money thing, the value of everything may expand 100X because of how much your money is worth, but if everyone gets 100X more money (because more was printed) are they really better off? No, everyone remains the same (give everyone 1 million bucks nobody is better off).

    Mathematical end point of growth doens’t make sense either because all banks can lend less the stipulated reserve ratio. Even if they were all at a mathematical end point, yet the markets were healthy, there wouldn’t be a problem (well there would be because you should overextend yourself).

    It’ snot a big conspiracy, but just greed gone too far.

  37. Steve

    Hay Baza
    Year & I’m the pope on weekends, but that’s another story. I can tell your a very smart man barry & I know you’d be awear of the power play, very {& I mean verrrry} powerful & Mind boglingly rich conglomerants & inderviduals, are easly capable of manipulating the markets. Coordinated mass selling of stocks at there peaks {causing panic selling} & buying value shairs in a depretion {trillions in value profits} in just a few months. Now your not going to tell me this dos’t happen?
    Cheers Buddy.

  38. barry econ

    I’m not saying these things don’t happen. What I am saying is that it’s not as simplea s, “the govt gave a 700 billion bail out so they printed 700 billion more notes”. That didn’t happen.

  39. Steve

    Hi Bazza.
    Ok buddy I give up. But It’s no good any of us rambling on, trying to change the big picture, it’s not healthy, & it’s just not possable. All we, as individuals can do is watch our corner of the wold. & to all you big high rollers & fat cat’s, I’m reeeallllyyyy sorrrry about your losses but I,m sure you’ll all servive.
    As for the rest of us poor bar—-ds. We have got to stop being the poor uninformed victoms here. The truth is out there, don’t lisson to what is said but watch what is being dune. We can’t afford to be so simplistic anymore. Get out there & lobby your gov reps {fed, state, & local } Make a change for you. It maybe a gov backed non profit instertute for wager/salery/super {what ever income based orgeization } only for members. Only for personal expendure {not buisness not personl gain/buying & selling} as I suggested or it may be some other fantastic revilation that is so simple. Some times you just have to think outside the box. This is the best time to force big changers by lobbying gov reps.
    The best way to stop shooting you self playing russin rullet is to stop playing the game. Find your self a safer one.
    Cheers
    Steve

  40. barry econ

    Well put. I have moved additional comments that were of exceptional thought and quality into a new thread to make things manageable. Great topics and thoughts. Please view the new article here:

    http://www.discusseconomics.com/banking/money-creation-where-does-the-money-come-from/

    You may still post comments pertinent to this article in this comment section.

  41. Bob

    To Debt Based Economics:

    one lad who left the country …….. but came back after he deemed it safe…so I understand… Leonard W. Clampett….Australian author….of “Hand over our Loot 1″… &” 2.”..& “Who said we have to pay interest?” Please read/scan the “1935 Parliament of Tasmania Monetary System…Report of the select Commitee” ….it is on the net.There are many references said in different ways that Banks create money out of thin air. It appears that Bankers usually are upset that they do not understand how their Bank realy creates money out of thin air…..
    It appears many of us in the finance industry are what we call ourselves “mushrooms”….fed a lot of manure. Hey the system has to have the illusion of being strong….now the new generation know that they have been mushroomed as well…..the gobbly gook presently being presented to the public in the media is increasingly becoming a new version of the Mad Hatters Tea Party polluted further by a whole range of highly paid cowboys paid huge money for failure. Should these dudes be called economic terry wrists & be treated as such? or a protected species protected by those who will profit by this system. Suggest we follow the yellow brick road…..the money trail. The mind boggles.

  42. tts

    There is much confusion about money(notes and coins) and credit
    by banks.When the bank gives you a loan,basically it creates a book/accounting value to-day(convertible into money)which will be destroyed as and when you,the recipient,will have produced income(from your employment) or profits(from your enterprise) to offset the value previously created.In whatever way you utilise the funds you receive from the bank these will,depending on the velocity of your/others’ transactions,ultimately land in the banking system as deposits in the form of cash or checks.So to say that banks lend your deposits does not seem valid.If the cash reserve ratio is 10% then a bank can create 90% new money e.g if you deposit $ 1000 in cash the bank can afford to create $ 9000.If you deposit a check of the same amount,the bank cannot create money as it must find $100 from the Central Bank to comply with the reserve ratio.
    Thus,in a nutshell,banks’money creation is only limited by the amount of cash in the form of notes and coins in circulation issued by the Central Bank.That is why all banks are fearsome of cash runs because the notes issued by the Central Bank are not sufficient to satisfy the amount of money created.When the economy is booming more people are employed(more income) and businesses prosper(more profits) the Central Bank must print more notes to sustain that additional expansion thus enabling banks to create more money.

  43. Carolyn

    What you are talking about is the velocity of money. For example, interest as paid by a consumer, is very real as it cuts into what money they do have to pay the debt. However, if the balance of the debt is paid off, then the bank has the interest as well as the principle. Home mortgages is one thing, unsecured loans like credit cards, are another. The interest paid by the consumer to the bank is used by the bank to pay their expenses and their other depositors. However, the default rates are rather silly, IMHO because if the universal default rule applies, the consumer now has a bigger payment to make, thus making it more difficult to discharge the debt, which leads to people defaulting because of bank intractability.

    Velocity is the ability of money being moved through the system. If I owe Charles fifty dollars, I pay him. That debt is satisfied. He owes Doris thirty dollars and Chad twenty. He pays them. Those debts are satisfied.
    Doris pays Ron the thirty she owes him and Chad pays Jenny the twenty he owes her. Thus, fifty dollars just paid 150 dollars of debt.

  44. Bob

    Well….it seems in Australia that the Banks lent billions over their Deposits …..a report on TV said 700 bill$ over their Deposits…& the Gov’t will use Taxpayers money to bail out these Foxes….amazing. The Banks lend thin air money…..& want Tax Payer to bail them out……Why….in reality there was no money. Oh they say that they borrow other Banks money…….ever hear of contra Accounts? One could not help thinking as the system is sleight of Hand…..aka Tasmanian Government 1935 Report on th Monetary System…..Appears the Banksters could raise contra a/cs amongst themselves….Banksters appearing to lend to each other…..for the same interest rate….if any….heheheh…..Foxes in charge of the hen house….wanting all the eggs, new chickens & the neighbours eggs & chickens & more. Goodness these guys in the Res system…..lend what the ain’t got. heheheh. ponzi scheme… ain’t got nothin’ on this…… appears this has to be better as it has protection from Gov’t & it appears the the Legal lads have to protect it……or it will collapse…..whoops that is happening now it would appear.

  45. peter c

    I have watched “money as debt” and it would appear that banks can create money by lending money out such that each loan becomes a corresponding credit in the originating or another, bank and therefore the basis for creating further debt money and so on ad infinitum

  46. barry econ

    They technically don’t add to infinity assuming the reserve ratio above. I believe all banks must adhere to some form of reserve ratio.

  47. Bob

    Well, well……seems all Economic gobbly gook. The 1st head/major owner of the private Bank Bank of England (in 1694) said Banks profit from creating money (by way of a debit to an account which has the borrowers name attached to it) out of this air. Of course neither the Bank, Shareholders or Depositors are short of the funds supposedly lent to the borrower. So y’all tell me the multiplier effect is the game. In my opionion the real game is legalised white collar crime supported by the Judiciary……& court rulings. Appears in reality the money supposedy given to a borrrower does no exist….so how can it be paid back. The lending scam the Banks have done has bit them on the butt & why should any Gove support them……they will do it all again….Unless they are controlled & the public have acces to their records….& are aware of their modus operandi. How many Bankster top dogs have been put in jail so far???? ….for scamming the system??

  48. Prosper Mabuya

    I am completely lost.

  49. Mammoth

    I get that banks create money out of ‘thin air’ for loaning out. What I don’t get is this: part of my country’s national debt is due to domestic banks borrowing from international banks and loaning out the money. Why do they need to do this? Isn’t the reserve ratio supposed to limit how much banks can lend? Why on earth are banks borrowing money when they can create it based on the deposits they hold?

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