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How Banks Create Money


Setantii
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Yeah I know, another thread about banking but I really need to get to the bottom of this.

Even though the banking system is in meltdown I've yet to see any mention in the mainstream media of how our debt based economy actually works. Of course I'm talking about the system known as Fractional Reserve banking. For a mere mortal like me with a basic education the idea that banks create money from nothing seems absurd. In fact until a few years back I stupidly assumed that a £ note equated to an amount of gold in the Bank of England!

So I researched this system to try and understand what it's all about and my current conclusion is that banking is just one huge pyramid scam. I'll explain why.

How Banks Create Money

Banks actually create money when they lend it. Here's how it works: Most of a bank's loans are made to its own customers and are deposited in their checking accounts. Because the loan becomes a new deposit, just like a paycheck does, the bank once again holds a small percentage of that new amount in reserve and again lends the remainder to someone else, repeating the money-creation process many times.

http://www.dallasfed.org/educate/everyday/ev9.html

Reserve Requirements and Money Creation

Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81. As the process continues, the banking system can expand the initial deposit of $100 into a maximum of $1,000 of money ($100+$90+$81+$72.90+...=$1,000).

http://www.ny.frb.org/aboutthefed/fedpoint/fed45.html

Now if I go to a bank and ask for a loan (to pay my taxes) they will deposit an amount of 'money' into my account (which is in fact 'credit' created via the Fractional Reserve System). To be legal tender it must fulfil at least two conditions. One is that it is acceptable for the settlement of debts, and two, that it is acceptable for the payment of taxes. As the government will accept this credit as payment it becomes Legal Tender.

As legal tender equates to real money, the bank has just magically conjured up 'money out of thin air'.

More important however is this question -

If the banks create money (credit) from nothing, yet nobody ever creates the interest needed to repay these loans in full, then how, as a society, can we ever get out of the increasing cycle of debt?

Then again perhaps I've got it all wrong. As I said earlier I'm just an Average Joe trying to get my head around this whole concept. Is there any fundamental flaw in my reasoning?

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First point we don't have a fractional reserve system, we have a voluntary reserve system with basel 2 compliance

http://en.wikipedia.org/wiki/Basel_II

http://en.wikipedia.org/wiki/Reserve_requirement

The Bank of England holds to a voluntary reserve ratio system. In 1998 the average cash reserve ratio across the entire United Kingdom banking system was 3.1%

Countries with a 0% reserve requirement

USA

Australia

Canada

Mexico

Sweden

United Kingdom

In the Uk the bank can lend out all capital if it wants, any country with a 0% reserve can cycle the money to the max...

Edited by moosetea
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Then again perhaps I've got it all wrong. As I said earlier I'm just an Average Joe trying to get my head around this whole concept. Is there any fundamental flaw in my reasoning?

If there's only £100 in existence and you owe £110 it's mathmatically possible to pay this off without being coerced into taking out another loan (although the gov't havn't figured this out yet). Simply perform £10's worth of work and then pay off your debt.

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If there's only £100 in existence and you owe £110 it's mathmatically possible to pay this off without being coerced into taking out another loan (although the gov't havn't figured this out yet). Simply perform £10's worth of work and then pay off your debt.

Hence the constant demand by Government for growth in the economy - and the reason why they are shit scared of deflation.

I think they have worked it out.

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If there's only £100 in existence and you owe £110 it's mathmatically possible to pay this off without being coerced into taking out another loan (although the gov't havn't figured this out yet). Simply perform £10's worth of work and then pay off your debt.

And if you export to another country - receive foreign currency - buy the home currency from a bank - you can pay off the loan without extra borrowing. No?

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Hence the constant demand by Government for growth in the economy - and the reason why they are shit scared of deflation.

I think they have worked it out.

House price increases cannot be counted as 'growth' as nothing has grown apart from debt. They're scared of deflation because once people's homes and jobs have been taken away from them they've got nothing left to lose.

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If there's only £100 in existence and you owe £110 it's mathmatically possible to pay this off without being coerced into taking out another loan (although the gov't havn't figured this out yet). Simply perform £10's worth of work and then pay off your debt.

unless you borrow more money to pay the interest today... repeat and rinse and you have higher inflation for ever... Your paying today's debt repayments with borrowed money from future earnings and inflation and growth to ensure you we all get paid more in future.

DEBT==MONEY==WEALTH

Edited by moosetea
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I never understood Fractional Reserve. The way I see it is the regulators (i.e. the Government who have power and forces such as Police and the Military) enforce a system where a bank has to have a certain amount of cash in relation to it's lending and some other requirements like a massive lump sum to form the bank in the first place.

People put money into the bank which is then lent out again on the assumption not everyone will withdraw their cash

at the same time. The regulators require say 6% of the total to always be ready to go, cash equivilent things like cash

and gold or even shares people have bought in the bank count towards that.

They can borrow money from other banks and pay interest at a set interbank rate, which makes it worthwhile for the

competing bank to lower their lending ability overall because the other bank is unlikely to fail and they get the money

back very quickly anyway. Free profit. Also they themselves might need to borrow from another bank one day. Something

like LIBOR is used to set the interest the banks pay each other.

If everyone withdraws their money the bank has raise more money to cover the loss of cash to cover the lending they did, if the share price falls they have to raise more money to cover the loss of capital, either by issuing more shares or somehow convincing people to give them their cash. If people default on their loans they have to raise capital.

That's how I see it , but it might be wrong. The take 1 quid and lend it 10 times I can't get my head around.

Edited by Mr. Parry
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House price increases cannot be counted as 'growth' as nothing has grown apart from debt. They're scared of deflation because once people's homes and jobs have been taken away from them they've got nothing left to lose.

Money supply has grown.

Buying houses is growth - just not sustainable growth - its unproductive. It's a ponzi scam. They are scared of deflation because it means less money around to service debt. People have to go bust.

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I never understood Fractional Reserve. The way I see it is the regulators (i.e. the Government who have power and forces such as Police and the Military) enforce a system where a bank has to have a certain amount of cash in relation to it's lending and some other requirements like a massive lump sum to form the bank in the first place.

People put money into the bank which is then lent out again on the assumption not everyone will withdraw their cash

at the same time. The regulators require say 6% of the total to always be ready to go, cash equivilent things like cash

and gold or even shares people have bought in the bank count towards that.

They can borrow money from other banks and pay interest at a set interbank rate, which makes it worthwhile for the

competing bank to lower their lending ability overall because the other bank is unlikely to fail and they get the money

back very quickly anyway. Free profit. Also they themselves might need to borrow from another bank one day. Something

like LIBOR is used to set the interest the banks pay each other.

If everyone withdraws their money the bank has raise more money to cover the loss of cash to cover the lending they did, if the share price falls they have to raise more money to cover the loss of capital, either by issuing more shares or somehow convincing people to give them their cash. If people default on their loans they have to raise capital.

That's how I see it , but it might be wrong. The take 1 quid and lend it 10 times I can't get my head around.

The problem is that it is impossible to enforce... If I write a cheque made out to CASH for 1 million pounds today and give it to you (even though I dont have any money in my bank), and then you use the cheque to pay for a house, and that cheque/debt token gets passed on from person to person as an symbol of money (banknote) and used to buy stuff everything will be fine just as long as people believe I have 1 million pounds and the cheque is worth 1 million CASH.

I dont have 1 million but that doesnt matter, everyone believes and the money has value even though it is worthless. This is money, this is what a bank note is, this is what the digits on a computer screen are. Pure unudulterated trust. Currency falls are due to falls in trust and belief.

Edited by moosetea
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And if you export to another country - receive foreign currency - buy the home currency from a bank - you can pay off the loan without extra borrowing. No?

The home currency that you obtain in exchange for your foreign currency will have been borrowed into existence by someone else.

If you use it to repay your home currency bank debt then the money will dissappear (together with an equal and opposite amount of debt.)

It is impossible for the whole community of users of a debt-based commercially issued currency collectively to be free of debt in that currency.

Total debt to the money/credit issuing banking cartel must always exceed the total money supply.

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The problem is that it is impossible to enforce... If I write a cheque for 1 million pound and give it to you, and then you use the cheque to pay for a house, and that cheque/debt token gets passed on from person to person as an symbol of money (banknote) and used to buy stuff everything will be fine just as long as people believe I have 1 million pounds. Its ****** I dont have 1 million but that doesnt matter, everyone believes and the money has value even though it is worthless

As you said it's not enforced, and it relies only on trust. Until the system breaks there is no need to regulate the banks.

If people are unlikely to pay back money, if the loan is secured on something falling in value they should be made to re

weigh the risk. Northern Rock had it's core Tier 1 relaxed to allow it to continue, Mac and Mae also have relaxed requirements now.

There needs to be a regulator who can enter the offices, remove all the documents and arrest the workers culpable in a dawn raid.

Followed by a long time in prison to think about their crimes.

Otherwise the system breaks, and banks see no need to keep supporting each other because they hold no risk.

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Watch these, and you'll understand. This is about the FED, but it's no different in the vast majority of the world's central banks, all owned by the same cartel.

http://www.youtube.com/watch?v=_36o9TZovGY

http://www.federaljack.com/modules.p...ticle&sid=1828

You don't get this information in school or on state television because it is all owned by the same interests. Don't listen to anyone who calls 'tin foil hat' on this. They're just name callers after all and deserve to be treated with the due contempt.

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A bank functions in a similar manner to a corner shop that allows customers to have things on credit which the customer pays back later.

Each credit item issued carries a risk of none repayment and genuine loss to the bank because "bank money" can only leave the 'banks economy' as real reserves or currency. And each bank is running its own 'bank economy' using its own 'bank money' inside the general economy.

If a bank issues you a loan and you buy a car from another customer then if your loan goes bad the bank has given the 'free bank money' it created to another customer. The customer can then spend that 'free bank money' so that it escapes outside the bank and then the bank must pay its own real reserves and currency to other banks for them to support their own 'bank economies'.

So in some ways it is like a game of monopoly where monopoly money and real money exist side by side to be used by the game. So you need real money to eat and drink and be kept warm but you can buy things from each other using monopoly money as you agree. but in order to buy something outside the game the monopoly banker has to exchange your monopoly money for real money. Therefore each payment you get for going past go can be used as real money. But the monopoly banker is limited in how much real money he can pay out by the amount of real money he can earn in the game via interest rates and fees etc etc paid to him. Therefore if you want to make a withdrawal of money from the game the banker is likely to say to you 'i can let you have 1 but you will need to come back next week for the 5'.

Meanwhile if a bank thinks you are good for credit and you want to buy a car from another customer the banker is happy to acts as the intermediatory between you to facilitate that transaction based on his assessment that even if this loan goes bad that only a certain allowable percentage of loans will go bad.

The bank facilitates commerce with bank money and real money. It has been done like this since the dawn of time. Credit for your food was here since the time of the first hunter gatherers millions of years ago.

I am not saying these are perfect examples but they are approximations i think.

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The home currency that you obtain in exchange for your foreign currency will have been borrowed into existence by someone else.

If you use it to repay your home currency bank debt then the money will dissappear (together with an equal and opposite amount of debt.)

It is impossible for the whole community of users of a debt-based commercially issued currency collectively to be free of debt in that currency.

Total debt to the money/credit issuing banking cartel must always exceed the total money supply.

There is no rule that debt is money.

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The problem is that it is impossible to enforce... If I write a cheque made out to CASH for 1 million pounds today and give it to you (even though I dont have any money in my bank), and then you use the cheque to pay for a house, and that cheque/debt token gets passed on from person to person as an symbol of money (banknote) and used to buy stuff everything will be fine just as long as people believe I have 1 million pounds and the cheque is worth 1 million CASH.

I dont have 1 million but that doesnt matter, everyone believes and the money has value even though it is worthless. This is money, this is what a bank note is, this is what the digits on a computer screen are. Pure unudulterated trust. Currency falls are due to falls in trust and belief.

Moosetea

It is no different to a goldsmith who issues two notes for one amount of gold deposited or 100% Fractional reserve..

Edit: Sorry i meant here Zero fractional reserve where nothing is held in reserve. [/blue]

It is not only trust as "blind trust". It also has to be *belief* that the goldsmith is able to recover his claim notes and pay back the depositors gold before he pays out all gold as required by the claim notes in circulation *and* he has exhausted his abilities to recover the claimed gold that his borrowers are still liable to repay him because an equivalent claim note issued to them or amount in gold still has not been returned by them as agreed when the loan was taken out.

The goldsmith acts as intermediatory between the people to facilitate trade. His bank problem is a problem also for the people and him to resolve.

Edited by aliveandkicking
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Moosetea It is no different to a goldsmith who issues two notes for one amount of gold deposited or 100% Fractional reserve.. It is not only trust as "blind trust". It also has to be *belief* that the goldsmith is able to recover his claim notes and pay back the depositors gold before he pays out all gold as required by the claim notes in circulation *and* he has exhausted his abilities to recover the claimed gold that his borrowers are still liable to repay him because an equivalent claim note issued to them or amount in gold still has not been returned by them as agreed when the loan was taken out. The goldsmith acts as intermediatory between the people to facilitate trade. His bank problem is a problem also for the people and him to resolve.

Yes, gold failed in it's first test.

http://books.google.co.uk/books?id=s8hiamc...esult#PPA342,M1

And before this, as soon as they realised you didn't actually have to keep 100% it all starts again.

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The secret is:

Debit: loan owed by bank customer

Credit: deposit account owed to customer

That's how they account for any loan or credit. The entries do not touch the banks 'cash' at all hence they are not directly constrained in the number of loans they can make by the 'cash' they hold. The deposits are created as and when the credit agreements are signed.

You have to remember that a banks set of accounts is a mirror of what is 'normal' for a business. Customer deposits are credit balances i.e. they owe their customers the money (check you bank statement).

My asset is the banks liability. My liability is the banks asset.

Thats all there is to it.

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Yes, gold failed in it's first test.

http://books.google.co.uk/books?id=s8hiamc...esult#PPA342,M1

And before this, as soon as they realised you didn't actually have to keep 100% it all starts again.

Mr Parry

Sorry i meant 0 % fractional reserve gold banking where two identical claim notes are issued for one deposited amount of gold

One claim note goes to the depositer. and the other to the borrower.

If the borrower gives the claim note to third person the goldsmith gives the third person the gold.

If the depositor comes back in the goldsmith has to go and see the borrower and find out how he is going to get the gold back. His claim is not with the third person but with the borrower who gave the claim to the third person.

The gold claim is still due from the borrower.

If the goldsmith is known to be successful at recovering his claims then people will be happy to deposit their gold with him.

If all people have an interest in the goldsmith being successful at recovering his claims then claims are more likely to be recovered by the goldsmith and depositors further protected by their own community and its values and principals.

In a state of lawlessness and no community or society the goldsmith has to be handy with a gun or know somebody who is.

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