ShackledNation
Libertarian
It is well accepted that under our current banking system, banks create much of this country's supply of money. Below I will lay out how this actually happens, and welcome criticism or additions (I am simplifying it a bit).
For the sake of example, I will use a single monopoly bank (Bank A). With multiple banks, the ultimate reality doesn't change, but one bank is easier for illustration. The reserve requirement is 10%.
1.
Adam deposits $100 in cash at Bank A, opening a typical checking/debit account. Thus the Bank now has $100 in cash, and Adam has a $100 demand deposit at the bank. Adam's account acts as an IOU from the bank, with the bank owing him $100 in cash should he decide to withdraw it. However, he need not actually spend the cash. He can write checks from his account, or simply swipe a debit card. In fact, Adam never has to use cash at all--the IOUs circulate as money instead, in the form of electronic data or changes on the ledger at the bank in the case of a physical check.
The balance sheet at Bank A looks like this after this initial deposit:
Assets
Cash.............................$100
Total.............................$100
Liabilities
Adam's Demand Despoit....$100
Total.............................$100
The reserve ratio is calculated (based on the simplicity of this example) by dividing cash by demand deposits. In this case it is 100/100=1=100%.
2.
At this point, the bank has a reserve ratio of 100%. The textbook example (not actually what happens in practice) of what happens is that the bank loans out $90, and then that $90 allows for $81 in loans, the resulting deposit allowing for more, etc. This process is repeated until the bank creates $900 in loans. It also typically uses two banks, or multiple banks. To illustrate the textbook example, I will illustrate only what happened after the first $90 loan is made to a woman named Bertha, then the 2nd $81 loan is made to Chris.
After Bertha's Loan:
Assets
Cash.............................$100
Bertha's Loan.................$90
Total.............................$190
Liabilities
Adam's Demand Despoit....$100
Bertha's Demand Deposit...$90
Total.............................$190
After Chris's Loan
Assets
Cash.............................$100
Bertha's Loan.................$90
Chris's Loan...................$81
Total.............................$271
Liabilities
Adam's Demand Despoit....$100
Bertha's Demand Deposit...$90
Chris's Demand Deposit.....$81
Total.............................$271
The reserve ratio is now 100/271, which is 36.9%
3.
The textbook example, however, is not actually what happens in practice. Banks do not loan out 90% of their reserves, and then wait for more deposits to make more loans. They simply create loans first, with the same end result. The Bank of England has admitted such is the way things are, among others. Rather than make single loans and wait for deposits again and again, the bank simply makes loans from the initial deposit until the requirement is at 10%. Here is the result, assuming the bank decides to make 100 loans of $9.
Assets
Cash.............................$100
Single Loan....................$9 (times 100)
Total.............................$1000
Liabilities
Adam's Demand Despoit....$100
Single Demand Deposit......$9 (times 100)
Total.............................$1000
And there you have it. Money is created through the mere issuance of loans under a fractional reserve banking system.
For the sake of example, I will use a single monopoly bank (Bank A). With multiple banks, the ultimate reality doesn't change, but one bank is easier for illustration. The reserve requirement is 10%.
1.
Adam deposits $100 in cash at Bank A, opening a typical checking/debit account. Thus the Bank now has $100 in cash, and Adam has a $100 demand deposit at the bank. Adam's account acts as an IOU from the bank, with the bank owing him $100 in cash should he decide to withdraw it. However, he need not actually spend the cash. He can write checks from his account, or simply swipe a debit card. In fact, Adam never has to use cash at all--the IOUs circulate as money instead, in the form of electronic data or changes on the ledger at the bank in the case of a physical check.
The balance sheet at Bank A looks like this after this initial deposit:
Assets
Cash.............................$100
Total.............................$100
Liabilities
Adam's Demand Despoit....$100
Total.............................$100
The reserve ratio is calculated (based on the simplicity of this example) by dividing cash by demand deposits. In this case it is 100/100=1=100%.
2.
At this point, the bank has a reserve ratio of 100%. The textbook example (not actually what happens in practice) of what happens is that the bank loans out $90, and then that $90 allows for $81 in loans, the resulting deposit allowing for more, etc. This process is repeated until the bank creates $900 in loans. It also typically uses two banks, or multiple banks. To illustrate the textbook example, I will illustrate only what happened after the first $90 loan is made to a woman named Bertha, then the 2nd $81 loan is made to Chris.
After Bertha's Loan:
Assets
Cash.............................$100
Bertha's Loan.................$90
Total.............................$190
Liabilities
Adam's Demand Despoit....$100
Bertha's Demand Deposit...$90
Total.............................$190
After Chris's Loan
Assets
Cash.............................$100
Bertha's Loan.................$90
Chris's Loan...................$81
Total.............................$271
Liabilities
Adam's Demand Despoit....$100
Bertha's Demand Deposit...$90
Chris's Demand Deposit.....$81
Total.............................$271
The reserve ratio is now 100/271, which is 36.9%
3.
The textbook example, however, is not actually what happens in practice. Banks do not loan out 90% of their reserves, and then wait for more deposits to make more loans. They simply create loans first, with the same end result. The Bank of England has admitted such is the way things are, among others. Rather than make single loans and wait for deposits again and again, the bank simply makes loans from the initial deposit until the requirement is at 10%. Here is the result, assuming the bank decides to make 100 loans of $9.
Assets
Cash.............................$100
Single Loan....................$9 (times 100)
Total.............................$1000
Liabilities
Adam's Demand Despoit....$100
Single Demand Deposit......$9 (times 100)
Total.............................$1000
And there you have it. Money is created through the mere issuance of loans under a fractional reserve banking system.