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I'm working this out on the fly here, but here it goes. People are labelled with single letters. Let's say that a bank is only allowed to lend out 90% of the de

I'm working this out on the fly here, but here it goes. People are labelled with single letters. Let's say that a bank is only allowed to lend out 90% of the deposits. - A deposits $300k Total deposits: $300k, total lendings: $0k, total lendable: $270k - Bank lends B $270k to buy C's house - C deposits $270k from the sale of his house. Total deposits: $570k, total lending: $270k, total lendable: ($570k * 0.9 = $513k, $513k-$270k = $243k) - Bank lends D $240k to by E's house - E deposits $240k from the sale of his house Total deposits: $810k, total lending: $510k, total lendable: ($810k * 0.9 = $729k, $729k - $510k = $219k) - Bank lends F $210k to by G's house - G deposits $210k from the sale of his house Total deposits: $1,020k, total lending: $720k, total lendable: ($1020k*0.9 = $918k, $918k - $720k = $198k) In this process, the bank has turned $300k into $1,020k, and has loaned out $720k, while never loaning out more than they have deposited. That's the magic of fractional reserve banking.

perl4ever 9y ago
The bank didn't somehow grab those three houses (C, E, and G) for free - the assets and liabilities balance out. So I don't think it makes any sense to say they turned $300K into $1,020K. C, E, and G already had existing houses, and the series of events isn't going to change the amount of deposits or loans in the world as a whole. It doesn't give the bank a profit of $720K. They get interest on $720K, but they have to pay interest on $1020K so obviously they need a spread in rates to do it. As far as I can tell, you're just describing the bank getting a larger balance sheet and they've got to raise more capital to do it which limits profits.
- tonyarkles 9y ago
  You're completely correct. The assets and liabilities do balance out, and the bank isn't creating a $720k profit. The total money supply has grown though. From an initial $300k, they now have 4 people who all, looking at their bank statements, have deposits totaling $1M. If they all tried to withdraw that at the same time, there'd be trouble, but fractional reserve banking rests on the assumption that they won't. And yeah, there's a pretty significant spread on interest rates between deposits and loans. The GP post was talking about "creating a dollar". This is precisely how banks "create dollars". As those loans are repaid and the deposits are withdrawn, they're subsequently "destroying" those dollars from a money supply perspective.
  - perl4ever 9y ago
    Isn't the building of the houses (the actual economic activity) what expanded the money supply, not the bank(s)? And isn't this exactly how the economy should function - we create more stuff, so all else being equal, the numbers that denote how much stuff we have get larger? Saying the banks create dollars implies they are controlling the money supply.
    - tonyarkles 9y ago
      Nope. If I sell you my (fully owned) house for $300k, no additional money has been created. There's still only $300k of money. It's the act of lending out some fraction of your deposits/loans from the central bank that allows commercial banks to "create" money. And yes, the banks are controlling the money supply. See https://en.wikipedia.org/wiki/Fractional-reserve_banking https://en.wikipedia.org/wiki/Fractional-reserve_banking for more detail.
      - perl4ever 9y ago
        It seems to me the loans are assets, and the deposits are liabilities, so the loans don't create any money in the economy. Edit: why do you say withdrawing money destroys it? It removes it from a bank's balance sheet, but not from the economy...

perl4ever 9y ago

The bank didn't somehow grab those three houses (C, E, and G) for free - the assets and liabilities balance out. So I don't think it makes any sense to say they turned $300K into $1,020K. C, E, and G already had existing houses, and the series of events isn't going to change the amount of deposits or loans in the world as a whole. It doesn't give the bank a profit of $720K. They get interest on $720K, but they have to pay interest on $1020K so obviously they need a spread in rates to do it. As far as I can tell, you're just describing the bank getting a larger balance sheet and they've got to raise more capital to do it which limits profits.

tonyarkles 9y ago
You're completely correct. The assets and liabilities do balance out, and the bank isn't creating a $720k profit. The total money supply has grown though. From an initial $300k, they now have 4 people who all, looking at their bank statements, have deposits totaling $1M. If they all tried to withdraw that at the same time, there'd be trouble, but fractional reserve banking rests on the assumption that they won't. And yeah, there's a pretty significant spread on interest rates between deposits and loans. The GP post was talking about "creating a dollar". This is precisely how banks "create dollars". As those loans are repaid and the deposits are withdrawn, they're subsequently "destroying" those dollars from a money supply perspective.
- perl4ever 9y ago
  Isn't the building of the houses (the actual economic activity) what expanded the money supply, not the bank(s)? And isn't this exactly how the economy should function - we create more stuff, so all else being equal, the numbers that denote how much stuff we have get larger? Saying the banks create dollars implies they are controlling the money supply.
  - tonyarkles 9y ago
    Nope. If I sell you my (fully owned) house for $300k, no additional money has been created. There's still only $300k of money. It's the act of lending out some fraction of your deposits/loans from the central bank that allows commercial banks to "create" money. And yes, the banks are controlling the money supply. See https://en.wikipedia.org/wiki/Fractional-reserve_banking https://en.wikipedia.org/wiki/Fractional-reserve_banking for more detail.
    - perl4ever 9y ago
      It seems to me the loans are assets, and the deposits are liabilities, so the loans don't create any money in the economy. Edit: why do you say withdrawing money destroys it? It removes it from a bank's balance sheet, but not from the economy...