3 ms·

The “new currency” exception is very significant, because under our fractional-reserve banking system, banks have the power to create money. If you deposit $10

by sethg 16y ago

The “new currency” exception is very significant, because under our fractional-reserve banking system, banks have the power to create money. If you deposit $100 in a bank, the bank can immediately loan out $90 of it to borrowers (who may put that money in their own banks, etc. etc.), thus creating money from nowhere. I.e., if those borrowers can’t pay back their loan and the bank writes it off, your $100 is still safe.

ubasu 16y ago
I thought fractional reserve meant that the bank can now loan out $900, which is the creating money part. (perhaps you had a typo?)
- cwp 16y ago
  No, they only loan out $90. But that is creating money. Where did that $90 come from? It didn't come out of your account; you still have $100. Imagine how pissed you'd be if you went to make a withdrawal and the bank said, "no, you can only have $10 right now, we lent the rest to somebody and they haven't paid it back yet."
  - bigiain 16y ago
    The $900 figure comes from the assumption that the $90 they lend out eventually lands in somebody else's account, and they then also lend out 90% of that $90, and then recurse that all the way down till there's nothing left to lend out again: perl -e'$s = 100; while($s > 0.1){$t = $t + $s * 0.9;$s = $s * 0.9;} print $t' 899.140495544283 (edited: I have no idea why HN dropped out the asterixes in that code...)
    - deleted 16y ago
      [deleted]
    - prodigal_erik 16y ago
      Asterisks without whitespace (or a leading indent) mean italics: http://news.ycombinator.com/formatdoc http://news.ycombinator.com/formatdoc
- SkyMarshal 16y ago
  A common misconception, but OP is right. A single bank can't create money this way, but a network of banks in a fractional reserve system can. Wikipedia has a particularly clear explanation of how it works: "When cash is deposited with a bank, only a fraction is retained as reserves, and the remainder can be loaned out (or spent by the bank to buy securities). The money lent or spent in this way is subsequently deposited with another bank and increases the cash reserves of that second bank, allowing that second bank to keep a fraction of the new deposit and lend or spend the remainder. Thus the excess cash travels from bank to bank to bank creating new deposits as it goes. Although no individual bank does anything other than lend part of what is deposited with it, the practice of fractional reserve banking in a multi-bank system expands the money supply (cash and demand deposits) to a large multiple of the cash reserves in all banks." There's a good table and graph illustrating the process down the page a bit: http://en.wikipedia.org/wiki/Fractional_reserve_banking#Example_of_deposit_multiplication http://en.wikipedia.org/wiki/Fractional_reserve_banking#Exam...
deleted 16y ago
[deleted]
Retric 16y ago
Money creation by banks has nothing to do with people "failing to pay back loans". It works like this, banks have an account with their money, and an account with your money, and an account with Bob's money, and an account with everyone's money. Bank: 100$. You: 100$. Bob: 0$. Bank's Vault: 200$ If you loan 100$ to bob the accounts now look like: Bank: 100$. You: 0$. Bob: 100$. Bank's Vault: 200$ If the bank loans the money to bob, who deposits the loan back into the bank: Bank: 100$. You: 100$. Bob: 100$. <- Magic! Bank's Vault: 200$ However, the bank is really adding a new account Loans's -1 00$. Note: (Loan's: -100$ + Bank: 100$ + You: 100$ + Bob: 100$ = Bank's Vault: 200$ ) By law they can can only give a negative value up to ~90% of the Bank's Vault's value to Loan's. Granted world wide there are more than 1 bank, but because people don't keep a lot of hard cash on hand loan's just end up being deposited in another bank in the system which can then loan the money back to your bank as needed etc. PS: Now when Bank's Fail the Fed can actually make huge amount's of money from thin air, but that's a separate process.

by sethg 16y ago

ubasu 16y ago

I thought fractional reserve meant that the bank can now loan out $900, which is the creating money part. (perhaps you had a typo?)

cwp 16y ago
No, they only loan out $90. But that is creating money. Where did that $90 come from? It didn't come out of your account; you still have $100. Imagine how pissed you'd be if you went to make a withdrawal and the bank said, "no, you can only have $10 right now, we lent the rest to somebody and they haven't paid it back yet."
- bigiain 16y ago
  The $900 figure comes from the assumption that the $90 they lend out eventually lands in somebody else's account, and they then also lend out 90% of that $90, and then recurse that all the way down till there's nothing left to lend out again: perl -e'$s = 100; while($s > 0.1){$t = $t + $s * 0.9;$s = $s * 0.9;} print $t' 899.140495544283 (edited: I have no idea why HN dropped out the asterixes in that code...)
  - deleted 16y ago
    [deleted]
  - prodigal_erik 16y ago
    Asterisks without whitespace (or a leading indent) mean italics: http://news.ycombinator.com/formatdoc http://news.ycombinator.com/formatdoc
SkyMarshal 16y ago
A common misconception, but OP is right. A single bank can't create money this way, but a network of banks in a fractional reserve system can. Wikipedia has a particularly clear explanation of how it works: "When cash is deposited with a bank, only a fraction is retained as reserves, and the remainder can be loaned out (or spent by the bank to buy securities). The money lent or spent in this way is subsequently deposited with another bank and increases the cash reserves of that second bank, allowing that second bank to keep a fraction of the new deposit and lend or spend the remainder. Thus the excess cash travels from bank to bank to bank creating new deposits as it goes. Although no individual bank does anything other than lend part of what is deposited with it, the practice of fractional reserve banking in a multi-bank system expands the money supply (cash and demand deposits) to a large multiple of the cash reserves in all banks." There's a good table and graph illustrating the process down the page a bit: http://en.wikipedia.org/wiki/Fractional_reserve_banking#Example_of_deposit_multiplication http://en.wikipedia.org/wiki/Fractional_reserve_banking#Exam...

deleted 16y ago

[deleted]

Retric 16y ago

Money creation by banks has nothing to do with people "failing to pay back loans". It works like this, banks have an account with their money, and an account with your money, and an account with Bob's money, and an account with everyone's money. Bank: 100$. You: 100$. Bob: 0$. Bank's Vault: 200$ If you loan 100$ to bob the accounts now look like: Bank: 100$. You: 0$. Bob: 100$. Bank's Vault: 200$ If the bank loans the money to bob, who deposits the loan back into the bank: Bank: 100$. You: 100$. Bob: 100$. <- Magic! Bank's Vault: 200$ However, the bank is really adding a new account Loans's -1 00$. Note: (Loan's: -100$ + Bank: 100$ + You: 100$ + Bob: 100$ = Bank's Vault: 200$ ) By law they can can only give a negative value up to ~90% of the Bank's Vault's value to Loan's. Granted world wide there are more than 1 bank, but because people don't keep a lot of hard cash on hand loan's just end up being deposited in another bank in the system which can then loan the money back to your bank as needed etc. PS: Now when Bank's Fail the Fed can actually make huge amount's of money from thin air, but that's a separate process.