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Thread: Fractional reserve lending - do banks create money out of thin air?

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    Default Fractional reserve lending - do banks create money out of thin air?

    I know banks are allowed to lend out more than their deposits (like 10x), but exactly how does this work? Do they simply create a debt out of thin air ? Trying to understand this process abit better.

    If I was underwater on my mortgage and learned that the bank created the debt out of nothing - I'd seriously question whether I needed to pay it back. What a racket.



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  3. #2

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    I'm not an expert but basically banks are allowed to not hold all of their deposits for demand deposits (checking accounts).

    So if I put a $100 bill in the bank they are allowed to lend out up to $90 to someone but I still "have $100" in my checking account when I look at the entry online.

    It makes no sense to me, it fraud.

    But don't count on getting anything back on those grounds though.

  4. #3

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    Quote Originally Posted by matt0611 View Post
    I'm not an expert but basically banks are allowed to not hold all of their deposits for demand deposits (checking accounts).

    So if I put a $100 bill in the bank they are allowed to lend out up to $90 to someone but I still "have $100" in my checking account when I look at the entry online.

    It makes no sense to me, it fraud.

    But don't count on getting anything back on those grounds though.

    I think it's worse than that. My understanding is that they can lend up to 9x the amount you deposit - so they make up $900 for every $100 on deposit. I may be wrong but am hoping to clarify here if that is the case and where that $900 comes from.

  5. #4

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    Quote Originally Posted by cbc58 View Post
    I think it's worse than that. My understanding is that they can lend up to 9x the amount you deposit - so they make up $900 for every $100 on deposit. I may be wrong but am hoping to clarify here if that is the case and where that $900 comes from.
    No, a $100 deposit means they can lend $90.
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  6. #5

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    Quote Originally Posted by matt0611 View Post
    I'm not an expert but basically banks are allowed to not hold all of their deposits for demand deposits (checking accounts).

    So if I put a $100 bill in the bank they are allowed to lend out up to $90 to someone but I still "have $100" in my checking account when I look at the entry online.
    Exactly. Let's say the bank finds out that at no point more than 10% of the money in sight deposit accounts is actually demanded by the owners of the accounts. So it lends out up to 90% of every sight deposit to others. Those people eventually spend that money to people who will deposit it themselves, etc., etc.

    Mathematically, Y*[(1-x)/x], where x is the reserve ratio and Y is the initial deposit, is the maximum amount of money created out of thin air. [(1-x)/x] is called the money multiplier. So with a 10% reserve requirement, you can end up with up to 9 times the amount of money created out of thin air. Well, actually 8 times out of thin air + the original deposit.

    The alternative would be to disallow the lending out of money in sight deposit accounts, so that the capital would just wait in your bank account idle, while 90% of it will not be used at a given time. And also higher interest rates for borrowing money, but negative interest rates for sight deposit accounts (you'd have to pay the bank for that service).

    Personally I'd have no problem with fractional reserve banking in a free banking environment. As long as everyone is aware of it. By depositing money in a fractional reserve bank you basically agree to not get all your money back in the case of a bankrun.

    And yes you'd have to pay the mortgage back. You agreed to. Nobody forced you to make that contract.

  7. #6

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    Quote Originally Posted by mz10 View Post
    No, a $100 deposit means they can lend $90.
    But that 90$ can be deposited again, and from that 81$ can be lent out again, and so on.

  8. #7

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    thanks for clarifying - i knew it was created out of thin air but unsure of the method/amount. so... it really is created out of thin air - isn't it? so it may be safe to say that 80% of the economy is riding on an air pocket ?

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  10. #9

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    First of all, I've been a little wrong. The amount of money maximally created out of thin air would be 9 times the amount of the deposit, not 8.
    The multiplier, including the initial deposit, would be 1/reserve requirement. In our case with 10% it would be 1/0,1 = 10. Or a nine-fold of the initial deposit out of thin air.

    Quote Originally Posted by cbc58 View Post
    thanks for clarifying - i knew it was created out of thin air but unsure of the method/amount. so... it really is created out of thin air - isn't it? so it may be safe to say that 80% of the economy is riding on an air pocket ?
    No. That would only be the case, if all the physical bank notes and coins would be deposited in sight deposit accounts and all but the reserve would be lent out and so on and so forth. This multiplier only shows you the maximum amount of money created by commercial banks would be (1-reserve rate)/reserve rate times the amount of cash. However, the real multiplier is also determined by other factors. Not all of the cash is deposited. Even if everybody wanted to deposit all the cash, it's not necessarily the case, that there is demand for such a huge amount of loans, nor willingness to lend out so many loans (as is currently the case). In this case banks wouldn't even let everybody deposit their cash, or at least there wouldn't be any interest on those deposits.

    Currently, according to those graphs:





    the real multiplier is actually smaller than 1. The money base, M0 (money created by the central bank, or cash and bank reserves at the Fed) exceeds M1 (cash and sight deposits). I just realized that this is the case since late 2009 and it really surprised me. What that means, if I'm not totally wrong here, is that the amount of reserves the commercial banks hold at the Fed exceeds the amount of cash deposits, since cash is part of M0 and M1. That's really amazing. For the last 2-3 years if the Fed increased M0 by X, the amount of money in circulation (M1) increased by less than X.
    Last edited by Danan; 01-06-2013 at 11:15 AM.

  11. #10

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    isn't that because the fed is paying money on those deposits and the banks will just take it without the risk? i knew the banks created 9x or so money from the deposit... wasn't sure how exactly and should have reviewed that crash-course vid first. but i believe this whole economy is smoke and mirrors and that we are operating in a matrix movie-like existence. add derivatives to this and we are really in Wonderland.

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    Let me put $!00 in the bank. I used to have $100- now I have zero but the bank owes me $100. They have $100. With a ten percent reserve requirement, they are allowed to loan out 90% of that or $81. Now I have zero, the bank has $11, and the borrower has $89. Person B isn't going to spend that money today, so he pits it into the bank for a few days. Now the bank has $100 deposit on their records and one for $89. That is not necessarily money they have but money the owe. They are basically in debt for that amount.

    Person C comes along and wants to borrow some money. They have already made a loan against my deposit but they are allowed to make a loan against person B's deposit. His account had $81 so they can lend out 90% of that or $72.90. That leaves them with $8.10 from that loan as a reserve plus the $11 left in my account or $19.10. B has no money since he put it in the bank (loaned it to them) and I have zero dollars, and person C has $72.90. The actual money is getting smaller and the amount the bank is keeping is getting bigger. There is still just $100 in the system- that hasn't changed. More has not really been created.

    What has grown is the amount of people in debt.
    I am owed $100 by the bank.
    The bank is owed $90 from person B for his loan.
    The bank is also owed $72.90 from person C.

    Let's make it people. I have $10. I loan $10 to Bob. Bob then loans the same $10 to Chris. There is still only one $10 bill. But the total owed is $20. If I want my $10 back, Bob is going to have to try to get his $10 from Chris and Chris is going to have to get $10 from somebody else. If I want to take my $100 out of the bank, the bank is going to have to get $100 from somebody else. They can't simply "create it".
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    Quote Originally Posted by Danan View Post
    First of all, I've been a little wrong. The amount of money maximally created out of thin air would be 9 times the amount of the deposit, not 8.
    The multiplier, including the initial deposit, would be 1/reserve requirement. In our case with 10% it would be 1/0,1 = 10. Or a nine-fold of the initial deposit out of thin air.



    No. That would only be the case, if all the physical bank notes and coins would be deposited in sight deposit accounts and all but the reserve would be lent out and so on and so forth. This multiplier only shows you the maximum amount of money created by commercial banks would be (1-reserve rate)/reserve rate times the amount of cash. However, the real multiplier is also determined by other factors. Not all of the cash is deposited. Even if everybody wanted to deposit all the cash, it's not necessarily the case, that there is demand for such a huge amount of loans, nor willingness to lend out so many loans (as is currently the case). In this case banks wouldn't even let everybody deposit their cash, or at least there wouldn't be any interest on those deposits.

    Currently, according to those graphs:





    the real multiplier is actually smaller than 1. The money base, M0 (money created by the central bank, or cash and bank reserves at the Fed) exceeds M1 (cash and sight deposits). I just realized that this is the case since late 2009 and it really surprised me. What that means, if I'm not totally wrong here, is that the amount of reserves the commercial banks hold at the Fed exceeds the amount of cash deposits, since cash is part of M0 and M1. That's really amazing. For the last 2-3 years if the Fed increased M0 by X, the amount of money in circulation (M1) increased by less than X.
    Some corrections. The Monetary Base is cash circulating and at banks plus any money reserves the banks are keeping at the Fed. M0 is the cash portion. MB is the monetary base- not M0. These "excess reserves" are NOT included in any of the monetary measures M0 to the M4s. That is how the base can be bigger than M1.

    http://en.wikipedia.org/wiki/Money_supply
    MB: The total of all physical currency plus Federal Reserve Deposits (special deposits that only banks can have at the Fed). MB = Coins + US Notes + Federal Reserve Notes + Federal Reserve Deposits

    M0: The total of all physical currency including coinage. M0 = Federal Reserve Notes + US Notes + Coins. It is not relevant whether the currency is held inside or outside of the private banking system as reserves.

    M1: The total amount of M0 (cash/coin) outside of the private banking system plus the amount of demand deposits, travelers checks and other checkable deposits

    M2: M1 + most savings accounts, money market accounts, retail money market mutual funds, and small denomination time deposits (certificates of deposit of under $100,000).

    MZM: 'Money Zero Maturity' is one of the most popular aggregates in use by the Fed. It is M2 – time deposits + money market funds

    M3: M2 + all other CDs (large time deposits, institutional money market mutual fund balances), deposits of eurodollars and repurchase agreements.

    M4-: M3 + Commercial Paper

    M4: M4- + T-Bills (or M3 + Commercial Paper + T-Bills)

    L: The broadest measure of liquidity that the Federal Reserve no longer tracks. Pretty much M4 + Bankers' Acceptance
    The money mearsures are generally ranked based on their liquidity. The base is basically "potential" money. If the banks start lending out their excess reserves instead of parking them with the Fed, MB (the monetary base) will go down and the other M's will go up along with the money multiplier. Note that the multiplier dropped sharply along with the rise in the base becasue the banks stopped most lending and kept money at the Fed where it was not circulating or multiplying by getting spent on things.
    Last edited by Zippyjuan; 01-06-2013 at 06:22 PM.
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  14. #13

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    Quote Originally Posted by Zippyjuan View Post
    Let me put $!00 in the bank. I used to have $100- now I have zero but the bank owes me $100.

    ...

    If I want to take my $100 out of the bank, the bank is going to have to get $100 from somebody else. They can't simply "create it".
    Yes they can create it. That is taught in every mainstream textbook, as well as generally accepted among anyone in the financial industry.

    My example is straight out of the economics textbook, "Macroeconomics - A European Text" by Burda & Wyplosz. In it it also says btw that M0 = monetary base the way I described it (the notations can vary geographically).

    When we say it creates money out of thin air, we talk about M1. M1 is cash + sight deposits and it is evidently possible to increase overall sight deposits by up to the inverse of the reserve requirement. That's called the money or reserve multiplier.

    Your problem seems to be that you only consider cash as money. If I put 100$ in a sight deposit account I still have that money. I just transformed cash into another form of money that is also part of M1. If I want to cash out that money, yes, the bank has to take that from someone else. But if everybody wants to cash out their sight deposit accounts, the bank couldn't do it. And not only because it lent it out to other people in the line of the bankrun, but because it lent the initial cash deposits out multiple times. How else would the total amount of money in sight deposits exceed the total amount of cash in circulation at every given time?

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    How else would the total amount of money in sight deposits exceed the total amount of cash in circulation at every given time?
    What is a "sight" deposit?

    Ah- see that is what we would call a "demand account". Readily accessable money. http://financial-dictionary.thefreed...eposit+account
    Sight deposit account
    Similar to a demand deposit. Funds in a sight account can be transferred quickly without restriction to another account or converted into cash. Term is mainly used in Europe
    If I want to cash out that money, yes, the bank has to take that from someone else.
    Economically, the only money which truely matters is money which is being exchanged for goods and services. Otherwise it is doing nothing. Other than perhaps accruing interest, money in a bank is the same as money under a mattress. If a bank loans out money for somebody to spend, that increases the money circulating. If they take a deposit, that is removing money which could be spent. In the example, I could have spent the full $100. But since the bank is required to keep part of their deposits on hand and not loan that money out, the money which can be spend gets smaller with each deposit/ loan sequence (note that by step three in my example the $100 is down to $79.10 which can be spent). If I take out my $100 so I can spend it, that would in theory add $100 to the money which could be spent but the bank is out of balance between its deposits and its loans. It has to borrow $100 from somebody else which shrinks the available spending money by the same $100 I intend to spend so the supply of "active" money stays the same.

    How else would the total amount of money in sight deposits exceed the total amount of cash in circulation at every given time?
    The sight account is not the money but an IOU and in our economy only a portion of money is cash- most are electronic numbers rather than paper and metal.
    Last edited by Zippyjuan; 01-06-2013 at 09:27 PM.
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    I like my system If you deposit $100 with me I will lend out $90 to Bob, but I will only give him $45 and Bob still owes me $90. And when you take out your original $100 I still keep $45 the interest I charged Bob if he does not pay I break his leg
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    Quote Originally Posted by Zippyjuan View Post
    The sight account is not the money but an IOU and in our economy only a portion of money is cash- most are electronic numbers rather than paper and metal.
    It may be electronic, but it is just as real. Some central banks are already planning for a time without cash. Even today in many currency areas the use of electronic payments that transform money directly from one demand deposit to another is the predominant form of payment.

    And also the fact remains that there are more IOUs for cash than there is cash in existence. People trade with those IOUs just as if they were cash and treat it exactly equally. That's why it's included in M1 which most people refer to as "money". For all practical purposes the two are indistinguishable. And that's exactly why commercial banks are able to create money out of thin air (though regulated by the central bank via the reserve requirements, the Fed Funds Rate, etc.).

  18. #17

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    Quote Originally Posted by cbc58 View Post
    I know banks are allowed to lend out more than their deposits (like 10x), but exactly how does this work? Do they simply create a debt out of thin air ? Trying to understand this process abit better.

    If I was underwater on my mortgage and learned that the bank created the debt out of nothing - I'd seriously question whether I needed to pay it back. What a racket.
    10 people, 1 bankster owns a bank, 50k total in the commodity known as federal reserve notes.
    1 person goes to bank, wants a loan for 50k.
    bankster originates loan. You now have 50k. 100k total in the commodity known as federal reserve notes.
    You get to buy stuff before inflation hits.
    The bank reserve requirement is a scam. At least two countries have none.

    Banksters prosper at others expense, their work, their skill, their time. While all of us are forced, at gun point, to use their faux commodity.
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  20. #19

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    Quote Originally Posted by mz10 View Post
    No, a $100 deposit means they can lend $90.
    But because of the central banking system, that lent $90 can be deposited in a bank, and then $81 of the that $90 can be lent out, (as the bank would have to keep $9.)

    So now, that $100 deposit has allowed bank A to loan out $90, and bank B to loan out $81. Which means in total, the banking *system* is now making $71 more in loans than the initial deposit.

    That $81 can then be deposited into bank C. Bank C will keep $8, and loan out $73.

    Now the banking system is loaning out $144 more than the initial deposit.

    Continue the cycle, and eventually it approaches that wonderful mathematical constant "e", Mathematically it comes to the fact that banks, AS A GROUP, can lend out about $900 for every $100 deposited.

    Keeping in mind that the federal reserve is a cabal of the major banks of the united states, and you can see how they love to issue debt. It means they get money, both via interest, but also, it just, literally, makes money out of thin air for banks.

    Yeah, being a banker is a good racket!
    Last edited by UWDude; 01-07-2013 at 06:09 PM.

  21. #20

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    Quote Originally Posted by cbc58 View Post
    I know banks are allowed to lend out more than their deposits (like 10x), but exactly how does this work? Do they simply create a debt out of thin air ? Trying to understand this process abit better.

    If I was underwater on my mortgage and learned that the bank created the debt out of nothing - I'd seriously question whether I needed to pay it back. What a racket.
    Well debt is just a contract. The debt was acquired with deposit which is conceptually equates to counterfeit money.

    I suppose in a fashion, if FRB were exposed for the fraud it is, debt holders could sue the banks for fraud and lack of contractual consideration.

    But many economist critical of FRB actually see the borrower as the co-conspirator in FRB. Think of "deposit money" as being a counterfeit version of base money (real money). If I was a car dealer and the local counterfeiter used me to launder his money into the system...would I complain as long as this didn't get exposed? No...because I benefit from the excess demand which drives up my prices. Same thing for the borrower...the excess supply artificially deflates the interest rates and encourages too much borrowing and "investment" (aka chain stores, shopping malls, McMansions). That's not real...

    Who gets hurt? When deposit money gets expanded...it takes the same way counterfeit money does. By inflation or by offsetting lower prices that would have happened due to external prices. Too often FRB critical look at the small picture of just the borrow, lender, depositor to see who gets hurt...when they should consider the big picture. Inflation + bankruns + bailouts + capital miss-allocation/bubbles are inevitable results of our accepts of legalized counterfeiting.

  22. #21

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    Quote Originally Posted by Danan View Post
    the real multiplier is actually smaller than 1. ... That's really amazing. For the last 2-3 years if the Fed increased M0 by X, the amount of money in circulation (M1) increased by less than X.
    Your understanding of classical FRB is still quite correct...it just has to be plugged into a modern context.

    The first consideration is that M1 is not defined in a useful manner because it excludes a lot of reserves (base money). So while one thinks of MB>M1>M2>M3...as a natural pyramid...it is not unfortunately.

    Now how can this happen...how can MB held by banks not count toward M1? Shouldn't all reserves assets held at a bank have a corresponding demand deposit liability? Well no, because reserves can be matched against bank equity or against near-demand-deposits or even longer term liabilities.

    So for example a bank could have say 10million in reserves + 90million in savings accounts matched against 100 million in debt. No demand deposits...so things look rosey, right? Of course not...the bank is still gambling as bad as ever and if/when a liquidity fire breaks out they are in trouble. Near-demand deposits are little different than demand deposits. Just slightly different interest rates and maturity times. Both types of deposits can overbook reserves and play their pyramid games.

    In fact, in many ways our economic 'experts' have shifted away from measuring M1 and more so to M2 because M2 is so darn similar to M1. But when you look at the ratio of M2 to MB...now that is positive and a better (but not complete) gauge of what the banks are up to.

    Now there are many specific reasons that explain why M1 can dive while MB can climb.

    * Sweeps accounts (reserve requirement fraud...which banks make M1 look like M2 to avoid regulations)

    * The Fed pays banks not to gamble some of money (big since 2008 and outrageous)

    * Economy has more rich people or businesses have more money. Average Joes uses a demand deposit...businesses and rich guys will use interest bearing short term deposits. So this can be a sign the rich are getting richer.

    * Basically, M1 gets promoted to M2 and it makes it look like M1 just vanished when it didn't.

    * The money market is not functioning...this happened during 2008 with our liquidity fire and still hasn't restarted (it shouldn't naturally because it is based on fraud..so the fed is trying to artificially start it by dumping tons of reserves into the banking system).

    * Banks being risk averse during tough times (which with all the new base money we have can mean hyper-inflation when they do start lending again...aka buying loans with counterfeit money).

    Advanced FRB can kind of be summed up as mismatching shorter term liabilities against longer term assets. This is inherently unstable because there are always more short term promises than short term assets...and the financiers just have to hope that the short term promises never get redeemed or can be converted into long term promises. The government makes this fraud possible by adding more short term promises to the system in exchange for long term promises, to ensure that all short term promises can be kept.

    Another modern consideration to consider is the role of the Fed's 'open market' and indirect lending from it. Banks don't have to lend in increments to achieve the full multiplier...they've studied this and banks just make whatever loans the loan officer feels are good. Then they achieve financing after-the-fact. Much of it comes indirectly from the Fed as demanded which is absurd. So take the classical multiplier model, and insert the banker has the indirect controller of the size of the monetary base and the ability to re-max new based instantaneously.

  23. #22

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    Quote Originally Posted by Danan View Post
    ..............................Personally I'd have no problem with fractional reserve banking in a free banking environment. As long as everyone is aware of it. By depositing money in a fractional reserve bank you basically agree to not get all your money back in the case of a bankrun.

    .............................................
    it would still be fraud to NOT have a demand deposit available for immediate redemption. A 1 pt type disclaimer on page 57 of a 'contract' does not change that.

  24. #23

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    Quote Originally Posted by truelies View Post
    it would still be fraud to NOT have a demand deposit available for immediate redemption. A 1 pt type disclaimer on page 57 of a 'contract' does not change that.
    Correct. I don't understand the "free banking" argument. It is akin to arguing that the cure for counterfeiting is to legalize counterfeiting.

  25. #24

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    Technically speaking it does not create money out of thin air although the way it leaves people perceive their money FRB has the effect as if it did create money out of thin air. And I think it's debatable why that is, I'd argue because people just don't bother to thoroughly read the contracts they signed with a bank since they know banks are FDIC insured and they don't care what happens with their money or the bank.
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    Quote Originally Posted by hazek View Post
    Technically speaking it does not create money out of thin air although the way it leaves people perceive their money FRB has the effect as if it did create money out of thin air. And I think it's debatable why that is, I'd argue because people just don't bother to thoroughly read the contracts they signed with a bank since they know banks are FDIC insured and they don't care what happens with their money or the bank.
    not sure if you are talking about the fed or banks, but if the banks are creating upto 9x the amount of debt from one deposit, then to me that's creating money out of thin air. wonder if credit unions can do the same thing. you are right that most people don't care - and that is a huge problem because it impacts their daily lives and they don't even know it. i guarantee you that 95% of the population doesn't understand that they don't have money in the bank even though their statement says they do - it's belongs to the bank and all you have is a promise to pay it back - if able. think that's right.

  27. #26

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    Quote Originally Posted by cbc58 View Post
    wonder if credit unions can do the same thing.
    Yes...credit unions also practice FRB...they're nothing more than not-for profit banks...in which profits are rolled back into lower interest rates. So they're bad too.

  28. #27

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    Quote Originally Posted by cbc58 View Post
    not sure if you are talking about the fed or banks, but if the banks are creating upto 9x the amount of debt from one deposit, then to me that's creating money out of thin air. wonder if credit unions can do the same thing. you are right that most people don't care - and that is a huge problem because it impacts their daily lives and they don't even know it. i guarantee you that 95% of the population doesn't understand that they don't have money in the bank even though their statement says they do - it's belongs to the bank and all you have is a promise to pay it back - if able. think that's right.
    No, technically speaking they are not creating money.

    On their balance sheet they are taking deposits and loaning a portion of it out while still offering demand deposits. As long as this isn't hidden from their depositors (and it isn't, read your contract with your bank) then there's no fraud and certainly no creation of money. But because these are demand deposits and because banks are FDIC insured and because they have a lender of last resort people don't read and understand their contracts with their banks and they don't know that their demand deposit is levered up to who knows how much so they ignorantly act in the market place as if there is more money when in fact all there is is loans being reloaned that are being reloaned that are being reloaned ect..
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    Quote Originally Posted by LibForestPaul View Post
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    Can you demonstrate what is incorrect in what I said? Thanks.
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    Quote Originally Posted by hazek View Post
    No, technically speaking they are not creating money.

    On their balance sheet they are taking deposits and loaning a portion of it out while still offering demand deposits. As long as this isn't hidden from their depositors (and it isn't, read your contract with your bank) then there's no fraud and certainly no creation of money. But because these are demand deposits and because banks are FDIC insured and because they have a lender of last resort people don't read and understand their contracts with their banks and they don't know that their demand deposit is levered up to who knows how much so they ignorantly act in the market place as if there is more money when in fact all there is is loans being reloaned that are being reloaned that are being reloaned ect..
    I understand what you are saying "technically speaking" - but they are creating debt which is the basis for money creation so therefore they are creating money - but not technically speaking. What a racket.

  31. #30

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    Quote Originally Posted by Danan View Post
    But that 90$ can be deposited again, and from that 81$ can be lent out again, and so on.
    yes, so at the end of the day, there may be close to $900 in circulation. But that's FAR less than somebody saying one $100 is deposited, they're allowed to lend out $900, because that means the next deposit will allow said bank to lend out $8100, where would that stop?

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