Banking

"Banks don't lend money, they create it from debt. The bank lends promises to provide money which they don't possess." —Irving Fisher

• If the debtor wants to take cash from this debt, then the bank converts the debt into fiat currency, which the debtor must accept as currency.

the only money that the bank creates is the principle amount of the loan. The interest payments must come from elsewhere in the circulation of money (that money is also derived from bank loans)

• Therefore in the aggregate, the debtors must repay the principle + interest of a loan from a total money pool that is composed only of principle.

Banking Origins: The Goldsmith's Tale

• note: This is not how it really happened, but rather an allegorical history of banking.
• source: Money as Debt

Imagine you are a minter from the middle ages: you take gold, and melt it into a standardized coin, which saves people the trouble of having to verify the gold's purity and weigh it. At some point, the minter needs a place to put his gold, so a vault is created to store it. Soon, other people need a place to store their gold, so they arrange to have the minter also take their gold. In exchange, he gives them a claim check, basically saying "the bearer of this check can redeem it to receive the stated amount of gold". What has just been created is in some sense money, since vendors in the market can deal with just the claim checks: they never have to actually handle the gold that it represents. Now, the minter is in a position where he can just lend out the claim checks to those looking for a loan. He doesn't need to actually give out the gold, so the depositors are safe from any kind of mishandling of their money. In exchange for keeping their gold with the minter, they were given a small interest payment. Thus the idea of a bank was born. But this is not how banking works in the 21st century.

At some point, the minter (now more so a banker) realizes that since no one has visibility into his vault, he can give out claim checks as debt for gold that didn't actually exist. The only risk to this was a bank run. The result of this ability to create claim checks and issue credit to borrowers allowed the economy to expand at such a pace that would never have been possible otherwise. Because of this, the practice of printing off claim checks and lending it out was considered legal, but regulated: bankers agreed to limits on the amount of fictional claim checks that could be lent out. Often, the ratio has been 9 to 1 (only 1/9th the value of money in the economy has to be held as gold). This is the fractional reserve system. Note, the modern day fractional reserve system works the same in principle, but with one impactful distinction: The ratio in question is new debt money to existing debt money on deposit in the bank.

Modern banking

In the past, one paper dollar was redeemable for an equivalent amount in silver. Now, $1 is only redeemable for another $1

A bank's reserves consist of 3 parts

• amount of government issued cash in vault
• amount of credit it has with central bank
• amount of existing cash it has on deposit from its customers

When a loan customer needs $10,000 to buy a car. Upon approval, the bank opens a new credit account, and acknowledges that it owes the borrower $10,000. This $10,000 is not taken from anywhere, and is created on the spot. The borrower does not take this money out as cash, and instead writes a check to the owner of the car. The owner of the car then takes this cheque to the bank and deposits it. At a 9:1 fractional reserve ratio, the bank is then able to create a new loan of $9,000. Like a russian doll, this can continue along, with the next amount being $8,100. All of this new money has been created entirely from debt. The process only stops when the money is taken out as cash and not deposited at a bank. This is the unpredictable nature of the money creation mechanism.