Note, that the following is taken (typed by me) from the documentary “Money as Debt”. Please note that it’s difficult to type as fast as someone talks (depending on the speed of speech, etc), so I may have one or two mistakes, but overall I think it’s fine. If you’re interested, please watch the whole documentary, as it puts the entire current US economic crisis into perspective, and explains the reasons behind it.
This is only one tiny portion of it, the documentary is very in-depth and explains a lot more, about the exponential growth of the US economy due to rapid and above all exponential consumerism through debt, and why it cannot continue to function the way it does.
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In the past, it was common to require banks to have at least $1 worth of real gold in the vault to back every $10 of debt created. Today reserve requirement ratios no longer apply to the ratio of new money to gold on deposit but merely on the ratio of new debt money on existing debt money on deposit in the bank.
Today a bank’s reserves consist of 2 things, the amount of government issued cash that the bank has depositied with the central bank plus the amount of already existing debt money, the bank has on deposit.
To illustrate this in a simple way, lets image that a new bank has started up and has no depositors yet, however the bank’s investors have made a deposit of $1111.12 of existing cash money at the central bank. The required reserve ratio is 9:1.
Step 1: The door’s open, and the bank welcome their first loan customer. He needs $10,000 to buy a car. At the 9:1 reserve ratio, the new bank’s reserve – the central bank allows it to legally conjure nine times that amount (9×1111.12) – or $10,000 on the basis of debt. This $10,000 is not taken from anywhere, it’s brand new money simply typed into the borrow’s account as credit. The borrower then writes a cheque on this bank credit to buy the car.
Step 2: Then seller then deposits this newly created $10,000 at her bank. Unlike the highly-powered government money at the central bank, this created money cannot be multiplied by the reserve ratio, instead it’s divided by the ratio. At the ratio of 9:1 a new loan (of $9000) can be created on the basis of the $10,000 deposit.
Step 3: If that 9,000 is then deposited by a third party, at the same bank or a different one, it becomes the basis for a third issue of bank credit, this time for the amount of $8,100. This is like one of those Russian dolls, where each layer contains one slightly smaller than the previous, each new deposit creates the potential for a slightly smaller loan, in an infinately decreasing series.
Now, if the loan money is not deposited at the bank, the process stops. That’s the unpredictable part of the money creation mechanism. But more likely, at every step the money will be deposited at a bank, and the reserve ratio process can repeat itself over and over, until almost $100,000 of banking money has been created in the banking system.
All of this new money has been created entirely by debt, and the whole process has been legally authorised, from the initial deposit of $1111.12, which is still sitting untouched at the central bank.
What’s more, under this ingenious system, the books of each bank and the chain must show that it has 10% more on deposit than it has out on loan. This gives banks a very real incentive to seek deposits, in order to make loans, this supports the general but misleading impression that loans come out of deposits.
Now, unless all the successive loans were deposited at the same bank, it cannot be said that any one bank got to multiply it’s initial, high-powered reserve money by almost 90 times ($1111.12 * 90 = $100,000) by issuing credit out of nothing – however, the banking system is a closed loop, bank credit created at one bank becomes a deposit in another, and vice versa. In theorical word of perfectly equal exchanges, the ultimate effect would be exactly the same – as if the whole process took place within one bank, that is, the bank’s initial central bank reserve of $1111.12 allows it to ultimately collect interest of up to $100,000 – which the bank never had.
As a result of lobbying by the banks, the requirements to make a deposit to the central bank have all but disappeared in some countries, and actual reserve ratios can be much higher than 9:1. For some types of accounts, 20:1 and 30:1 are common.
And even more recently, by using loan fees to raise the required reserve from the borrower, banks have now found a way to circumvent reserve limitations entirely, so, while the rules are complex, the common reality is simple – banks can create as much money as we can borrow.
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It’s kind of like, USA has hacked it’s own economy and created it’s wealth as debt out of nothing, and unless they stop hacking, the server admin is going to ban them.