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How Can Banks Create Money Out of Nothing?

Banks and their fractional reserve system simply explained.
How Can Banks Create Money Out of Nothing?

The titled question may seem very weird. But, is it true that the banks create money out of nothing? Yes! True! But there is a lot more going on that most people don’t understand. I myself get baffled sometimes understanding this. People say money doesn’t hold in the tree. But the truth is, modern banks can make money faster than that. Yes, you have heard it right. Let’s find out how!

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Most of the money in our economy is created by the banks in the form of deposits. It’s just a few numbers that appear in your bank account. Money is created whenever banks make loans. You will also be amazed knowing that 97% of the money in the economy today just exists as the bank deposits whilst only 3% is just physical cash.

The money that the bank makes is not like our paper money that bears the signature of the government. When you check your balance, the money that flashes up on the screen is just a few electronic numbers. The bank only keeps 3-10% of the paper money with them. (This percentage varies upon the amount depositors want to deposit and the country) When we go to the bank and want to deposit our paper money, we are not actually depositing our paper money which will be reserved safely in the banks. Instead, we actually lend our money to the bank. And within certain legal limits, the banks can use the money as they please. For example, lending to another person or institution. This is where the money making machine reaches its maximum level.

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Because, here’s a term that raises up its head named “Fractional Reserve Lending”. This means that banks are legally allowed to reserve a fraction of your deposit and lend the rest of the money elsewhere. This reserve ratio varies from country to country. Let’s move for an example to understand this easily. Let's consider this percentage to be 5%. So, if you deposit 1000$ into your account, then the bank can legally take out (95%) = 950$ from your money and they can lend this to another person or institution. Even without notifying you. As the theory of fraction reserve lending, banks must reserve 5% of your deposit money. This reserve money is called “Vault Cash”. The question is, if the bank really took your 950$, then how does it yet show 1000$ in your account? The answer is: Bank already has created an IOU instead of that money which is called “Bank Credit”.

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Well, this IOU money is totally different from paper money that only exists on computers. The number is actually typed by a human. These numbers are actually a liability from bank to you. Nothing else! So, now you understand 950$ is newly created. Thus, it makes 1950$ in the economy. People usually take a loan from a bank to buy something. Suppose a borrower borrows 950$ from a bank that lends him from your 1000$ account. Now, this borrower buys something by 950$. Guess what? The seller will deposit that 950$ to his bank account. Hence, his bank again lends the 902.5$ (95% of 950$) to another one as a debt. That means, this 950$ creates another IOU of 902.5$ which turns 950+902.5 = 1852.5$ in the economy.

Bank actually reserved 5% of the money which was 47.5$ only. But for the IOU it shows the whole 950$ money in his bank account. This is how by creating electronic IOUs, banks can effectively create a substitute for paper money. This thing is repeated over and over time. Imagine, the base money was only 1000$. Now it made a lot of money out of nothing. The whole credit money is only backed by 1000$ paper money. And this paper money is backed by just the air. Yes, just the air. The reality is that the amount of this currency supply through banks is much more and faster. The more borrowers there are, the more this currency supply will increase. Most of the currency supply is increased through this banking way which is backed by just the AIR.

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Yet people like to bash Cryptocurrencies, like Bitcoin, for being worthless when in reality it takes a lot of energy, dedication, and brains to mine and secure bitcoin.

Let this be a reminder that you must always not take things for granted, especially in this peak of corruption we now live in since the Covid money has been distributed and they are continuing to scheme with our deposited money. Actually most of the American Covid Relief was printed based on how much tax people paid. Other relief came in the form of subsidies to business. Certain businesses were targeted with this ‘free’ money.

Always be skeptical, let that be today's reminder. Enjoy saving your wealth.

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