mainarticles   mainarticles
mainarticles
mainarticles   mainarticles
mainarticles
mainarticles

Home | Business | Customer Service


How Banks Create Money Out Of Thin Air

By: Kalinda Rose Stevenson, PhD
 

Bankers know how to create money out of thin air. In fact, banks are money factories. Banks exist to make money. You might think that banks are in business to provide services such as banking accounts and loans to their customers. It's true that banks provide essential financial services. However, the reason that the banks provide such services is that banks need money to use as raw material to create more money. Where does this money come from? It comes from customer deposits. In other words, it comes from the money you and I deposit into the bank.

Notice very carefully, banks "create" money. It's not simply that banks "earn" profits when they provide bank services and loans. Banks actually "create" new money that did not exist before.

For example: You deposit $100,000 into a one-year Certificate of Deposit at 5% interest. Your money now becomes raw material for bank loans.

Banks must operate under Federal Reserve rules. One rule concerns reserve rates. Banks cannot loan out all of their customers' deposits. They must keep a percentage "on reserve." The reserve rates vary between 3 and 10 percent. With a 3 percent reserve, the bank must keep only 3% of your $100,000 on reserve. It can loan out the remaining 97 percent. With a 10 percent reserve, the bank must keep 10% of your $100,000 on reserve. This means the bank can loan out only 90 percent, or $90,000. To keep the numbers simple, let's assume that the reserve rate is 10 percent.

This is the point where the bank does its money magic. It makes a $90,000 loan to a borrower. Now, this $90,000 loan goes on the bank's balance sheet as a $90,000 asset. This is the critical point at which the bank creates money out of thin air.

But the process does not stop here. Since the bank now has an asset of $90,000, it can make another loan based on this asset. Since the same Federal Reserve rules apply, the bank must keep 10% of this asset on reserve. This means it can loan only 90% of the $90,000. This means that Loan #2 is $81,000. By creating another loan, the bank has created another asset. The $81,000 loan to the borrower becomes an $81,000 asset for the bank. Once again the bank creates money out of thin air.

And since the bank now has an additional $81,000 asset, it can make another loan. Once again, the bank must keep 10% of this asset on reserve. This means it can loan only 90% of the $81,000 asset. Loan #3 is $72,900.

Even though the Federal Reserve allows banks to make five to six loans based on the original $100,000 deposit, we'll stop at three. Each new loan is a new asset, which means new money for the bank. Let's add up how much new money the bank created.

You deposit $100,000 into a CD. The bank creates three loans based on the original $100,000 deposit. Loan /Asset #1 = $90,000 Loan/Asset #2 = $81,000. Loan/Asset #3 = $72,900. The total = $243,900 in assets for the bank. This is $243,900 in new money.

When you cash out your CD, you get your $100,000 deposit back, in addition to the $5,000 interest. Meanwhile, the bank has created $243,900 of new money. After it pays you 5% interest, the bank has made a tidy profit of $238,900. ($243,900 - $5,000 = $238,900.) If the numbers are confusing, go over them again until you see how magical this process is. This is how banks create money.

The process is not as linear as my example. Banks don't make a series of separate loans based on an original deposit. When you deposit your money into the bank, your money becomes part of a large pool of money, which the bank can use to make loans. But my oversimplified example shows how banks use customer deposits to make money out of thin air. You deposit money, the bank keeps some on reserve, and uses the rest to make loans. The loans become assets, and the assets become new money.

What difference does it make to see how banks use money to create money? You and I can't do what banks do, by loaning on the same money more than once. The real point of this example is to take some of the mystery out of money.

The critical point is to see that money is not a commodity. Money is not equivalent to currency. Money is created in money-making transactions.

So, if you want more money, think the way bankers think. Ask how you can use money to create more money. If you really think the way bankers think, you will use someone else's money to create more money. The crucial idea behind all of this is: The greatest limit to money is the belief that money is limited.

Article Source: Main Articles

Kalinda Rose Stevenson, Ph.D. Learn how making money is different than earning money in a real estate investing book, "No Money Limits." Visit www.NoMoneyLimits.com to get your Free "52 Heart of Money Insights."

This article may be reproduced wholly or in part without written permission provided the byline, resource area, and any hyperlinks remain in order to give proper credit to the author.

Internet search engines and directory listings are imperative to your sites existence and success. Submit Your Website to the Searchen Networks directory and search engine to achieve authoritive inbound links.

Please Rate this Article

 

Click the XML Icon Above to Receive Customer Service Articles Via RSS!
Additional Articles From - Home | Business | Customer Service
mainarticles
mainarticles Submit Articles
mainarticles Member Login
mainarticles Top Authors
mainarticles Most Popular Articles
mainarticles Submission Guidelines
mainarticles Ezine Notifications
mainarticles Article RSS Feeds
mainarticles New Stuff
mainarticles About Us
mainarticles Link to Us
mainarticles Contact Us
mainarticles Privacy Policy
mainarticles Terms of Service
  :: Top Author Businesses:
Try your luck, Play BlackJack
 
  :: Our Supporters:
 
 
 
 
mainarticles
mainarticles
Main Articles. All Rights Reserved. © 2005, 2006
Use of our service is protected by our Privacy Policy and Terms of Service.
mainarticles
 

Powered by Article Dashboard