Where Does Money Really Come From?

Debt: The Source of Most Money

The way in which the banking system creates money by pyramiding debt is elementary economics. Say Person A, a wheat farmer, sells $1,000 worth of wheat and deposits the money in Bank M. Retaining 10 percent of the deposit as a reserve, Bank M is able to loan $900 to Person B, which Person B deposits in her account in Bank N. Now Person A has a cash asset of $1,000 in Bank M and Person B has a cash asset of $900 in Bank N. Keeping a 10 percent reserve, Bank N is able to make a loan of $810 to Person C, who deposits it in Bank 0, which then loans $729 to Person D, and so on. 

The deposit of the original $1,000 earned from producing a real product for consumption by real people ulti­mately allows the banking system to generate $9,000 in additional new deposits by generating a corresponding $9,000 in new debt - new money created without a single thing of value having necessarily been produced.

The banks involved in this series of transactions now have $9,000 in new outstanding loans and $10,000 in new deposits on the loans on the basis of the original deposit of $1,000 from the sale of wheat. They expect to receive the going rate of interest, let’s say 6 percent. This means that the banking system expects to obtain a minimum annual return of $540 on money that the system has basically created out of nothing. This is part of what makes banking such a powerful and prof­itable business!

In this instance, we have used the classic textbook example of how banks create money, taking into account the 10 percent reserve (the actual average is a bit less) that under present law must be deposited with the U.S. Federal Reserve system. Without such a reserve require­ment, the banking system could, in theory, pyramid a single loan with­out limit, which is essentially what happened (accelerated by profound “moral hazard”) during the Japanese real estate bubble and its subsequent collapse.

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