How Banks Magically Create Money

Updated on March 8, 2019
Tommy Limpitlaw profile image

A keen observer of world affairs. Whether it's political or economical (both the same really) I like to keep myself informed.

Money Money Money
Money Money Money | Source

It's Not Even Money

The issuance of money is a vague and complicated matter, but if you look into it, you will see that we are being defrauded by our governments and the banks. It’s vague and complicated, because it’s meant to be. That way, they can keep magically creating as much money as they need. But the thing is, they’re not actually creating money. Money isn’t those pieces of paper with a monarch or former president printed on that allow us to buy goods every day. That is currency and that is very different from money.

The currency that we use is basically an IOU. Money needs sound value. It has to be tied to a store of value like gold and silver, and be valuable for a long-term investment. It has to maintain its purchasing power over long periods of time. Think about it: If you were to keep $100 of today’s paper currency in your possession, through inflation it would lose its purchasing power over time. That is not the definition of money.

Inflation is a slow and insidious tax that eats away at any currency we have, which means it makes more sense to spend it than keep it. But the thing is: Inflation isn’t the fault of rising prices; it’s a manifestation of the creation of free flowing currency. Because there is so much of it, the new currency in existence naturally devalues itself against all the commodities and the result is the rising price of everything around us. That is not the definition of money; it’s currency. And the reason it has lost so much value is because the governments and banks’ infatuation with spending has absolutely devalued it.

Central Banks Printing Press
Central Banks Printing Press | Source

How Currency is Created

The Treasury borrows money by issuing a Treasury Bond, which is basically an IOU and a promise to pay back the money to the banks that buy them, with interest of course. With their newly acquired bonds, the banks go to the Central Banks, who write the banks a cheque for their bonds and like magic: currency is created. So, basically, the Treasury and Central Banks are swapping IOUs, using banks as a mediator, to magically create the new currency into existence. This is repeated over and over and over again and again and again (I’ll stop there, but you get the picture?).

The newly created currency is then distributed from banks to different parts of society, such as governmental departments. They then spend it wisely on wars, their friends’ Corporations, and of course governmental employees. And it’s when this newly formed currency is distributed back out to mainstream bank accounts that the vast majority of currency is created.

When currency is deposited into a bank account, which is what happens to most people’s currency in the western world, that amount isn’t actually stored for safekeeping. It’s deposited as a loan to the bank, who are then allowed to do whatever they see fit with it and the thing they love to do most is create more of it. They can create much more currency into existence using a very legal form of currency creation: Fractional Reserve Lending.

Fractional Reserve Lending

Fractional Reserve Lending is just like what it says on the tin: The banks reserve a fraction of the money deposited into their safekeeping. And when I say fraction, I mean a fraction. It varies from bank to bank, but a conservative bank will fractionally reserve 10% of your deposit. With the other 90% they just create IOUs and keep them for us until we need it, but for the banks, that 90% is like a seed to a new magic money tree.

Fractional Reserve Lending
Fractional Reserve Lending | Source

Here’s how their money tree sprouts and blossoms: If $1000 is deposited into your bank, the bank will safely keep $100 of it for you. They will then type a $900 IOU into their database to make the rest up and safely store it in their system for you. The other $900 is theirs to do whatever they want, which is play on the stock markets or lend it to other people for a charge. This might seem fair considering banks are providing a service, but the money tree really gets aroused when that $900, which was lent to someone else, is deposited into that persons account.

That $900 deposited in the borrower’s account is then fractionally reserved, and so the bank only has to store $90 of it, while it can lend $810 to someone else. This would be paid into somebody else’s account, and the bank would only have to hold 10% of that while lending another 90% to somebody else. This cycle is repeated over and over and over. In fact, for every $1000 deposited, the banks can create an astonishing $10,000 of currency, while holding only $100 of the original deposit.

Surely the Banks Would Pay Up?

What if there was a surge of people who demanded their savings out of the bank? Well, the banks are pretty confident that won’t happen. After all, our money is safer in the bank, isn’t it? Of course, it’s not a great idea to store your life savings under your mattress, and the banks do provide security for us. However, if, for whatever reason, many people did start rushing to the banks, demanding what was theirs, banks wouldn’t be able to pay up.

If you remember the Greek Debt Crisis in the aftermath of the 2008 Economy Crash, Greeks started losing faith in their government and began demanding what they thought was legally theirs. The banks couldn’t possibly handle it and so they allowed a maximum of €60 per day. It was even worse in Cyprus in 2013. Their government had spent too much and they defaulted on their debt repayments, so what did the Bank of Cyprus do? With advice from the IMF, they stole 60% of all of the customers’ wealth. Just took it. There was nothing the Cypriots could do.

US Dollar - a Victim of Overspending and Inflation
US Dollar - a Victim of Overspending and Inflation | Source

Fiat Currency is a Promise of Value

There is no real, true value in currency. Since the world came off the gold standard, currency has been built on faith and a promise from the governments and banks. That almost failed in 2008 until the governments printed their way out of trouble. But all this free flowing printing affects any currency’s worth and the debt ceiling of every nation keeps getting higher.

The truth is, however, that the debt ceiling cannot be lowered. In fact, it isn’t even meant to be lowered. The whole system is designed on debt and debt is the only thing that keeps the system going. There will come a time, however, when the system strains under the weight of all that debt. And then our currencies will evolve from inflating currencies to hyperinflating currencies and the paper we own wont only be worth less, but worthless.

Questions & Answers

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      • Tommy Limpitlaw profile imageAUTHOR

        Tommy Limpitlaw 

        8 months ago from Leeds, England (Now residing in Thailand)

        Yeah, it's disgusting how they just make money out of fresh air. That's why they came off the gold standard: to spend, spend, spend... They can manipulate it for as long as possible, but when it crashes, I think it'll dwarf 2008. Italy could be the catalyst for it.

        As for investing, I think it's good to diversify.

      • CWanamaker profile image

        Christopher Wanamaker 

        8 months ago from Arizona

        Another great article! Clearly you have knowledge in this subject. It's scary to think that our money is really value-less. I have been told that the wisest thing you can do with money is to invest in assets that can produce value for you and others. When the economy crashes and/or money becomes worthless, your assets will still have intrinsic value and can be used to barter with. This is especially the case if you invest in things that people need like infrastructure, energy, water, food production, land, etc.

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