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How MONEY & BANKING Really works - Part 1 (2 of 5)
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over the years the fractional Reserve System and its Integrated Network of banks backed by a central bank has become the dominant money system of the world at the same time the fraction of gold backing the debt money has steadily shrunk to nothing the basic nature of money has changed in the past a paper dollar was actually a receipt that could be redeemed for a fixed weight of gold or silver in the present a paper or digital dollar can only be redeemed for another paper or digital Dollar in the past privately created Bank credit existed only in the form of Private Bank notes which people had the choice to refuse just as we have the choice to refuse someone's private check today in the present privately created Bank credit is legally convertible to government issued fiat currency the dollars loonies and pounds we habitually think of as money fiat currency is money created by government Fiat or decree and legal tender laws declare that citizens must accept this Fiat money as payment for debt or else the courts will not enforce the obligation so now the question is if governments and Banks can both just create money then how much money exists in the past the total amount of money in existence was limited to the actual physical quantities of whatever commodity was in use as money for example in order for new gold or silver money to be created more gold or silver had to be found and dug out of the ground in the present money is literally created as debt new money is created whenever anyone takes a loan from the bank as a result the total amount of money that can be created has only one real limit the total level of debt governments place an additional statutory limit on the creation of new money by enforcing rules known as fractional Reserve requirement requirements essentially arbitrary fractional reserve requirements vary from country to Country and from time to time in the past it was common to require Banks to have at least $1 worth of real gold in the vault to back $10 worth of debt money created today Reserve requirement ratios no longer apply to the ratio of new money to gold on deposit but merely to the ratio of new debt money to existing debt money on deposit in the bank today A bank's reserves consist of two things the amount of government issued cash or equivalent that the bank has deposited with a Central Bank Plus the amount of already existing debt money the bank has on deposit to illustrate this in a simple way let's imagine that a new bank has just started up and has no depositors yet however the bank's investors have made a reserve deposit of $1,111 12 of existing cash money at the Central Bank the required Reserve ratio is 9 to1 step one the door is open and the new bank welcomes its first Loan customer he needs $10,000 to buy a car at the 9 to1 Reserve ratio the new bank's Reserve at the Central Bank also known as high-powered money allows it to legally conjure into existence nine times that amount or $10,000 on the basis of the borrower's Pledge of debt this $10,000 is not taken from anywhere it's brand new money simply typed into the borrower's account as Bank credit the borrower then writes a check on that bank credit to buy the used car step two the seller then deposits this newly created $10,000 at her bank unlike the high-powered government money deposited at the central bank this newly created credit money cannot be multiplied by The Reserve ratio instead it's divided by The Reserve ratio at a ratio of 9 to1 a new loan of $9,000 can be created on the basis of the $10,000 deposit step three if that $99,000 is then deposited by a third party at the same bank that created it or at a different one it becomes the legal basis for a third issue of bank credit this time for the amount of $8,100 like one of those Russian dolls where each layer contains a slightly smaller doll inside each new deposit contains the potential for a slightly smaller Loan in an infinitely decreasing series now if the loan money created is not deposited at the bank the process stops that's the unpredictable part of the money creation [Music] mechanism but more likely at every step the new money will be deposited at a bank and the reserve ratio process can repeat itself over and over until almost $100,000 of brand new money has been created within the banking system all of this new money has been created entirely from debt and the whole process has been legally authorized Ed by the initial Reserve deposit of just $1,112 which is still sitting untouched at the Central Bank what's more under this ingenious system the books of each Bank in the chain must show that the bank has 10% more on deposit than it has out on loan this gives Banks a very real incentive to seek deposits in order to be able to make loans supporting the general but misleading impression that loans come out of deposits now unless all the successive loans are deposited at the same bank it cannot be said that any one bank got to multiply its initial high-powered money Reserve almost 90 times by issuing Bank 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 a theoretical world of perfectly equal exchanges the 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 a little over $1,100 allows it to ultimately collect interest on up to $100,000 the bank never had if that sounds ridiculous try this in recent decades as a result of steady lobbying by the bank Banks the requirements to make a reserve deposit at the nation's 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 to1 and 30 to1 ratios 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 requirement limitations entirely so while the the rules are complex the common sense reality is actually quite simple Banks can create as much money as we can borrow
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