i know this is not really relevant but i was reading those pound on money pamphlets and other things and ezra pound is always going on about how banks create money from thin air. then i was reading the thing vimothy linked to, how banks work and it says there
nowhere in this exercise does the bank "create money." It borrows from one entity (the depositor mostly) and loans to another. It is an intermediary. Nor does the bank "multiply money." Try asking a banker, "How much money did you multiply last year?" Huh?
so what is the real true answer then?
I think Lewis is a bit more on the ball than IdleRich gives him credit for. Banks are basically big piles of loans (to its customers) and debt (from other banks) and a smaller capital base (i.e. shareholder equity). Banks borrow money at one rate and lend to someone else at another, and therefore hope to make a profit. In normal times, when the economy is healthy, banks don't need large reserves because they can borrow from other banks if, say, any given depositor wants his or her money back. Banks do keep reserves ("provisions") against loss, but these are typically small because they don't earn the bank any return. The bank is expected to maintian a certain asset to capital ratio (which Bear Stearns
must have fallen foul of) -- Lewis says it's about 10:1, and this high leverage is either the killer and the cream depending on how the economy's doing.
As I understand it, the banks don't create money, they borrow it to make loans to others. That's why, on a financial statement, assets = liabilities + equity.
Well, what people are talking about when they say banks create money is (presumably) fractional reserve banking. Basically that means a bank only has to keep a certain fraction of the money loaned to it in reserve at a given time (on the expectation that not everyone will take out all their money at once) and can lend the rest out. Say the reserve is ten percent and a bank is lent £100, they only need to keep £10 and can lend out the other £90 to someone who will spend it and give it to someone else. Say that person then puts the money in the bank again, the bank only needs to deposit £9 (10%) and can lend out the other £81 which will find its way back into the banking system and the bank can lend a further £72.90 and so on and so forth until it has lent a total of £900 with the original £100 that was deposited. Money may not have been "created" or "multiplied" but £100 has been used to lend £900....
Is that the right way to think about it? Someone lends the bank £100, they lend out £90 (probably more) to someone who then
lends it back to the bank, who promptly lend it out to someone else. That's what deposits are, right -- liabilities?