[whyhow]

So the depositor put $1,000,000 in the bank and the bank loans $850,000 to a small business so it can buy more inventory. The small business goes to the widget manufacturer and writes a check which the manufacturer deposits into the bank. So now the bank has 1,850,000 in deposits and 850,000 in loans.

The bank takes the new deposits and loans out 85% of it ($723k) to another small business. This small business goes and uses it to pay its employees and they all deposit the money in the bank. Now the bank has $2.573m in deposits.

The employees and the manufacturer can all withdraw the money at any time. So I struggle to see how this isn't creating money.

The fractional reserve system lets the bank loan the same dollar out multiple times. How isn't this creating dollars? If the bank takes one dollar and loans 85 cents to you and 73 cents to me, isn't there more money?

[amurthy1]

> The employees and the manufacturer can all withdraw the money at any time

This isn't quite correct. If all parties go to withdraw their money at the same time, the bank will not be able to give it, because they only actually have $1M in reserve.

In practice, if there are more withdrawals than than the bank has in reserve, it is usually able to get short term loans from the central bank which than ACTUALLY creates the money and loans it to the bank.

However, over the long-term if too many of the bank's loans default, they won't have enough assets to cover the deposits, which is how banks usually fail.

[hinkley]

And you might think, "Well, there are so many banks, that money probably won't end up back at mine," but yes, there are so many banks, all of them giving out loans. My million ends up all over town and the world, but so does yours.

[eru]

There's not more base money, but more money-like assets.

[renewiltord]

And AFAICS, the sum of this 'base money' + other expanding groups of money-like assets is where the M2, M3, etc. definitions of money go to.

[eru]

Yes, exactly.

[AmericanChopper]

Because doing it one time, or 10 times, or 1,000 times doesn't change anything about how it works. If everybody pays all their debts, it all adds back up to $1,000,000 in cash (plus interest for the bank(s)).

[hinkley]

But everyone hasn't paid their debts, and they won't pay the biggest one for a very long time. All that negative money is floating around.

[whyhow]

No it doesn't. In my example the bank loaned out $850k to the first small business and $723k to the second. That's $1,573,000. The bank started with $1million.

It absolutely matters how many times the dollars come back to the bank because that is the pathway that lets the bank loan the same original dollar out multiple times.

[AmericanChopper]

I think you’re forgetting the bit where the business that took the $850,000 loan is left with $850,000 debt and $0 balance after they spend all of it. Every time it passes through the system the amount recirculated simply decreases by the reserve %. It all still adds up to the original amount (plus interest).

In your example though, the bank has a different problem of offering unsecured loans, which could lead to some losses for them.