[NikolaNovak]

>>See Fractional Reserve Banking for the gory details, but the gist of it is, private banks create money out of thin air (within limits) so they can lend it to you. And then they charge interest back for it.

So I've googled and read upon it every time I hear this almost exact same sentence (and I see it every now and then), and I don't get it at a basic level. I have little to none awareness of high level finance, but my understanding of 'fractional reserve banking' is thus:

1. 100 people deposit $1 each to a bank. It has $100 of deposits

2. Without fractional reserve banking, bank would basically have to keep $100 in its vaults. It would be useless money going nowhere doing nothing.

3. With fractional reserve banking, bank basically has to (say) keep $10 in its vaults (digital as they may be), but can loan $90 to other entities (and do more complicated things with it). There are risks and benefits to this, and it is basically a full time job of many people at the bank and regulator to find various balances of risk and benefit, to bank and society, based on the policy and goal.

I don't understand where, in this simple math, does a regular bank "create money out of thin air". I'd love to understand when and how this may be the case (but NOT via angry youtubers, please:).

I do understand that central banks and/or the government control circulation and "create money" through various mechanisms, but I never get the feeling that is what we're talking about when people say "fractional reserve banking means private banks get to make money up".

[loup-vaillant]

> I don't understand where, in this simple math, does a regular bank "create money out of thin air".

Through rinse & repeat.

When the bank has loaned those $90, the deposits still show $100, and are still available to their respective owners. Just not all at once, but we don’t care as long as the illusion is maintained — and it is.

Where those $90 go? to other deposits. So where we had $100, we now have $190. Only $100 of those are central money, but again, as long as the illusion is maintained (and it is), everything works exactly as if we had $190. And since money is but a convention, a good enough illusion is actually real. $90 really have been created.

And those $90 that have been added to deposits can also be used to lend money. $81 in the current example. So now we have $271. Rinse & repeat indefinitely, eventually you end up with up to $1000 total, with $900 created out of thin air. As long as the illusion works at least. And it does.

Sure, sometimes it breaks down. Sometimes we get a bank run. But in practice the illusion is so important that the state steps it an make it real: by creating actual central money to compensate for the bank run. Heck, often just the promise of doing so is enough to prevent the bank run in the first place, and maintain the illusion.

Strictly speaking money hasn’t been created. It’s just an accounting trick. But the trick works. Those $900 may be fake money, but if people are using it (and they are), it’s also real money. It’s not real real money, but it’s close enough.

[CrazyStat]

> but we don’t care as long as the illusion is maintained — and it is.

> as long as the illusion is maintained (and it is)

> a good enough illusion is actually real.

> As long as the illusion works at least.

> But in practice the illusion

> maintain the illusion.

You sure like that word.

It's not an illusion. The money is real. It's real real. It's real real. There is nothing fake or illusory about it. It is just as equally real as a $100 bill straight from the Bureau of Engraving and Printing.

Stop pretending that it's not.

> But in practice the illusion is so important that the state steps it an make it real: by creating actual central money to compensate for the bank run. Heck, often just the promise of doing so is enough to prevent the bank run in the first place, and maintain the illusion.

This is false. FDIC is insurance. The money that is used to step in and rescue a bank is real money that comes from banks that pay insurance premiums to have their depositors' money insured. It's not "central money" created by the state. It's exactly the same kind of money that banks lend out to you and me. Banks pay insurance premiums to the FDIC and when a bank fails the FDIC uses those insurance premiums to step in and insure the deposits.

> Strictly speaking money hasn’t been created.

This is also false. Money really is created when banks give out loans based on fractional reserves. This is called the money multiplier effect, and it's a really important economic factor. But it's not fake money, it's real money. Real real money.

[loup-vaillant]

Yeah, the money is real. Yeah the money has been created. But you can't start from there when explaining it to a sceptic.

And there's still is one way the money isn't real: if everyone runs to the bank to retrieve their money they can't. Not all at the same time. But they never do, so the money is real.

> This is false. FDIC is insurance. The money that is used to step in and rescue a bank is real money that comes from banks that pay insurance premiums to have their depositors' money insured.

Oh, I see. A tad more complicated than I though, but the effect is the same, so my central point remains.

---

My step dad used to work in banks, and you, he, and I agree on how this all works. Interestingly though he didn't want to see it as "creating" money. He didn't quite accept the connotation, and I suspect the full consequences of fractional reserve. His exact word was that banks are authorised to transform money (which I suspect is a legal term in France).