FEBRUARY 10
Money From Nothing
When a Loan Creates Money
The Signal
When a bank creates a loan, new money and new debt are created together.
The Reading
Imagine you want to buy a $900,000 house. You have saved $100,000, so you ask the bank for an $800,000 loan. The bank says yes. Where did that $800,000 come from?
Most people imagine the bank takes money other people have saved and lends it to you, but that’s not generally how modern banking works. When the bank creates your $800,000 loan, it can also create $800,000 of new bank deposit money. Two things appear together:
$800,000 of new money.
$800,000 of new debt.
The money was created out of thin air. So was the debt, but it’s real, and you pay it back with interest. It isn’t just home loans. Business loans, personal loans and credit-card lending work through the same banking system. Millions of new loans can grow the pool of money people have available to spend, and borrowing doesn’t just create debt. Bank lending can also add new money to the money pool. If that money pool grows faster than the things people can buy, prices can rise. That is inflation.
Banks cannot create unlimited money. There are rules and limits that we will discover tomorrow. However, think about your $800,000 loan. You may work for decades to repay it. Part of each repayment reduces the debt. Another part is interest paid to the bank.
The bank created the loan with entries on its balance sheet. You work to repay it, plus interest. Much of the money in your country began in a similar way: someone went into debt.
First Principles
Banks can create new deposit money when they create loans.
Bank lending can grow the money pool and contribute to inflation.
Borrowers repay their debt plus interest.
Today’s Challenge
Today, you are the bank. Write:
HOME LOAN: $800,000
You approve it.
A repayment arrives. Cross off the part that reduces the debt. Circle the interest paid to your bank. Are you smiling? Lots of money for you. The longer your customer takes to repay, the more profit for you.
You love issuing credit cards now. Juicy, extra-high interest, and customers can take forever to repay.
Reduce the debt on the $800,000 home loan. Collect the interest, again and again. Reduce the debt a little and collect the interest.
Now ask yourself: who works for decades to repay the $800,000, and who created the loan with entries on a balance sheet and makes a huge profit from money created out of thin air?
Tomorrow’s Signal
Fractional Reserve Banking