I don’t get it. I don’t get it. I don’t get it. I don’t get it.
When a bank makes a $1,000 loan, that creates $1,000 in the recipient’s account, but I don’t get how the loan, the absence of money, is an asset on the lending bank’s books. If it’s because the money will be paid back, then isn’t it’s value based on a corresponding debit of the recipients account thus nullifying the created money?
Edit: I am not asking how banks make a profit. I get that. I am asking how NEW DOLLARS are created. There are more dollars in existence now than there were say 100 years ago. I want to understand how they came to be. The answer I’ve found so far is that NEW DOLLARS are created when a commercial bank makes a loan.
Second Edit: For those saying commercial loans don’t create new dollars, apparently they do, but I don’t get it. For reference:
https://positivemoney.org/how-money-works/proof-that-banks-create-money/
In: 23
Most of the “money” that runs through the economy is not dollars but bank debt.
The number you see in your bank account? Repeat out loud “This is how much my bank owes me.”
Banks are heavily regulated because they can literally create money out of thin air. Their liabilities (the money they owe to depositors) has to be balanced out by assets like a mortgage.
When someone takes out a 30yr mortgage say for 500K, the bank charges interest so they make 600K total at the end of 30years.
This mortgage becomes an asset of the bank and is worth 600K
At this point, the buyer has not even started paying a single cent yet the bank has magically created 500K out of thin air and sent it directly to the seller of the house who has 500K of new spending power to buy lambos or another house or whatever.
At this point, the bank has a 600K asset, basically a “wage slave contract” over the individual who took out the loan. This asset can even be sold to 3rd parties.
However, the asset is not worth the full 600K because there is a risk of default, the lendee may die, declare bankruptcy, etc… So if that’s an X% risk then someone may only be willing to value the asset at 550K.
TLDR; they make money out of thin air by changing numbers in a database. They take a small fee for creating “time contracts” that allow you to bring your future income into the present.
** If this time magic is irresponsibly used, then too much money is created and the banks can go bankrupt because their assets become worthless. Since most money is bank debt this means that the world’s money stops moving. Banks are like hearts, if they stop beating, the whole body stops.
Best way to grasp this is to look at the definitions of money. There’s M0: physical cash; M1: M0 plus bank deposits; M2: M0 plus M1 plus savings, certificates of deposit, money market accounts; M4: previous plus and so on, Essentially, any instrument readily exchangeable at face value. So it’s a series of debts, from most secure/least risky on down, fading out into IOUs and junk bonds somewhere down the chain. You buy a coffee with your card: bank transfers some of its debt to you to debt to coffee-shop. It’s created whenever any two or more parties record a transferable debt, and extinguished when the debt is written off.
Banks are the main record-keepers. This was not always so, and there are still other record-keepers. Banks also lend – they create debt, But many others do too – and those other debts can creep up the chain until they too are ‘money’.
The dollars that are created are the dollars that show on your account balance when you open your banking app.
That $2000 that got paid into your account by your employer is long gone, loaned out to someone else with interest added on.
But you’re sitting there on your coach happy cause you’ve got $2000 when in fact it doesn’t exist. The bank is betting that most people don’t withdraw their $2000 at the same time and they can keep enough cash sitting around that if you withdraw $50 from an atm they can cover it.
But of everyone does try to withdraw their $2000 then they’re screwed. This is what’s called a ‘run’ on the bank.
Some answers may seem confusing, so let me break down in simple steps and you, /u/DanGabriel let us know which step is confusing. (for simplicity assume same day, interest free transactions)
**Step 1.**
I am a bank. I have 100 EUR cash (owners put it in, so bank has on balance sheet 100 EUR cash on asset side and 100 EUR equity on liability side that is due to owners as their capital)
Persons /u/DanGabriel , Persons B and C have accounts in bank, but currently at 0 EUR.
**Step 2.**
I lend 90 EUR to DanGabriel and DanGabriel takes out this money as cash (assume, by law I’m required to keep 10% of assets in reserve; my assets are now 10 EUR cash and 90 EUR in loans to DanGabriel; and 100 EUR equity)
DanGabriel has 90 EUR in cash. (and 90 EUR debt)
**Step 3.**
DanGabriel goes to Person B and buys toaster from him, pays him in cash.
DanGabriel has toaster and 90 EUR debt.
**Step 4.**
DanGabriel has toaster and 90 EUR debt.
Person B then goes to bank (me) and deposits 90 EUR in his account.
Person B has sold toaster and has 90 EUR in bank account.
Bank (me) has on Asset side has 190 EUR (100 EUR cash = (10 I had before, +90 received as deposit) and 90 EUR loan to DanGabriel) and Liabilities (100 EUR equity due to owners, and 90 EUR owned to Person B that he has in account)
This should be already enough. As you can see bank has “created money” from EUR 100, it has assets of EUR 190 already. Seems that money in economy is also more – 100 EUR in cash in bank’s safe and 90 EUR in Person’s B account.
Just to continue example in shorter steps
**Step 5.**
Bank lends EUR 81 to Person C, Person C takes out as cash.
Bank now has assets EUR 190 = EUR 19 cash + EUR 171 loans to DanGabriel and C
**Step 6.**
Person C buys concert ticket from Person D.
Person D deposits his money in bank’s (mine) account.
Now bank has assets of EUR 271 (EUR 100 cash (deposited), EUR 171 loans to DanGabriel and Person C), while on liability side it has EUR 100 owner equity and EUR 171 in liabilities that are bank accounts of person B and Person D).
See, even more money in economy. And it goes on and on.
Duncan deposits $1000 in his savings account. The bank now has $1000 they can lend to Malcolm. Duncan’s account still says it has $1000 in it. Now there are $2000.
Another way to think of it is that dollars are created when you put the dollars in the bank, and it’s our fault.
Say I have a $100 bill. There is $100 total. End of story. Simple.
Now I go to the bank and I put it in my account. Now I have a bank account that says $100 on the screen, and the bank has $100. I don’t have $100 any more, just a bank account that says I do. The bank has all the money, which is $100.
But if I start counting my bank account as actual money, then I’m double-counting. I count the $100 account as $100 and I also count the bank’s $100 bill as $100, which adds up to $200 in total.
Honestly i alway knew that bank was capable of making money like a money tree. Its why we got such inflation to where it gotten as bad as it gets.
There no standard on min or maximum its all relative to population and fools to control. Obviously with current trend higher the population = more money for the elite
I’ll try and eli5 level explanation.
Imagine i have a vault with 100$ in it.
I can lend Jack 50$ for a year. But because ingots and coins are heavy, and can be lost, and stolen, etc. I can just give Jack a piece of paper saying: i (the bank) will give 50$ in coins to Jack, or whoever he paid those 50$.
Chances are, those people will accept the paper and not get the coins within the year. Jack will pay back after a year, and all is fine.
But i can also write 10 such papers, lend 500$ and be fine. (Profit increases tenfold this way) If the people pay me back, I’m good. My only problem occurs if too many cannot pay me back and suddenly i, the bank, owe more than i have.
Last time i checked, banks in Europe needed about 11% of the capital they lend, which means for every 11$ they actually owned, they could lend out 100$. And that’s after-banking-crisis rules…
As for your edit:
Now more money exists because money is bound to some value let’s take gold ingots (which is no longer true, but for eli5..). You did up some gold, smelt ingots, put them in a bank vault, print an according number of paper dollars.
Now you have more money than a year ago, in this world.
Let’s look at a country with only a single small bank to make it easier to see what’s happening. They have one depositor who deposited $100,000. The total deposits of the nation are $100,000 in deposits. If the next day the bank gets a loan application, they might be ready to make a $90,000 loan to the borrower.
Now the loan is made. What’s the borrower going to do with the money? It’s going to be deposited back in the bank (either by the borrower or when the borrower spends the money buy the guy who owns the business where the borrower spent the money). Now there are deposits of $190,000 in the only bank. No more currency exists, so the bank created the extra $90,000 with their loan.
Now because they have additional deposits. They can make another loan creating more money (the cycle is the same).
Obviously, in a nation with many banks, this pattern will be much harder to follow (the people paid by the borrower might bank in many different banks) but from the perspective of the system it’s almost exactly the same.
If you loan your car to a friend, it’s still your car. If your friend starts paying you in installments for your car, it’s still partially your car until he’s paid all the agreed payments. So, you maintain ownership of that asset and slowly replace the vehicle with cash. But essentially, you retain the same level of assets the entire time.
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