When you transfer money from one bank to another, are they just moving virtual bits around? Is anything backing those transfers? What prevents banks from just fudging the bits and “creating” money?
In: 1559
On the creating money part banks in a roundabout way sort of do create money in the credit system. To simplify, banks make money by loaning out your money. When person A deposits money in the bank lets say £100, the bank will not make money if that money isn’t loaned out to someone else. So they loan it out to person B but what if Person A came back and wanted their money back? The bank obviously can’t give it back to them because Person B has it, so what the bank will do, is assume Person A will only ever come back for £10 at any time. This is good because the bank has £90 to give out to person B.
At this point, there is £190, the £100 that Person A is entitled to and £90 person B has in hand.
But what if Person B puts that £90 back into the bank. The bank will repeat the process keeping £9 and lending out £81 to person C. Now there is £271 even though there is only £100 of cash put in (£100 for Person A, £90 for Person B and £81 for person C).
If this process keeps going, with the bank assuming that every person will only ever come back for 10% of their money. The original £100 given to the bank by Person A turns into £1000 throughout alot of people even though no new money is deposited.
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