Economics 101: Creating Money

Banks create money. That's their main purpose. When a bank loans you $100,000 to buy a house, they don't actually have $100,000 sitting in a vault somewhere. In fact, at most, they have about $10,000 because the "liquidity ratio" in the U.S. is between 0 and 10% [[http://en.wikipedia.org/wiki/Reserve_requirement#United_States]]. (Watch Bailey try to explain this next Christmas while you're watching It's A Wonderful Life for umpteenth time) The other $90,000 is, effectively, a kind of credit... a promise to pay in the future. Yes, they will cut a check for $100,000 but they're only allowed by the government to do that as long as they have deposited no more than 10% of that amount with the Federal Reserve. Every dollar the government prints, is either in the bank or a promise to pay in the future... a bank or someone holding government bonds (i.e. Treasury bills, Savings Bonds, etc.). Thus, about 90% of the "wealth" in the U.S. is in these promises-to-pay. The more common name is "credit."

2014-01-24

This paper effectively refutes the accepted explanation of "fractional reserved banking" the "money multiplier"
http://www.thefreelibrary.com/Money,+credit+and+bank+behaviour%3A+need+for+a+new+approach.-a0250677146 and makes the case that it was this reversal of cause and effect that caused the actions taken in response to the 2008 financial crisis to be largely ineffective.