Federal Reserve Interest Rates - How Banks create Money Out Of Thin Air
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Bankers know how to originate money out of thin air. In fact, banks are money factories. Banks exist to make money. You might think that banks are in enterprise to provide services such as banking accounts and loans to their customers. It's true that banks provide primary financial services. However, the presuppose that the banks provide such services is that banks need money to use as raw material to originate more money. Where does this money come from? It comes from customer deposits. In other words, it comes from the money you and I deposit into the bank.
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Notice very carefully, banks "create" money. It's not naturally that banks "earn" profits when they provide bank services and loans. Banks de facto "create" new money that did not exist before.
Here is an example of how banks originate money. You deposit 0,000 into a one-year Certificate of Deposit at 5% interest. The bank now can use your money to originate loans.
The Federal sustain sets the sustain rate for the bank from 3-10%. A 3% sustain rate means that the bank must keep 3% of the 0,000 on sustain and can loan the remaining 97%. A 10% sustain rate means that the bank must keep 10% of the 0,000 on sustain and can loan the remaining 90%. For our example, let's assume that the sustain rate is 10%. This allows the bank to loan ,000 of your 0,000 deposit.
So, the bank makes Loan #1 of ,000 and keeps ,000 on reserve. This is the primary point where the bank creates money. According to the bank's balance sheet, the ,000 loan to the borrower is also a ,000 asset for the bank. By its own brand of money magic, the bank has created ,000 out of thin air.
But the process does not stop here. Since the bank now has an asset of ,000, it can make an additional one loan based on this asset. Since the same Federal sustain rules apply, the bank must keep 10% of this asset on reserve. This means it can loan only 90% of the ,000. This means that Loan #2 is ,000. By creating an additional one loan, the bank has created an additional one asset. The ,000 loan to the borrower becomes an ,000 asset for the bank. Once again the bank creates money out of thin air.
And since the bank now has an added ,000 asset, it can make an additional one loan. Once again, the bank must keep 10% of this asset on reserve. This means it can loan only 90% of the ,000 asset. Loan #3 is ,900.
Federal sustain rules allow the bank to make five to six loans based on the primary 0,000 deposit. Each loan creates an added asset. We'll stop at three loans, report the process, and add up how much money the bank has created.
You deposit 0,000 into a Cd. The bank creates three loans based on the primary 0,000 deposit. Loan /Asset #1 = ,000 Loan/Asset #2 = ,000. Loan/Asset #3 = ,900. The total = 3,900 in assets for the bank. This is 3,900 in new money.
When you cash out your Cd, you get your 0,000 deposit back, in expanding to the ,000 interest. Meanwhile, the bank has created 3,900 of new money. After it pays you 5% interest, the bank has made a tidy profit of 8,900. (3,900 - ,000 = 8,900.) If the numbers are confusing, go over them again until you see how magical this process is. This is how banks originate money.
To make this point, I have oversimplified the process. A bank doesn't de facto make a series of cut off loans based on a particular deposit. Your deposits come to be part of a pool of money the bank can use to make loans. But this oversimplified example demonstrates how banks originate money out of thin air. A bank commerce money by using the deposits of customers to make loans. The loans come to be assets and the assets turn into money.
What distinction does it make to see how banks use money to originate money? You and I can't do what banks do, by loaning on the same money more than once. The real point of this example is to take some of the strangeness out of money.
The process a bank uses to originate money demonstrates that money is not a commodity in tiny supply, where there is only so much to go around. Money is not equivalent to currency. Money is created in money-making transactions, which means there is no potential limit to money.
So, if you want more money, think the way bankers think. Ask how you can use money to originate more money. If you de facto think the way bankers think, you will use person else's money to originate more money. The crucial idea behind all of this is: The most limit to money is the confidence that money is limited.
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