Paphitis,
Thank you for your reply ......I appreciate the detail. I find the subject fascinating and realised a long time ago that most people don’t have a clue where money comes from nor the basis of its creation.
However in reply I have to say that I think your concept of money creation and banking is completely wrong.
My answer would be considerably different from yours because you have not included, nor mentioned, the crucial and global banking practice called ‘
Fractional Reserve Banking’ (FRB). It is this concept that will be the systems downfall and if you are not aware of the practice and how it works then you will never understand the flaw that will eventually collapse the Global banking and financial sector. It is a house of cards and based on an illusion of imaginary wealth by their creation of money from nothing.
You deserve a detailed explanation, albeit simplistic in content:
When you deposit say $1000 with the bank, it ceases to be your money, it is now the property of the Bank and their only obligation to you is to refund the money when you ask for it ........ well .............. that’s the idea providing you haven’t read the small print or happen to live in Cyprus!
Banks are required by Law to hold a fraction of the deposited amount as ‘reserves’ and the rest they are free to lend. Until quite recently that reserve has been as little as 3% but in Cyprus and more generally I believe the reserve requirement is now 10%.
So, of your deposit into your account of $1000, 10% ($100) the bank puts on a shelf as their ‘reserve’ and the remaining 90% ($900) they can loan out. When the bank loans the 90% to another customer it is paid into another bank account, (that may even be with the same bank) and again they hold 10% ($90) and can loan 90% ($810). Now, they have re-created your remaining $900 ($1000-$100) as new money in another account. That money did not exist until the loan was created by the bank. Your personal account will still credit you with the full deposit of $1000, a liability on the bank because they have to repay that money when you ask for it.
This process is repeated time and time again. The next time it goes through a bank account the deposit of $810 will be, 10% on the shelf ($81) and lend out 90% ($729). By this process, on a 10% fractional reserve the original $1000 will be increased to around nine times its original value. The original deposit now has a monetary value of $10,000 and ........... 90% of that is new money created as debt. Any ‘reserves’ held in excess of the required 10% amount, (i.e. not loaned out) are known as ‘excess reserves’ and are deposited with the Central Bank where the bank gets paid interest. These deposits, along with the Gold reserves and foreign currency reserves now form part of the Central Banks National Reserves. All this from an initial deposit by you of $1000, not bad going on the ‘something for nothing’ scale?
This works fairly well on a small scale when it is used within the commercial banking system. The Glass-Steagall Act of 1933 kept the commercial banks and the ‘Investment’ Banks as separate entities but, in 1999 this act was repealed by Pres. Clinton and the two completely different banking structures became a single entity. The investment banks now had access to the commercial bank vaults! The same thing happened to building societies when they were bought up by the banks.
This allowed the ‘Investment’ (Casino?) arm of the banks to use this money as investment capital but with the protection afforded to commercial bank deposits. In other worlds your $900 now multiplied by FRB to $9000 is now used as the stake to gamble on various ‘Products’ developed by the financial system such as hedge funds, commodities, derivatives, futures and a whole host of similar products. All the time they are winning the bankers pocket the profits, when things go wrong ...... the tax payer picks up the losses. In Cyprus the depositors picked up the tab and this is now being introduced as the ‘Norm’ for bank failures in the EU and other countries and re-titled a ‘bail-in’......... New Zealand being one, I don’t know whether Australia has followed suit.
The banks can now use your money to make the Bankers and traders rich but, when the Markets/Product goes tits-up they can lose enormous amounts of money, way beyond anything their reserves could possibly handle ......... the Sub-Prime fiasco being just one example ......... now they need bailing-out to replenish the reserves so that the whole system can start all over again. The losers? You and me as tax payers and/or bank depositors!
The second question:
The banks scream ‘
We are too big to fail .... we must be bailed out!’...................
The Government response is to ask the Central Bank for the Billions it needs for the bank bail-out. The Government issues Government Bonds to the CB for the amount needed, effectively these are dated IOU’s, and in return the CB transfers the same face value by electronic transfer for the Treasury to use ...........
to bail out the very same banks! This bail-out replenishes the bank’s reserves and allows them to create more money out of thin air.
So the Government has now increased its debt and has to pay the CB interest on this ‘loan’. This loan is all New Money and did not exist until the Banks created it as debt. If you or I tried to do this we would end up serving a lot of time for fraud ........ but hey, these are banks so that’s OK then? You couldn’t make this up if you tried!
The money generated by the casino banks is used to create even more money, it does not circulate through a natural wealth creating system. Therefore when financial services and banking are included as part of the equation for calculating GDP it is misleading, as this is simply ‘money’ stored on micro-chips and is in the main circulating through the financial system and not through the wealth creation system. The investment capital REAL Industry needs to grow normally comes from the commercial banks and gives a poor return for Bankers when compared with the likely returns from the ‘investment’ side, hence the difficulty many smaller businesses have in acquiring capital from the bank through loans, even though that is the primary function of a commercial bank.
This creation of new money evokes a continuous cycle of boom-and-bust and an ever expanding spiral of debt. This debt can never be repaid because, ..................... if it were even possible to pay off all the debt, which it is not ................. there would be no money for anyone to spend! As an example of the danger ............ the current liability of the derivatives market, when it fails, is 20 times the Worlds total GDP and that is just one financial ‘product’!!!!! The UK and most countries in general where the Central Bank is associated with the World Bank, IMF and The Bank of International Settlement, are all operating in the same way, including Australia.
This is just the tip of the iceberg ................. look up Fractional Reserve Banking or Creation of Money on YouTube, there are a whole host of examples.
However ............ there IS a solution which favours The People but will ruin a nice little earner for the Bankers and the Top 1%!
If Glass-Steagall was reinstated and the Central Banks were owned and controlled by the People (The Government) instead of Private Banks, then any money is created without debt and does not attract interest. It also circulates from Government back to Government in the way of capital projects/purchases and wages, through the normal circulating currency system as companies/people spend, through taxes on purchases and finally it then returns to the Government and is re-spent to circulate ad-infinitum through the expenditure/tax cycle again, instead of going back to the banks to pay off loans and interest. This monetary system also requires no imposition of income tax on earnings, as was the case in the USA before the creation of the Federal Reserve Bank in 1912(?) the taxes are all on purchasing/expenditure.
The financial system is Global and includes not just the banking system but the Stock Markets, where receipts for the initial purchase value (shares) can change hands at the rate of thousands of times a second. Share values have no direct relationship to the performance of wealth creating industry, merely the performance of The Markets.
Although primarily dealing with the USA, this documentary applies to all capitalist societies. It is well directed and is not a ‘let’s blame the banks’ type of video. Those that contribute their knowledge (23 of them) have the background and qualifications to be taken as well informed and as such the whole documentary has credibility. It is a very good informative dialogue. I think you will find it both informative and interesting.
http://www.youtube.com/watch?v=5fbvquHSPJU
This article is much clearer:
