Free The Crash Course: The Unsustainable Future of Our Economy, Energy, and Environment by Chris Martenson Page B

rule, which permits banks to loan out a proportion—a fraction—of the money deposited with them to other people who wish to borrow some money. In theory, that amount is 90 percent, although, as we’ll see later, banks often loan out much closer to 100 percent of their deposits than 90 percent. As the thinking goes, it is very unlikely that all of the bank’s depositors would demand all of their money back at the same time, so most of it can safely be lent out under the assumption that only a fraction will be demanded by depositors at any one time. Because banks retain only a fraction of their deposits in reserve (10 percent), the term for this institutional practice is “fractional reserve banking.”
     
    Back to our example. We now have a bank with $1,000 on deposit, which it is itching to loan out. After all, banks don’t make money by holding on to it; they make their living by paying a lower rate of interest to depositors while lending to borrowers at a higher rate. Banks live on the “spread” between these two rates.
     
    Because federal rules permit our bank to loan out up to 90 percent of deposits, our bank seeks out and finds an individual who wishes to borrow $900. This borrower then spends that $900, perhaps by giving it to their accountant, who, in turn, deposits it in a bank. It doesn’t matter which bank; it could be the same bank or a different bank. All that matters is that the money goes back into the banking system, which all money eventually does. For now, to keep things simple, suppose the accountant deposits this money at the very same (the only) bank in town.
     
    With this new deposit, the bank now has a fresh $900 deposit against which it can loan out 90 percent, which works out to $810. So it gets busy finding somebody who wants to borrow $810 and loans them the money, which then gets spent and (surprise!) redeposited in the same bank. So now another fresh deposit of $810 is available to create a loan of $729 (which is 90 percent of $810), and so on, until we finally discover that the original $1,000 deposit has mushroomed into a total of $10,000 in various bank accounts. This is how fractional reserve banking can, and does, turn $1,000 into $10,000.
     
    Is this all real money? You bet it is, especially if it’s in your bank account. But if you were paying close attention, you would realize that there’s more than just money in those bank accounts. The bank records the existence of $10,000 in various accounts, but it also has the notes to $9,000 in debts, which must be paid back. The original $1,000 is now entirely held in reserve by the bank, but every new dollar in the town, all $9,000, was merely loaned into existence and is now “backed” only by an equivalent amount of debt. How is your mind doing? Is it repelled yet?
     
    You might also notice here that if everybody who had money at the bank, all $10,000 dollars of it, tried to take the money out at once, the bank would not be able to pay it out because . . . well, they wouldn’t have it. The bank would only have $1,000 sitting in reserve. Period. You might also notice that this mechanism of creating new money out of new deposits works great as long as nobody defaults on a loan. If and when that happens, things get tricky. But that’s another story for another time.
     
    For now, I want you to understand that money is loaned into existence. When loans are made, money appears as if by magic. Conversely, when loans are paid back, money disappears, as the debts and the money cancel each other out when the loans are paid back. This is how money is created. I invite you to verify this for yourself. One place you can do that is the Federal Reserve, which has published all of this information in handy comic book form, which you can order from them for free. 4
     
    You may have noticed that I left out something very important in the course of this story: interest. Where does the money come from to pay the interest on all the loans? If