It is said that approximately a third of people believe that when they deposit money in a bank, it keeps it – in a safe or something similar – until they claim it back.
Other two-thirds believe that when they deposit money in a bank, it keeps a part and the rest is lent to whoever needs it in exchange for interest. That is why banks are crazy to get our payroll and deposits: to lend them.
These percentages might be true or not, but surely most of the people we know will feel comfortable in one of these two groups. Only a tiny minority know the truth: that neither the bank keeps your money nor is the deposited money used to give credits.
Banks simply create money from scratch when you request a loan. They need, of course, to keep a reserve because they are required by law and getting our savings to form that reserve is cheaper than borrowing it from another bank. Or that was the theory until recently because, in turbulent times like the present, things are changing and, for example, American banks since March 2020 no longer need to back their loans (https://www.federalreserve.gov/monetarypolicy/ reservereq.htm).
It is surprising that as much as we like money, and the importance it has for us, how little warned we are about this aspect, especially when this, far from being a technical curiosity, has direct consequences on our lives.
Who creates money?
Commercial banks, those you are precisely thinking about (Santander, HSBC, Deutsche Bank), create 95% of the money. Electronic money. Because hard cash, the remaining 5%, is created by central banks, which we will discuss in another article.
So it works like this. You go to your bank and ask for a € 200,000 credit to buy a flat. The bank hits a key and puts € 200,000 in your account. That money is only debited from an account that bears your name and says you owe € 200,000 plus interest. The money is generated out of thin air and in return, your debt remains. Money IS debt. If there is no debt, there is no money.
When you pay back your loan, the bank “eliminates” the money you give and reduces your debt. Once you have repaid the credit, your debt disappears, but so does the money. The bank only saves the interest it has earned for the service.
Suppose you buy an apartment with your loan. The money goes to a promoter who pays a construction company. This company pays workers, the owner of the land, the kitchen manufacturer, and so on. Everyone pays their employees, who spend the money on schools, trips, bars and a thousand other things. Your money makes the global economy work.
You work hard to repay the loan. The funny thing is that your salary comes, in one way or another, from other credits taken by other people or companies.
As long as people happily ask for loans, all is well. There is enough money so that you can pay off your debts.
What happens when money is not created
In 2007 in Spain, there were mortgages for € 300 billions. In 2013, once our housing bubble burst, they were just around € 37 billion. In other words, there were € 267 billions less in the economy than in 2007 (source INE).
Here’s the problem: when no one asks for credit, it is mathematically impossible for everyone who already has one to pay it back. The Spanish (and European) economy was out of money. There is no money to buy, companies have no one to sell to, people are fired: bankruptcies, evictions, poverty, etc.
If you are a bit insightful, maybe you realise right now there is just enough money in the system to repay all the credits but not to pay the interests.
People and companies have to request more and more credits (more amount). When this circumstance ceases to occur, the system collapses.
We see commercial banks create money at a high price: we have a system aimed at growth. There are millions of debtors who have to return the money to their creditors.
Crises are almost programmed because, sooner or later, a period comes in which fewer loans are requested than before. Immediately accounting goes not out: more debts are written off than new ones are created, there is less money in the system and, consequently, someone will not be able to pay back their debt. The mood declines, purchases are postponed, even fewer loans are requested. Banks hardly grant loans because the risk of non-payment is very high, and the crisis unleashes with fury. This usually happens to us every fifteen or twenty years.
Thus, human greed is not necessarily at the base of the unsustainable growth of the economy. It is rather a naturally unstable money creation system. And this has consequences. Many, as we will see.
To know more:
Where Does Money Come From? | Ole Bjerg | TEDxCopenhagen
HOW BANKS CREATE MONEY , Positive Money
Money creation in the modern economy http://gesd.free.fr/moneycreati.pdf
