Most people, including politicians, do not understand how the banking and our monetary system works and this creates a lot of misconceptions of the economy in general. I will try avoid any complex terms and explain on layman’s terms how the modern banking works.
Most people falsely assume that when you deposit money to a bank, the bank actually saves the money in its vaults. Thanks to the fractional reserve banking the bank needs to keep only a small fraction of the deposit and it can spend the rest of it as it wants. The bank can use the money to speculate on derivatives, stock, government bonds or financial instruments or simply lend the money to others.
Let’s assume the fraction which the bank is obliged to keep is 10%. If a person A deposits $1000 to a bank, the bank must keep 10 % of it, namely $100, but it can lend the remaining $900 to person B, who can deposit the money to bank. The bank needs to keep 10% of the $900, namely just $90, meaning it can spend $810 and so on. In just 3 iterations there is $3439 in the system and the bank has merely $271. What happens if A would draw out all of his money as cash? The bank doesn’t have enough money to allow that to happen. Luckily most customers do not want to draw out their money at same time and this very fragile and fraudulent banking system can continue. But in a matter of crisis, like the recent events in Greece have demonstrated, people flood to Automatic Teller Machines (ATM) to draw out their money. The bank doesn’t have enough reserves nor cash money, thus European Union and European Central Bank + International Monetary Fund (IMF) had to come to rescue Greece.
To make matters worse, the reserve is much lower than in the example above. In the euro zone the reserve requirement is mere 1% since 2012 (it was 2% before that). That allows the banks to multiply the money almost 100 times! This is the fuel of the current boom-bust death spiral economy. The fractional reserve banking has led to a situation that there is much more debt than there is money on this planet. It is simply impossibly pay back all the debt without dramatically increasing the money supply. Creating lots of money to pay back all the debt would lead to serious debasement of the money, meaning money would lose big part of its value. People with savings would suffer and prices would double or more. In worse case it could lead to hyperinflation.
Another false assumption to banks happens when a person loans money from a commercial bank. Most customers assume the bank is actually lending the money it owns, but the loaned sum just appears on the bank’s balance sheet. In other words new money was created into the system. And the bank is asking interest to pay back the money it didn’t own in the first place! If any normal company would operate like commercial banks do, that would be called “cooking the books” and those responsible of it would go to jail. I would call this a totally fraudulent system and any politician worth his salary should demand to abolish such system. Instead the banks enjoy the highest support from the world government.
After the 2008 the central banks have dramatically increased money supply to the commercial banks and started to buy back their own bonds. This is same as creating money out of thin air. Most of the this money went to the biggest banks and thus to the financial elite. And the sums I am talking about are trillions. Why haven’t we yet hit hyperinflation? Simply because there is so much debt on this planet and perhaps all the super rich elite haven’t yet spent all that money, thus it hasn’t trickled down to the lower levels of the economic pyramid.
Trickle Down Economy Doesn’t Work as Advertised
Those who are first to receive the newly created money benefit the most out of it. Thus if the vast majority of hundreds of billions which went to “save Greece”, actually went to the commercial banks, the main owners of the bank would the biggest ones to benefit from this. Trickle down works. It just takes a long time, many years, before the money money reaches the lowest levels of the pyramid. During that time the money has lost big part of its purchasing power. Thus the elite get richer, because they can buy more with the same money. The current system is totally rigged for the elite.
In my next blog article I will explain the economic turmoil we are experiencing now and solutions to the current debt crisis.