Thursday, January 29, 2009

How Banks are Magic

Doug Henning Greets You.

Ok, finally, how banks are magic.

If you remember, I said that a bank has to have on hand 10% of the money that it's been given. The other 90%, it can play with.

So, let's follow the money for a second. I deposit $100. The bank then takes $90 of that and gives to someone else -- Jorge -- as a loan. Jorge's trying to do some work on his house. So he takes that $90 and spends it at Home Depot.

Now -- and it'll get fuzzy here, so stay with me -- that $90 ends up going to help pay the payroll of the people who work at Home Depot. Or it goes in the boss' pocket. Or it's reinvested in the Home Depot, which means it's given to still other people as Home Depot spends the money. The point is -- that $90 ends up in the hands of other people.

And eventually, they -- whoever they are -- put that money in their bank. So the $90 that the bank could be spend is now back in the banking system's hands.

Following the rule we set up at the start -- the system has to hold onto 10%, i.e. $9 of that deposited cash. But the other $81, it can loan out.

So we started with $100. And off of that $100, the banking system gets to make loans of not just $90, but $81, and then 90% of that, $73, 90% of that, $65, etc. -- $58, $52, $47, $42, $38, $34, $31, $28, $25, $22, $20, $18, $16, $14, $13, $12, $11, $10 and even smaller amounts -- altogether, more than $800.

POOF! Instant money!

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