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Money Does Grow On Trees

Most people believe money is a limited supply of notes.

I used to believe that too, until I started searching for the answer.

In general, people believe that you deposit money into a bank account and the bank gives you interest on that money. The bank then later lends out that money to a lender, paying a slightly higher interest rate and then pockets the difference.

100 USD on a bank account that gives 1% (for simplicity) to the account holder becomes 101 dollar after 1 year.

The bank then lends out that same 100 dollar to a lender for an interest of 2-3% and the difference there is for the banks profit and risk.

Somehow people believe that's how banks are generating trillions of dollars in Profits every year.

But it's totally wrong, that's not how money is made at all.

Many also believe in fractional reserve banking, that banks are allowed to lend out 10 % of the cash at hand.

For example, if someone put 100 USD into a bank account, the bank can then lend out 1000 USD out of that. Paying 1% interest for 100 dollars and charging 2% interest on 1000 dollar giving them a nice profit for the risk.

Still wrong, but a little bit closer to the truth.

In reality the banks simply create the money they want to lend out.

Yes, that's correct, they just click a button and whoop - 1 million new dollars for the home buyers new home.

Then they charge interest on that 1 million USD of maybe 3 % per year.

With no money down and with extremely little risk, that's how they make their profits.

Bank of England has an excellent report on the matter. Bank of England report.

That's why banks lent out so much money during the 2003-2007 in many countries and that's why they have started doing that again in recent years.

The problem comes when its done recklessly, to people who can't pay back. Then that asset becomes a liability for the bank on the balance sheet. And realizing those liabilities is not something banks wanting to do because of the bonus system and the pressure from shareholders who is seeking ever larger profits and dividends.

Many banks then secretly "roll over" these loans, which means that they don't write them up as liabilities as they should but instead fake that they are producing loans "assets" for the bank.

That may blow up any time, but that's a subject for another post.

What we are seeing now however is a result of this, something most people don't understand.

What happens, when the loan the bank created out of thin air gets paid down?

The house buyer who took the 1 million USD loan starts to pay back his loan to the bank. The 1 million assets are now starting to decrease with the same amount the home buyer pays it down with.

For example, 1 million USD loan, with a monthly amortization of 1000 USD becomes after one year 988 000 USD.

The balance sheet of the bank is actually decreasing when the loan gets paid back. That forces the bank to go out and find a new home buyer so that they can keep expanding their balance sheet. To get higher bonuses and higher profits for the shareholders.

This "chase" of new loans created the great recession in 2008 and the same methods are still applied. Only now since the bad loans aren't paid for and the demands of ever increasing profits, have driven the balance worlds banks balance sheets larger and larger.