How banks create money out of thin air, lend it out and charge you interest

It’s a common misconception that banks use their savers’ money when making loans to people such as you and I to buy something we don’t have the cash for.
In reality, the money we borrow is created by the banks out of thin air at the time it is borrowed.

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Why it’s time to change money

It’s a common misconception that banks use their savers’ money when making loans to people such as you and I to buy something we don’t have the cash for. In reality, the money we borrow is created by the banks out of thin air at the time it is borrowed.

They can do this under our Reserve Bank’s rules. When you take out a loan, the bank simply types the loan amount into its computer and adds the credit to your account. I know, you want to call me a liar to my face.

When the loan is (eventually) repaid the original loan amount is deleted from the bank’s computer, and the bank keeps the interest (doubles and triples all-round).

The system is called credit creation or risk based lending and is based on the perceived risk the bank takes lending out this money.

But don’t take my word for it. Consider this from the Bank of England publication Money Creation in the Modern Economy: “Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.”

Now, lending on housing is low risk so banks only need to hold about 8 per cent of the money they lend in mortgages. If a bank lends you $500,000, it only needs to have $40,000 in its vault. What a wizard wheeze this is.

Lending to businesses and helping job creation, research and development, is a riskier undertaking, so the banks hold more than 20 per cent of the money they lend in reserve. One only has to look at the housing market to see which types of loan banks prefer to make.

Martin Wolf, chief economics commentator at the London Financial Times, said in 2014: “Why should we let such a social creation [money] be handed over to profit-seeking private enterprises?”

It’s a good question, and one that is increasingly being asked — but by only a few fool-hardy politicians.

According to the Reserve Bank the amount of money we the people owe the High Street banks is $233 billion dollars — and that’s just the household debt. As a nation we are spending 163 per cent of our disposable income. We are living on debt.

Sad to say that under the current system the debt can never be paid off. Even if we all tried really, really hard.

Here’s why. Think of our economy as a bathtub. Money is introduced into the bathtub as loans by the banks. Money leaves the bathtub when repayments are made. For our economy to grow, more money (debt) must go into the bath than leaves.

If all the debt could be paid off the bath would be empty and none of us would have any money — because apart from our notes and coins — money is debt.

Those looking to reform the monetary system say that instead of banks having the power to create interest-bearing debt, the Reserve Bank should issue our money debt-free.

Now, before you choke on your tea and spill it over your credit card statement showing 20 per cent interest, consider this; the Reserve Bank already has the power to create money because it produces our notes and coins.

This cash makes up 3 per cent of our money supply and the rest is digital debt created by private banks. All the Reserve Bank has to do to bring itself into the 21st century, buy a computer, and create the debt-free digital money we need.

And to keep money creation well out of the way of politician – because  we all know they couldn’t  be trusted with such awesome power –  a new independent body would have autonomy to manage the money supply as it sees fit.

This does not mean there would be no more interest bearing debt. Banks could still lend money — but not a cent more than is in their vault. This will stop rising house prices.

They could also continue to provide chequing and savings accounts, offer foreign exchange and sell insurance. They just won’t have a license to create money out of thin air.

Under this system, once the bank loans are repaid the money can be lent out again.

The government could use the interest-free money the Reserve Bank creates for infrastructure projects, roading, social  housing, schools and hospitals.

People would be put to work building the things we need (without having to raise taxes or rob Peter to pay Paul).

To find out more see https://www.positivemoney.org.nz/

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Author: Steve Hart

Steve Hart is a business journalist, editor, designer, podcaster and host of the Cool Nights radio show.