We are now a long way from the days when banks
existed to look after your pot of gold. There is no pile of money in your bank labelled
with your name, only an entry in a database that says you should be given this amount
of money when you ask for it. Let’s imagine that every month you get a
salary. I know, wild right? That salary goes directly to your bank, and
once there your bank can do whatever it likes with it, as long as it’s available when
you actually need to spend it. You have loaned the bank that money. For the duration of that loan, the bank is
free to lend that money to somebody else should it wish to do so. While regulation is different depending on
the country, a common requirement is that a bank should keep some fraction of what it
lends in reserve and covered by actual assets, though these assets could be something as
nebulous as the right to borrow more money if required from a country’s central bank. This reserve, known as a fractional reserve,
is usually around 10% of the bank’s assets. The rest it is free to lend. Let’s imagine that you want to buy a car. I know… Wow. You go to the bank and ask them to lend you
£10,000, and they agree. The bank doesn’t need anyone’s permission
to do this, and they do not take this money out of any stock they hold. They simply add it to your accounts balance. While governments tend to get the credit for
printing money, 97% of all new money comes from private banks. So now you have £10,000 and the bank has
an agreement from you to pay that money back with interest. You go and give that £10,000 to a guy in
exchange for that car you were so keen on. Now the seller of the car takes that £10,000
and deposits it back into the bank. The bank has to keep back 10% of that money
as reserve, but it is free to lend out £9,000, perhaps to a customer who wants a fractionally
cheaper car. That £9,000 goes into another bank, which
has to keep £900 of it but lends out £8,100 and so on. By the end of this chain nearly £100,000
worth of transactions will have completed using just the £10,000 your bank created
out of thin air. The supply of money has increased. This seems like magic, but it is in a simplified
form exactly what happens. Ideally as the loans get repaid the supply
of money reduces again and returns to its starting state, assuming nobody defaults. In theory we have a nice stable system where
money is created, circulates and then vanishes. In theory. The main issue is that these loans don’t
get repaid 100%, they get repaid with interest, so more than 100%. This is money from outside the stable system
and has to come from somewhere, so it’s created by banks in the form of more loans. Which themselves have interest attached. So what could be a stable system is in fact
constantly expanding. Right now, 30-40% of all financial transactions
are some form of interest. So the supply of money, instead of circulating
endlessly, has to be continually increased to account for interest. In our example, not just the interest for
the first £10,000 loan, but interest for each re-lending of that money down the chain. Fortunately we live in a world of infinite
resources, where things can expand indefinitely forever and nothing will ever go wrong. Oh, wait. Join us next time to discover that this might
not be the only issue with our current system. Oops.