Banking: Money for Nothing

Happy new year everyone. I've been quite busy recently. So, excuses the large gap between posts. I meant to have this in my last post, but it was already such a meaty post I’ll just create a new post for it. It's not as timely as my last post. It certainly seems like the Occupy protests have wound down, which is a shame. There's rumors of something happening in March, but we'll have to wait and see.

I’ve always had a bane for banks, specifically insurance banks. You pay every month in case something unfortunate happens, making the insurance company nice and rich without providing a single product or service. And when something actually does happen, you have to fight them tooth and nail get them to give you what they agreed.

To understand banks, you must first understand money. A long time ago, paper money was simply a substitute for a real product: gold. You could take your $1 to the bank and receive $1 in gold. This was called the gold standard. But, our economy grew beyond the amount of available rare metal, so we switched to a fiat money. Money now has value because or government says it does, and we have faith in our government and the value of our currency.

The financial crisis of that started in 2007 seems like a complex issues, but it’s actually quite simple. Read a few articles, here and here, and you begin to get the idea. Large investment banks invested sold loans to people who probably wouldn’t pay them back (sub-prime loans). And then sold “insurance” on these “investments”. When people stopped paying their loans, the investment banks were in trouble. Had these had been smaller banks it would have been no big problem. But these were huge international banks, they had insured and invested in many other companies. They were “to big to fail”.

Bear Sterns was lucky, they found a buyer. But Lehman Brothers was allowed to fail. Some blame it on the government wanting the free market to take over, others blame Lehman Brothers for being uncooperative. And it sent ripples across the market. When later financial institutions when to the government and essentially held the market hostage for government money, they got what they wanted.

Years ago, this would not be possible. There were laws to prevent banks from becoming too large and taking stupid risks. They were implemented around the great depression to prevent what happened then from happening again. But, our representatives repealed those laws. I don’t know if it was greed or stupidity that led to that decision.

Let me explain, to the best of my abilities, how banks create money out of thin air. Most people believed that money is created at a mint and makes it’s way into everyday life by some form of government magic. But this is not how it happens for most money. Most people know, when you deposit currency at a bank, that bank can loan out the majority of the money to generate income from interest in loans. As anyone can who’s watched It’s a Wonderful Life can tell you, this can get banks in a heap of trouble if everyone wants to withdraw their deposits. What most people don’t know is that banks can loan out more than you deposit (called a monetary base). Lets say you deposit $1 in a bank and the government has set a reserve rate of 1:9, the bank can now conjure $8 into existence and loan out $9!

Now remember how I said our money is fiat currency? How I said our money has value only because people believe in it? That is why preventing counterfeiters is so important, if we did not protect our money, it would become worthless. What would happen if the average person found out that the “money” on their credit card was conjured into exist out of thin air?