How Loans Create Deposits
Updated: Jun 12, 2022
Before we go into this, read Why Banks Don't Need You Money To Make Loans on Investopedia and How Is Money Created on Bank Of England's website. If you want to print them out, here are the pdfs.
Why Banks Don't Need Your Money to Make Loans
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How is money created_ _ Bank of England
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Since people struggle with how deposits don't create loans but loans create deposits, I thought I may give a simple example.
Let's say you spend $1000 on your new credit card. This $1000 is a revolving loan, as they call it in banking lingo. The credit card company brings the $1000 into existence. When you spend it, it marginally stimulates the economic engine (expands the economy by $1000 times the velocity of money). By circulating through the economy for 30 days, the new $1000 helps people who were waiting for money do their thing. You eventually earn $1000 and pay it back. This is what debt-based money means. In the real world, huge non-revolving loans are made to fuel the system. As you can guess, the money supply expands when more debt is created and contracts when debts are settled. To perpetuate this economy, you need to lure more and more people into debt. This is why consumption is praised and incentivized. It motivates people to get into debt to continue supporting their favourite basketball teams, rock bands, and corporate overlords. You want people to keep buying more and more useless stuff with debt so one day banks can take over all real assets and turn our world into a utopia.
You can quit reading here unless you want to read my ramblings.
The real economy goes as far as the original money (base money) can support, which used to be gold backed. In that system, you define 1 unit of your currency as equal to x amount of gold. If you have G amount of gold in total, you can issue G/x units of your currency. This system, however, no longer exists, because there was no way to devalue money and steal wealth from nations. For example, watch Nixon's suspension of the gold standard.
Anyway, the above-mentioned limitation of real money exists only in a nation of money worshippers. A nation that isn't a slave of money will continue to grow even if the money supply is constant. They will keep producing even if there is no new money to earn. Prices and earnings will drop nominally as more goods compete for the same money. And they will know that they are getting more prosperous. You don't need more money if you are already prosperous and everything is cheap. The nation may go a different route and issue more currency that is backed by other metals like silver, copper, or by commodities. More on this:
