Money Creation

Definition:

Money creation is accomplished through a system of borrowing and lending. Until the 1970’s, it was based on the total reserves of gold and silver.

Details on Money Creation:

Money is created principally by standards set by the federal reserve / central bank. The central bank will determine the amount loaned to it’s commercial banks. From there, the commercial banks will either lend money to investors or even other commercial users such as smaller banks or other third party loan dealers. The central bank will determine how much money can be kept in the bank and how much can be lent out. The amount a bank can lend is generally far higher than the amount it must hold in deposits which is why a run on the bank can be so dangerous.

The commercial bank lending to various money is how the money is truly created. If, for example, a bank has two people in a bank. Person A deposits a thousand dollars and person B takes out a loan for 10000$ at 5%. Person A is necessary for the bank to be able to create the 10000$ loan and B will be paying interest. The loan counts as money creation so the total money is now 10000$ higher than it was before because of the loan. As the interest is repaid, the money created will diminish as that money already “exists”. If we do this over many people over time, in normal circumstances, the amount of loan money will outweigh the money being payed back and slowly but surely money will be created.