Here’s a simple example of how banks, money, and economics work. Let’s say, Richie Rich starts a bank. At the same time, Bob the Builder finishes his first big job and receives a payment of 1 million dollars. He now takes that large sum of cash in a briefcase to Richie Rich’s bank and makes a deposit. The bank now has 1 million dollars.
Next, an experienced chef, Tony B, wants to open a restaurant down the road. Tony B doesn’t have enough money to build one so he goes to see Richie Rich about a loan. Richie Rich decided it was a good investment and issued 1 million dollars by crediting his account with that sum.
Tony B then happens to contract Bob the Builder to build the restaurant. Bob’s price is 1 million dollars. Once the job is done, Tony B writes a check to Bob who then takes that check back to Richie Rich’s bank.
So how much money does Bob the Builder have? 2 million dollars. But how much money is in the bank’s safe? Yep, 1 million dollars.
And the bank doesn’t stop there. Richie Rich can repeat this process again. Let’s say that Tony B wants to make the restaurant twice as big and Bob the Builder says he needs an extra million. So, the process happens again and now Bob the Builder now has 3 million dollars when the job is done. The bank, well it still has 1 million dollars.
Current US bank laws permit the bank to repeat these steps up to 10 times. In this example, Bob could have up to 10 million while the bank only has 1 million in cash which means that up to 90% of the money in the bank isn’t actually covered. It is our sole trust in an imaginary future, a promise that the whole system relies on. It’s really quite incredible when you think about it.
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