The Fractional Reserve Cycle
Deflation and inflation are two problems that arise in an economy that must be solved if a stable trade environment is to be reached.
Deflation arises when there is too little money to flow and inflation comes about when there is too much of it to know what to do with. Generally with deflation people are working and saving to pay off debts, there is too much debt and so there needs to be some stimulus to create more money in the economy. Western countries have dealt with this problem which is affecting the global and national levels of economic growth by printing money from thin air, several billion Dollars worth of new money in fact.
Here Ill out line their method of creating this new money. The government requires $10billion and goes to the Federal Reserve with the request. The Federal Reserve replies yes, we will buy $10billion in government bonds from you. The government then goes about drawing up some pieces of paper and marks out Treasury Bond onto each one continuing to do so until they have $10billion worth and sends those over to the Federal Reserve. The Federal Reserve then begins printing the money and types a few digits into a bank account and once this happens, this adds $10billion to the money supply. Only about 3% of the money supply is paper money, the rest is all digits on our screens. Government bonds however are instruments of debt by their design and when the Federal Reserve purchases these from the government with money made from nothing, the government is actually promising that they will pay back the $10billion to the Federal Reserve and so we can determine that the money was created out of debt. This new money that was deposited into the bank now behaves like any other deposit would. Like all fractional banking; this $10billion deposit now becomes part of the banks reserves and as stated by modern money mechanics, a bank must maintain legally required reserves equal to a prescribed percentage of its deposits. It then quantifies this by then stating, Under the current regulations, the reserve requirement against most transaction accounts is 10%. This means, that with a $10billion, 10% or $1billion is held as the required reserve and the other $9billion remains as what is called the excessive reserve and can be used as a basis for new loans. Its easy to assume that the $9billion comes from what is left over from the original $10billion when in fact this $9billion is more money that is created out of thin air on top of the $10billion deposited which brings it up to $19billion of new money created and this is how the money supply is expanded. As stated in Modern Money Mechanics, Of course, they (the banks) do not really pay out loans from the money they receive on deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes (loan contracts) in exchange for credits (money) to the borrower transaction accounts. In other words, the $9billion can be created out of thin air simply because there is a demand for such a loan and there is a $10billion deposit to satisfy the reserve requirements. Lets say that somebody takes out a loan on the now available $9billion and most likely deposits it into their own bank account and then that deposit now becomes part of the banks reserves and the process repeats itself in this bank. 10% is set aside and the remaining $8.1billion is created as new money for more loans. This cycle can continue as long as it takes until what the calculation amounts to as $90billion of extra money is created on top of the original deposit of $10billion. So out of ever amount of money that is deposited into an account, 9 times that amount can be conjured into existence.
Copyright (c) 2010 Jonah Myers
by: Jonah Myers
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