Tuesday, April 21, 2009

can banks really create money?

We now turn to one of the most interesting aspects of money and credit, the process called"multiple expansion of bank deposits" Most people have heard that in some mysterious manner banks can create money out of thin air,but few really understand how the process works. Few understand that all our money arises out of debt and IOU operations. Actually,there is nothing magical or incomprehensible about the creation of bank deposits.At every step of the way,one can follow what is happening to the bank,s accounts. The true explanation of deposit creation is simple. What is hard to grasp are the false explanations that still circulate.
According to these false explanations, the managers of an ordinary bank are able, by some use of their fountain pens, to lend several dollars for each dollar deposited with them. No wonder practical bankers see red when such power is attributed to them. they only wish they could do so. AS every banker knows, he cannot invest money that he doesn,t have;and money that he invests in buying a security or making a loan soon leaves his bank.
Bankers,therefore,often go to the opposite extreme,and sometimes argue that the banking system cannot(and does not)create money. "After all,"they say, "we can invest only what is left with us. We don,t create anything. We only put the community,s savings to work." Bankers who argue in this way are wrong. They have become enmeshed in our old friend the fallacy of composition:what is true for each is not thereby true for all .
The banking system as a whole can do what each small bank cannot do:it can expand its loans and investments many times the new reserves of cash created for it,even though each small bank is lending out only a fraction of its deposits.

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