Bankers are magicians who know how to create money. In fact, banks are in business to make money. They make money using the deposits of their customers. This is why banks provide bank checking accounts and loans. They need money to make more money. The deposits of customers become the raw materials the banks use to make more money.



At this point, the choice of vocabulary is critical. Banks are not just "earning" money. Banks are actually "creating" new money.

Here is an example of how banks create money. You deposit $100,000 into a one-year Certificate of Deposit at 5% interest. The bank now can use your money to create loans.

The Federal Reserve requires banks to keep a portion of their customer deposits on reserve. In other words, the bank cannot loan against the full $100,000 of your deposits. The reserve rate varies between 3-10%. With a 3% reserve rate, the bank is required to keep $3000 on reserve, and can loan the remaining $97,000. With a 10% reserve rate, the bank must keep $10,000 on reserve, and can loan the remaining $90,000. Let's assume that your bank has a 10% reserve rate, which means it can use $90,000 of your deposit to make loans.

So, the bank makes Loan #1 of $90,000 and keeps $10,000 on reserve. This is the critical point where the bank creates money. According to the bank's balance sheet, the $90,000 loan to the borrower is also a $90,000 asset for the bank. By its own brand of money magic, the bank has created $90,000 out of thin air.

But the process does not stop here. Since the bank now has an asset of $90,000, it can make another loan based on this asset. Since the same Federal Reserve rules apply, the bank must keep 10% of this asset on reserve. This means it can loan only 90% of the $90,000. This means that Loan #2 is $81,000. By creating another loan, the bank has created another asset. The $81,000 loan to the borrower becomes an $81,000 asset for the bank. Once again the bank creates money out of thin air.

You guessed it. The bank can use this $81,000 asset to make another loan. It keeps 10% on reserve, and makes a loan of $72,900. And once again, the loan to the borrower becomes an asset to the bank. The bank now has another asset, worth $72,900.

Federal Reserve rules allow the bank to make five to six loans based on the original $100,000 deposit. Each loan creates an additional asset. We'll stop at three loans, review the process, and add up how much money the bank has created.

You deposit $100,000 into a CD. The bank creates three loans based on the original $100,000 deposit. Loan /Asset #1 = $90,000 Loan/Asset #2 = $81,000 Loan/Asset #3 = $72,900. The total = $243,900 in assets for the bank. This is $243,900 in new money.

When you cash out your CD, you get your $100,000 deposit back, in addition to the $5,000 interest. Meanwhile, the bank has created $243,900 of new money. After it pays you 5% interest, the bank has made a tidy profit of $238,900. ($243,900 - $5,000 = $238,900.) If the numbers are confusing, go over them again until you see how magical this process is. This is how banks create money.

The process is not as linear as my example. Banks don't make a series of separate loans based on an original deposit. When you deposit your money into the bank, your money becomes part of a large pool of money, which the bank can use to make loans. But my oversimplified example shows how banks use customer deposits to make money out of thin air. You deposit money, the bank keeps some on reserve, and uses the rest to make loans. The loans become assets, and the assets become new money.

The purpose of this example is to demystify money. You and I cannot do what banks do. We can't make multiple loans based on the same money. The value of seeing how banks use customer deposits to create money is to understand how money is created.

The critical point is to see that money is not a commodity. Money is not equivalent to currency. Money is created in money-making transactions.

The crucial idea behind all of this is: The greatest limit to money is the belief that money is limited. If you want more money, adopt the money-making mindset of a banker. Ask how you can use money to create more money. If you really think the way bankers think, you will use someone else's money to create more money.