Where does money come from? money is created by banks. Banks create money, not from their own earnings or from the funds deposited by customers, but from the borrowers' promises to repay loans. Most importantly, borrowers not only promise to repay, but to repay with interest, and the bank writes the amount of money of both into the borrower's account.
Whereas most paper currencies used to be backed by gold, that is no longer the case, and we have instead a fiat currency backed by nothing except the word of the central banks that the money is worth its stated value. Moreover, money today is created as debt, that is, money is created whenever anyone takes a loan from a bank. In fact, every deposit becomes a potential for a loan-a process which can be and is repeated many times, ultimately creating infinite amounts of money from debt.
The bottom line is that banks can create as much money as we can borrow! One wonders how individuals, banks, governments, and other entities can all be in debt at the same time, owing astronomical amounts of money. This question is answered when we consider that banks don't lend actual money; they create it from debt, and since debt is potentially unlimited, so is the supply of money. But what is so wrong with this scheme? Hasn't it been working all these years? Actually, there are several things very wrong with it.
The first issue is that the people who produce the real wealth in the society are in debt to those who lend out the money in that society. Moreover, if there were no debt, there would be no money.
Most of us have been taught that paying our debts responsibly is good for ourselves and for the economy. We imagine that if all debts were paid off, the economy would improve. In terms of individual debt, that's true, but in terms of the overall economy, the exact opposite is true. We are continually dependent on bank credit for money to be in existence-bank credit which supplies loans. Loans and money supply are inextricably connected, and during the Great Depression, the supply of money plummeted as the supply of loans dried up.
Secondly, banks only create the amount of the principal of loan. So where does the money come from to pay the interest? From the general economy's money supply, most of which has been created in the same way.
The problem is that for long-term loans, the interest far exceeds the principal, so unless a lot of money is created to pay the interest, a lot of foreclosures will result. In order to maintain a functional society, the foreclosure rate must be low, so more and more debt must be created which means that more and more interest is created, resulting in a vicious and escalating spiral of indebtedness. Furthermore, it is only the lag time between the time money is created to the time debt is repaid that keeps the overall shortage of money from catching up and bankrupting the entire system. It takes only a few second of reading the headlines of the financial pages during this month, August, 2007, to notice that foreclosure rates and lag time are threatening to meltdown the entire U.S. economy. The preferred method of the Federal Reserve and central banks addressing this calamity is, yes, you guessed it: to create more debt. The lowering of interest rates in recent years, the bombardment of credit card applications we find regularly in our mailboxes, the red ink in which the United States government is drowning are all an attempt to stave off the collapse of the entire system.
Can any sane human being believe that this situation can persist forever? What is the inevitable outcome of a fiduciary game of musical chairs? Monetary historian, Andrew Gause, answered this question:
One thing to realize about our fractional reserve banking system is that, like a child's game of musical chairs, as long as the music is playing, there are no losers.
And finally, a system based on fractional reserve banking is, to say the least, not sustainable because it is predicated on incessant growth. Perpetual growth requires perpetual use of resources and the constant conversion of precious resources into garbage just to keep the system from collapsing.
A crucial assumption that must be questioned is the practice of usury or the charging of interest for lending money. It is a moral and a practical issue because it necessarily results in lenders ending up with all the money, particularly when foreclosures happen. Not only is debt deplorably profitable for lenders in terms of interest and service charges, but when borrowers cannot pay, as in the case of housing foreclosures, lenders walk away with the proceeds