The same place the money comes from to pay for any goods or services. Interest is simply the bank's mark up on the service it supplies just like a shop's mark up. There's nothing magical about interest or indeed about money which prevents it from being traded like anything else.




Cheers, however I am aware of what happens in reality. I was just intrigued as to how it works in the fictional scenario of banks creating money from nothing.

Please explain. I was trying to show that despite the central bank only depositing £10K the two banks managed to lend a total to £17.1K so £7.1K had been "created" in economic terms.

I think what is deemed to be the "money supply" is actually greater than that as it includes the amounts held on reserve by the commercial banks (but I am not sure about that).

I think you missed the point. The money that exists in the economy has to come from somewhere and by this I mean not your piggy bank or from your employer. All money in the economy is created in some way. Some of it is created by the mechanism I described.

While the o/p got it wrong for the reasons Cookridge_Rhino pointed out there are people who argue our fractional reserve banking system is a debt driven mechanism akin to a ponzi scheme because it relies on new borrowers perpetually entering the system.

Another argument against it is that it is inherently fraudulent because the banks promise to pay depositors their cash on demand but have not got a hope in hell of doing so. They rely on a run on the banks never happening but some economist argue that isn't such an unlikely event e.g. Northern Rock.



It is not fictional in that commercial banks do create money as I described which again as Cookridge_Rhino pointed out is not what the o/p meant.

Nothing was created other than the original deposit of 10k. The amount of money available to the real economy is less than the amount originally created. Money has moved, and the amount has reduced on each move as some has been retained. Adding it all together as in your example is flawed maths.

BTW I'm not suggesting that accountants don't look at things the way you described. I'm stating that it's made-up nonsense and in no small part responsible for the mess we're in now.

Not in economic terms it isn't. The money supply available is the amount deposited. So that is the original £10K in my example plus the £9K loaned to the second bank. Increasing the money supply like this is said to "create money" because it is active in the economy.

If the second bank loaned its £8.1K out to me and I kept it al in cash that is where "money creation" stops but the money supply is still £19K )not £17.1K as my previous post may have implied).



Oh OK. It is certainly how economists look at it. Of course the money banks lend doesn't just come from the central bank (the original £10K in my example) but from ordinary depositors as well but the fact is they only keep a fraction of what is deposited in reserve and loan out the rest and when they do you get what I tried to illustrate.

I think an interesting thing about this is it shows what is supposed to happen when the Bank of England prints money. They deposit it with the commercial banks with the idea they will lend it on as explained. The trouble is they then tell the banks they need to hold bigger reserves and add to that no one wants to borrow at the moment hey, presto "quantitative easing" as they call it doesn't work. In fact what the banks often do is use the money to buy government bonds! So all this new money doesn't find its way into the economy which is why Alistair Darling said the other day the B of E needs to stop quantitative easing until the banks play ball.

The way you describe is not really creating money. You are counting the same money being deposited/loaned multiple times. If you were to net up all the positions you'd get back to a constant level (in the absence of any central bank action). So in your example the net position remains £10K - the first bank has a net position of £1K (+10K, -9K), the second a net position of £900 (+9K, -8.1K) and there's £8,100 lent onwards. There's no extra money in the economy here - you're just counting some of it multiple times. Summing up all the deposits etc. does have some meaning, which is why economists do it.

To come back to my rloriginal questionrl, in reality where banks do not create money [ifrom nothing[/i, when a loan is repaid the money supply is reduced as that money is being counted one less time. Back to your example if the second bank is repaid and then repays the 9K to the first then the first bank now has £10K and that's your lot. The money the bank had "created" has now been "destroyed", if you like that terminology. I remain intrigued as to how LeighGionaire believes this works though (although I suspect he hasn't actually thought it through).

None of this makes interest in anyway special from any other charge any business makes for its products or services.



They cannot pay all their depositors at the same time. A bank which could do so would be unable to pay any interest on deposits as it would be unable to make any money from the deposits. They would have to charge a fee for holding the money just to cover their overheads - you'd essentially just be renting some space in their safe. The only reason banks pay people for depositing money is because they (believe) they can make more money investing it themselves.

So how come the money supply increases as a result of all this?



The drain on the money supply occurs when the money lent is not deposited or if in some way it is returned iti the central bank.



Interest is not special. It just requires money. The question is where does that money originate from?



And? Yes you would just be renting their safe. That is what kind of what full reserve banking means which is similar to what you describe.

With full reserve banking there can never be a run on a bank the bank can't meet. With fractional reserve banking there can be such a run and if it occurs then the "lender of last resort" has to bail the banks out i.e the taxpayer.

Haven't we done the 'let's return to the 14th Century and pretend the Lombards never existed" to death now? Can we move on from "money for nothing" and discuss the more intriguing topic of chicks for free?

Well because multiple people 'have' the same money.



A deposit and loan are the same thing just viewed from a different perspective. When you deposit money in your bank account you are loaning that money to the bank. When a bank makes a loan they are depositing that money with you.



It requires money just as the mark-up in a shop requires money. This again doesn't require new money, it is simply money circulating through the economy funding economic activity. So the shop owner borrows money to buy stock. He adds a mark up to the cost of the stock that covers his costs and his profit. Part of his costs are the cost of borrowing the money. When he sells the stock he pays the interest on the loan. The bank then has its profit which it puts back into the economy via another loan, the money markets, dividends etc.



And you'd have a massive decrease in economic activity as deposited money will just be sat there losing value. We are currently seeing the effects of banks having to maintain larger reserves and restricting lending. This has reduced the money supply.
The massive (and unprecedented) progress made over the last 20/30 has been funded by the financial industry. Moving money efficiently around the world to where it can be used most productively. This is pretty much the purpose of investment banks.

Well you can if you wish but I've to move these refridgerators...

The money supply does not increase because people "have" money. That decreases it because they are sitting on it i.e. it is not active in the economy.



What has that got to do with the way fractional reserve banking increases the money supply via lending? Nothing.



All money in the economy was created at some point and the amount of money in the economy varies over time. The money used to pay interest can be money created by commercial banks in the way described. If I borrow money at 0% interest on my credit card and use it to pay down another loan with a higher rate of interest rate I will be using money created by one bank to pay a loan on money another bank created. "Created" means created as described here rlhttp://en.wikipedia.org/wiki/Money_creationrl by the way.



And the reason it does is that restricts how much money they can create because they can't lend as much on.



The problem with the progress made over the last 20/30 years is the much of the assets the banks have been lending against have proved worthless. This leads to banks taking a dim view of other banks credit worthiness as they believe they risk insolvency so they cease lending to those banks. And lo and behold the money creation process hits another hiccup because lending is reduced for this reason (as well as because banks have to hold more in reserve).

Quote: Kosh "You may have to wait until one comes along with a religiously-motivated reason for promoting an alternative system. Or did the main thrust of the piece escape you?'" You don't have to be religiously motivated to promote an alternative to a debt based monetary system, as proven by the people behind www.positivemoney.org.uk/ prove.

Quote: Kosh "You may have to wait until one comes along with a religiously-motivated reason for promoting an alternative system. Or did the main thrust of the piece escape you?'" You don't have to be religiously motivated to promote an alternative to a debt based monetary system, as proven by the people behind www.positivemoney.org.uk/ prove.

Quote: Cookridge_Rhino "If money is simply created by banks, as you seem to think, completely out of nothing, how is a run on a bank possible? If tomorrow i go to any bank in the UK with a £1000 deposit, and i wish to buy a £100k house, and ask for a 200% mortgage (i want to buy a nice car and do up the house etc), they would say no. Why? In your version of reality it costs them nothing to give me the mortgage, the money is created out of thin air. From their point of view absolute worst case scenario In your scenario the bank have loaned out £200,000 which the customer then spent into the economy by buying a house and £100,000 worth of consumer goods. The bank got £1000 and the deeds to a £100,000 house. However they have to cover this loan by holding extra reserves of Central Bank money, say 10% so £20,000. But what if nobody will loan the bank this money on the interbank lending markets? Sure they have a house worth (in theory) £100,000 but a house isn't a 'liquid' asset so they are now £19,000 short causing liquidity difficulties. News of this gets out and there is a run on the bank as people want 'their' money, causing a liquidity crisis. www.positivemoney.org.uk/2012/07 ... went-bust/

Quote: Cookridge_Rhino "If money is simply created by banks, as you seem to think, completely out of nothing, how is a run on a bank possible? If tomorrow i go to any bank in the UK with a £1000 deposit, and i wish to buy a £100k house, and ask for a 200% mortgage (i want to buy a nice car and do up the house etc), they would say no. Why? In your version of reality it costs them nothing to give me the mortgage, the money is created out of thin air. From their point of view absolute worst case scenario In your scenario the bank have loaned out £200,000 which the customer then spent into the economy by buying a house and £100,000 worth of consumer goods. The bank got £1000 and the deeds to a £100,000 house. However they have to cover this loan by holding extra reserves of Central Bank money, say 10% so £20,000. But what if nobody will loan the bank this money on the interbank lending markets? Sure they have a house worth (in theory) £100,000 but a house isn't a 'liquid' asset so they are now £19,000 short causing liquidity difficulties. News of this gets out and there is a run on the bank as people want 'their' money, causing a liquidity crisis. www.positivemoney.org.uk/2012/07 ... went-bust/

Quote: SBR "Accepting that banks create money out of nothing when they make a loan. What happens to the repayments on the loan? Now part of the repayment will be covering the interest and so clearly that is profit for the bank (just like mark-up in a shop). However I'm unclear as to what happens to the part of the repayment that reduces the outstanding amount of the loan. Is part of the money which the bank created then destroyed so all of the repayment profit for the bank? Or does the repayment money cancel out the bank created money in some way?'" When you repay a bank loan the bank destroys the money (credit), apart from the interest which the bank keeps as profit. Quote: SBR "The “sin” here is not that of any one person or company – it is the collective failure of our society to educate itself about the nature of the financial, economic and banking systems we have depended upon for our material needs. The money system we have acquiesced in having foisted upon us operates on a kind of alchemy, which allows private banking interests to generate what we rather ludicrously refer to as “our” money. Those who interpret the meaning of these events speak as though there was a fixed pool of money which belongs to the Irish people, inferring that what has happened is that certain people have “stolen” from “us”. This is nonsense. “Our” money system is owned and controlled by the banks. This is the way our leaders have decided things should be, and there has been no appreciable dissent. Privately-owned banks, operating all but indifferently to the public good, create and destroy money more or less at will. Consequently, all but a tiny percentage of our money system exists in a digital limbo inaccessible by the people. For every euro of money created, a corresponding debt is brought into being, and this is multiplied over time by the process of levying interest. Thus, our economy consists overwhelmingly of debt, at once spelling our salvation and our doom.'" www.irishtimes.com/newspaper/opi ... 84392.html

Quote: SBR "Accepting that banks create money out of nothing when they make a loan. What happens to the repayments on the loan? Now part of the repayment will be covering the interest and so clearly that is profit for the bank (just like mark-up in a shop). However I'm unclear as to what happens to the part of the repayment that reduces the outstanding amount of the loan. Is part of the money which the bank created then destroyed so all of the repayment profit for the bank? Or does the repayment money cancel out the bank created money in some way?'" When you repay a bank loan the bank destroys the money (credit), apart from the interest which the bank keeps as profit. Quote: SBR "The “sin” here is not that of any one person or company – it is the collective failure of our society to educate itself about the nature of the financial, economic and banking systems we have depended upon for our material needs. The money system we have acquiesced in having foisted upon us operates on a kind of alchemy, which allows private banking interests to generate what we rather ludicrously refer to as “our” money. Those who interpret the meaning of these events speak as though there was a fixed pool of money which belongs to the Irish people, inferring that what has happened is that certain people have “stolen” from “us”. This is nonsense. “Our” money system is owned and controlled by the banks. This is the way our leaders have decided things should be, and there has been no appreciable dissent. Privately-owned banks, operating all but indifferently to the public good, create and destroy money more or less at will. Consequently, all but a tiny percentage of our money system exists in a digital limbo inaccessible by the people. For every euro of money created, a corresponding debt is brought into being, and this is multiplied over time by the process of levying interest. Thus, our economy consists overwhelmingly of debt, at once spelling our salvation and our doom.'" www.irishtimes.com/newspaper/opi ... 84392.html

This is the biggest flaw in the system. Nobody ever creates the interest needed. The only way that the global economic system as a whole can keep going is by continual debt expansion, creating new money to fund past debt plus interest payments.

Once you get to a stage where the borrower of last resort (The Government) can't take on more debt the system collapses, as we are going to see with the implosion of the Euro.