Where’s My Money?
An Intro to Banking and Monetary Policy — Post #7
Let’s say I get a job, and they pay me $100. I take it to a bank because my mom always told me it’s where we keep money safe.
I give $100 cash to the bank. They give me an account number, and assure that when I come back my money will be there.
From my point of view this is a great deal, I don’t have to worry about theft, and they even pay me a small amount of money (interest), for choosing their bank.
But don’t misunderstand, banks are not a charity. They are businesses and the owners gain financially (profit) from their services. Let me provide one version of how this is done.
- Eventually the bank is given more money (deposits) than is being requested back (withdrawals).
- The bank knows that most people will not request their money back tomorrow. Maybe 1 customer out of every 10 will ask for their money. So in order to function they need to have 10% of the customers money available (minimum reserves).
- This means that 90% of the customer’s money can be used by the bank to invest. Often this is done with loans. For example, Alex, asks to borrow $90 from the bank (from my $100) for 1 month. They agree to give him the money today, if when he returns, he gives them $95. In this scenario the bank would make $5.
The point I want to make is not that the bank makes $5 but that the amount of money circulating has doubled with the creation of this loan.
Before the bank lent Alex the money, the total amount of money between everyone was $100. After Alex had the money, the total amount of money between everyone was $190. I have $100 and Alex has $90.
This is known as the money supply, or the amount of all money in circulation.
The bank almost doubled the money supply with this loan. This is a small scale (micro) example, but it also happens on a large scale (macro) level every day.
Setting the minimum reserve requirements is one way that the Federal Reserve can effect the monetary and financial system. In the example above it is 10% which is currently the amount set for most US banks. This post is important because it introduces one way our money is manipulated and a major reason why Bitcoin was created.
Vocabulary:
Interest: A percentage of money that is paid to the person lending the money.
Minimum Reserves: The amount of money the bank is required to hold.
Money Supply: The total amount of money in circulation.
This is post #7. The others are located here.
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