According to most economics textbooks, and most people you might speak with, the process works as follows:

We’ll assume a deposit account interest rate of 1% APR, and a loan interest rate of 8% APR.

The Fiction

“Joe” walks into a bank and deposits $100.  He gets interest of 1% APR on his deposit.

The bank takes Joe’s $100 and counts it as an asset in its “Reserve” account, while also treating the $100 as a “Demand Deposit” liability.  Joe is able to supposedly withdraw his money at any point in time – “on demand”.

The bank has a “Reserve Ratio” of 10%.  This means that they are required to keep 10% of Joe’s money, or $10, in their Reserve account.  The remaining $90 gets treated as “Excess Reserves”.

Now the bank will seek to loan out the $90, since it is “excess”.  They loan the $90 to “Sam” at 8% APR.

Sam can take his $90 loan and do whatever he want with it.  Let’s pretend that he visits a home remodeling store (a.k.a. HR store) to buy supplies for a project.  The store will then deposit that  $90 into their bank, earning 1% APR.  For the sake of discussion, we’ll pretend that it’s the same bank as Joe’s.  It doesn’t have to be.

The bank takes HR’s deposit and puts it into their reserve.  The other $10 is still sitting in reserve, but it’s backing the original $100 deposit from Joe.  This means that the bank will have to keep $9 of HR’s $90 deposit in its Reserve account, and has $81 of that $90 in Excess Reserves.  The total amount in the bank’s Reserve account is now $19.  The bank seeks to loan out the $81 excess to somebody.

“Bill” takes out an $81 dollar loan at 8% APR.  He uses the money to pay a plumber.  The plumber happens to bank at the same place as Joe, but it doesn’t really matter. 

The plumber deposits the $81 in the bank at 1% APR.  The bank puts the $81 in its Reserve Account.  It needs to keep $8.10 in the account, and the other $72.90 goes into Excess Reserve.  The Reserve account now holds $27.10 ($10 + $9 + $8.10).

The bank then looks at lending out the excess of $72.90, etc., etc., etc.

Notice how the amount available to loan diminishes each time.  This amount will get very close to $0 after enough loan iterations.  What will things look like when that happens?

This process will result in Joe still having his $100 deposit account, along with the bank having given out a total of $900 in loans – for total assets of $1,000. There will also be $1,000 of demand account liabilities.  The Reserve account will contain $100, and the Excess Reserve account will contain $0.

The bank will be paying 1% APR on each of the various deposits it has received ($1,000) and getting 8% APR on the various loans that it has given out.

It’s easy to look at this process and see how Joe’s deposit money was used to make a loan to somebody else, while that loan money was used to make yet another loan, and so on.  The bank is just playing the part of an intermediary – paying out 1% interest and collecting 8% interest.

What happens when somebody defaults on a loan?  We’re told that this would result in hurting the depositors, since it is their money actually being loaned out.  We’re told that this is the reason why we need the Federal Deposit Insurance Corporation (FDIC) in order to insure the money of depositors against loss.

It all makes sense now, doesn’t it???

The Truth

What if I were to tell you this little fact:  The preceding example that is taught to virtually everyone IS A BALD-FACED LIE!  I wouldn’t blame you for backing away from my crazy “Conspiracy Theory”.  After all, that’s what we’ve been taught all of these years.  Anyone who doesn’t explain things like we have all been taught should be shunned – avoided – looked upon with disdain.

First off, what is a “conspiracy”?  What does it mean to “conspire”?  It means to “act in harmony towards a common end”.

What is a “theory”?  It is a “plausible or scientifically acceptable general principle or body of principles offered to explain phenomena”.  It is stronger than a “hypothesis”, which is “a tentative assumption made in order to draw out and test its logical or empirical consequences”.

So a conspiracy theory by definition is best described as “a plausible general principle or body of principles offered to explain a harmonious act towards a common end”.

There are many things that are called “conspiracy theories” that are really more of a “conspiracy hypothesis”.

Let it be known that my “conspiracy theory” is that international bankers are conspiring to a common end of control over the money supplies of the world and the labor of its people.  Does that make me a crazy person?  Should I be shunned?  I’ll let others determine the answer to that question. J

The Reality

What if I told you that banks don’t use ANY of the money from their depositors when issuing a loan?

What if I told you that banks are able to create credit (a type of money) for a loan and create a matching demand deposit account for the loan, all with a few keystrokes on a computer and a signed promissory note from the loan customer?

Let’s look at how this plays out:

“Joe” walks into a bank and deposits $100.

The bank puts Joe’s $100 into its Reserve account.

“Sam” comes walking in and wants a loan for $900.  The bank gives it to him by creating a new $900 credit entry on the asset side of its balance sheet and a $900 demand deposit on the liability side.

Sam buys a riding mower from “Fred”.  Fred deposits the $900 into the bank.

Where do we stand?

The bank has $1,000 of assets and $1,000 of demand deposit liabilities.  The bank also has $100 of Joe’s original deposit in its Reserve account.  This is EXACTLY the same as the scenario above, but the bank didn’t have to loan at a large number of incrementally smaller loans to get there!

Notice a few things that are different between the two scenarios.  First, the bank was able to leverage Joe’s deposit UP by a factor of 10 immediately, instead of holding $10 back and only being able to loan out $90.  Next, the bank only had to pay its 1% APR on Joe’s $100 until the $900 was deposited – instead of paying interest on all of the intervening deposits like in the example above.

Next, and MOST IMPORTANTLY (this is the part everyone should REALLY contemplate) the bank made the ENTIRE $900 loan out of NEWLY CREATED credit!

What happens if Sam were to default on his $900 loan?  The bank would get his riding mower – assuming that it was used to secure the loan.  Otherwise, the bank could garnish Sam’s wages.  Also, the bank is making 8% APR interest on credit that it created out of nothing!

There’s a term in law known as “Consideration”.  This is “an act or forbearance or the promise thereof done or given by one party in return for the act or promise of another”.

If you take the “standard” teaching of Fractional Reserve Banking then you could say that the bank, along with Joe and others, has some “consideration” on any loans given out.  After all, those loans were funded with the deposits of Joe and others.

However, the REAL way in which Fractional Reserve Banking is accomplished means that banks have ZERO “consideration” over the loans that they give out.  That newly created credit is just a balance sheet entry.  It is not composed of ANY money from other depositors!

So why do banks even need depositors?  Why not just create new loans and reap the interest?  It’s because the game they play would become very obvious if that were to occur.  Instead, they have banking rules which state that they must have at least 10% “reserve” in an account when measured against their entire net total of demand accounts.  THAT’S why they have depositors.  Each deposit of $20 allows banks to IMMEDIATELY loan out $180 to somebody else if they so choose.

Notice how I never said that banks have to withhold 10% of each deposit.  The rules NEVER state this.  In fact, here is what the Federal Reserve specifically says about the Reserve Requirements:

“Reserve requirements are the amount of funds that a depository institution must hold in reserve against specified deposit liabilities.”

Conclusion

Folks, please understand what all of this means.  It means that EVERY SINGLE LOAN was created with fresh, brand-new credit.  They are NOT based on the money of depositors like we have been taught!

Remember Joe’s $100?  It’s the only deposit that wasn’t based on a loan.  It’s STILL SITTING IN THE BANK’S RESERVE ACCOUNT!

Why do we need FDIC insurance to protect our deposits?  ALL of our non-loan deposits are sitting 100% at the bank!  FDIC insurance simply protects deposits that were based on loans.

Let me put it more directly.  Banks loan out money (they call it credit) in which they have no “consideration” over – nor does anybody else on the lending side.  They collect interest from the debtors on loans in which they have no “consideration”.  They confiscate assets and/or garnish wages over unpaid loans that they have no “consideration” over.

What does a bank do to loan out a $180K mortgage loan?

First, they wait for somebody to deposit $20K into their bank.  Then they take the $20K and put it in their Reserve account.  Next, they create a 30-year $180,000 loan at 5% APR by a few computer keystrokes (after the debtor signs their name to a promissory note).  Then they create a demand checking account for $180K.  The $180K is brand new credit.  It has $0 of depositor money.

The bank starts out earning $750/month in interest money from this new loan.  If the debtor loses their job and can’t make the loan payments then the bank gets to take the debtor’s REAL ASSET OF A HOUSE!!!

Then society proceeds to tell the debtor what a louse they are for skipping out on “Joe’s” money that helped make up the loan – when in reality, “Joe’s” money is still sitting in the bank’s Reserve account.

Let me add that I unequivocally believe that a person is responsible for their debts that were freely undertaken.  But what part does fraud, and the absence of “consideration” play into all of this?

Comments or questions?  brhamill@hamill.com

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