“Mama who makes our money?” asks little Wally. “I do not know exactly Wally, but I will investigate this for you. ” Mom, I want to learn how to make money, then I no longer have to work”, Wally screams.
What is money?
Money consists of banknotes and coins, currency, and checkbook money or bank money, remember the first time you went with your parents to open a bank account, that is called checkbook money. Checkbook money is strange, you have it but you can not touch it. Obviously it is always possible to withdraw money from your bank account. Bank money and currency together form the money in the hands of the public.
Who can create money?
1.) Federal reserve bank in Washington, also called the central bank
2.) Your local bank
How do they do it?
The central bank has a printing press and can print money, with that money the central bank buys loans from your local bank and government loans, often called government bonds. Only the central bank can make coins and banknotes.
Your local bank creates money by extending a loan, creating commercial bank money. When a loan is paid back, the commercial bank money disappears from existence. Your local bank can only create bank money.
Example 1 Central Bank.
Your local bank goes to the central bank and says: “I need some money, 30 dollar”, just as you go to the bakery and ask for one bread. Your bank buys money instead of bread, and because your bank has no money, she writes an loan agreement, indicating that your locale bank owes the central bank 30 dollars. This is like: You forgot your money and you ask the bakery to write down that you owe him one bread. The central bank employee goes down, prints three 10 dollar notes, and hands them to your local bank employee. And so there is 30 dollars created out of thin air.
Just as you must pay interest on your mortgage or car loan, your local bank also pays interest to the central bank, however interest is discussed later.
Example 2 Your local bank
You go to your local bank and deposit 100 dollars, 10 notes of 10 dollars. Imagine you’re the banks only customer, your local bank has now 100 dollar, which are yours, and your local bank must return the 100 dollar as soon as you decide to make an expenditure, i.e. your local bank has a debt of 100 dollar to you. Now Wally walks in and he needs some money. “Can I borrow 90 dollars” says Wally, “Of course” says your local bank employee, as he draws nine 10 dollar notes. Wally signs a loan , indicating that he owes the local bank 90 dollars. And so there is 90 dollars made.
Wait a minute there are still ten notes of 10 dollars! Wally has 9 notes of 10 dollar and your local bank has 1 note of 10 dollars, together 100 dollars. That’s right, and yet you still have your 100 dollar, and Wally has now 90 dollars, together you have 190 dollars, without increasing the number of 10 dollar notes. The other 90 dollar is bank money, money that you can not touch but you own. The bank assumes that you are not using your money now, and gives it to someone (Wally) who wants to use it immediately. In the instance that you claim your 100 dollar immediately after Wally got his loan, your local bank has to borrow money from the central bank.
So now you know who makes money and how it is made.The Federal reserve bank in Washington makes money by printing money and then lending it to your local bank. Your local bank makes money by lending it Wally and other people.