When you deposit your paycheck or some cash into your local bank account, you probably assume that it will be there when you need it. That's why your account is called a 'demand deposit' account because after you deposit it, you can demand it back. Your demand usually takes the form of a check or a debit card transaction.
Centuries ago, early bankers realized that not everyone asked for their deposits back at the same time. In fact, it was rare that demands for funds exceeded ten percent of the total on deposit. This amount of cash just sitting in the vault was a powerful temptation and bankers soon succumbed to it. They figured that they could take that ninety percent that never left the bank and loan it out and by charging interest on the loans could make a significant amount of money from other people's money. And, since most people do not even pretend to understand money and banking, this could be done without the depositor's knowledge. This fraud is known by the name fractional reserve banking.
This fraud worked most of the time but, occasionally, depositor's would lose faith in the bank for one reason or another and more than ten percent of the deposits would be demanded at the same time. But the bank didn't have the cash because it had been lent out. As soon as it became common knowledge that the bank could no longer honor demands for depositor's money, almost everyone wanted their money back. This is called a 'run' on the bank and almost always resulted in the failure of the bank and the loss of most of the depositor's money.
This situation resulted in demands by citizens for the government to do something. Now you would think that the government would just make it a crime to loan out depositor's money. But they didn't. They actually made the process legal. (Which makes me wonder if the government wasn't behind some of the bank runs in the first place.) Today, according to the Federal Reserve rules, it is legal for member banks (and almost all banks in the United States are now members of the Federal Reserve System) to loan out up to 80 percent of depositor's money without the depositor's knowledge. The Fed says this is ok now because the banks belong to the Federal Deposit Insurance Corporation which will pay the depositors of a failed bank. This works as long as only a few banks fail but a similar organization, the Federal Savings and Loan Insurance Corporation (FSLIC), was unable to pay off on all the savings and loans that failed and left the bailout to the taxpayers of the United States. It appears to me that your deposits in a US bank are still at risk.
Loaning out your money without your knowledge is bad enough but it gets worse. When the bank loans out your money, they don't usually give cash to the borrower. In almost all cases, they will issue a check. But let's examine where the money for the check comes from and what happens to it after it is issued.
When the bank grants a loan, they first get you to sign a mortgage agreement on some asset that you own. Then they issue the check. The accounting department now makes a bookeeping entry that debits your mortgage agreement as an asset and credits cash. The bank now has reduced it's available cash by the amount of your loan. But then you deposit the check into your account, either at that bank or at another bank in the system. Let's say it's the same bank. Now the accounting department makes another entry that debits cash in the amount of your check and credits your demand deposit account with the same amount. Notice what has happened here. The bank's cash account has not changed but they now have additional funds on deposit which they can now loan 80 percent of. They have just increased the local money supply by the amount of your loan and at the same time created more money that they can loan out.
The above process can continue through several transactions until the increase in the money supply is too small for a practical loan amount. It has been calculated that a dollar deposited in a modern US bank can be turned into ten dollars through this process.
Also notice something else about this process. Here again the loan was used to create money but there is no process to create enough additional money to pay the interest on the loan. That means that even at the local and personal level we cannot all pay off our debts and eventually this will result in the bank owning most or all of the real assets in the local area.
And making this situation even worse is the fact that the Federal Reserve Notes that we are forced (by the government) to use as currency isn't even constitutional. The Constitution For the united States says that only gold or silver coin can be made legal tender for payment of debts. So we cannot even discharge our debts. On a personal level, we can transfer our debt to someone else but the total amount of debt remains the same and, in fact, continues to increase.
Copyright at Common Law, West El Paso Information Network, 1996