[quote=jpinpb]I’m having trouble understanding the island example as it relates to what’s happening in our economy. We do have fractional reserve lending and we can print money at will, so it’s a much different scenario.[/quote]
Rich’s example leaves out the money multiplier, possibly for simplicity
Every macroeconomics textbook has an explanation of how credit money is created by the system of fractional banking that goes something like this:
Banks are required to retain a certain percentage of any deposit as a reserve, known as the “reserve requirement”; for simplicity, let’s say this fraction is 10%.
When customer Sue deposits say 100 newly printed government $10 notes at her bank, it is then obliged to hang on to ten of them—or $100—but it is allowed to lend out the rest.
The bank then lends $900 to its customer Fred, who then deposits it in his bank—which is now required to hang on to 9 of the bills—or $90—and can lend out the rest. It then lends $810 to its customer Kim.
Kim then deposits this $810 in her bank. It keeps $81 of the deposit, and lends the remaining $729 to its customer Kevin.
And on this iterative process goes.
Over time, a total of $10,000 in money is created—consisting of the original $1,000 injection of government money plus $9,000 in credit money—as well as $9,000 in total debts. The following table illustrates this, on the assumption that the time lag between a bank receiving a new deposit, making a loan, and the recipient of the loan depositing them in other banks is a mere one week.
Money “printing” such as the Fed’s MBS purchases of a trillion or so is a separate process from the standard operating procedure of the system.
