Its actually somewhat simple if you break it down to its simplest terms... and assume this is a vacuum and there are no other banks or depositors.
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$100 (in cash) deposited into a bank....
10% is said to be kept in reserve....thus $90 of that $100 is loaned out....(as a check from the bank)
BUT.....
the $90 loaned out is not taken from the $100 deposit... it is created out of nothing....why?
Because the original depositor can withdraw funds or write checks on his $100 he just deposited all day long. Yet...supposedly the bank has just loaned $90 of the original $100 out. It's a double claim on the same money...isn't it?
So in this example...lets say the original depositor then withdraws his $100 (
in cash) from the bank the day after the $90 loan was made? Does the bank say he can't do it? No, of course not. The bank just gives him his $100 in cash back. Now there is $190 in circulation from the bank....from the $100 originally deposited. Were did the extra $90 come from if it was not created?
The answer is... of course the $90 was created....in
checkbook form to the borrower.
"
Of course, they [banks] do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created."
(
Modern Money Mechanics last paragraph..page 6)
http://www.scribd.com/doc/3990690/Mo...oney-Mechanics
http://gilliganscorner.wordpress.com/2008/04/04/fractional-reserve-banking-a-primer/
Next...lets suppose the person who received the $90 check goes back to the bank to have it cashed in dollars?.....uh oh... the bank has no cash! Shivers go down the spine of the banker! Bank run...and panic starts! That is why we have a Fed to be a "lender of last resort" to that bank (
who would otherwise have to close its doors) in order to keep the charade of money creation in the banks going.
So you may ask...why even have a 10% reserve requirement if a bank can just create check book money? IMHO.. it's designed to obfuscate. The answer is... in many countries with fractional reserve banking they don't have a reserve requirement.
http://www.marketoracle.co.uk/Article9748.html
"Laws requiring banks and other depository institutions to hold a certain fraction of their deposits in reserve, in very safe, secure assets, have been a part of our nation's banking history for many years. The rationale for these requirements has changed over time, however, as the country's financial system has evolved and as knowledge about how reserve requirements affect this system has grown.
Before the establishment of the Federal Reserve System, reserve requirements were thought to help ensure the liquidity of bank notes and deposits, particularly during times of financial strains. As bank runs and financial panics continued periodically to plague the banking system despite the presence of reserve requirements, it became apparent that these requirements really had limited usefulness as a guarantor of liquidity. Since the creation of the Federal Reserve System as a lender of last resort, capable of meeting the liquidity needs of the entire banking system, the notion of and need for reserve requirements as a source of liquidity has all but vanished. Instead, reserve requirements have evolved into a
supplemental tool of monetary policy, a tool that reinforces the effects of open market operations and discount policy on overall monetary and credit conditions and thereby
helps the Federal Reserve to achieve its objectives. -
Quoted from FED Bullitin 1993
http://www.federalreserve.gov/monetarypolicy/0693lead.pdf
