The Alchemy of Banking ---------------------- I want to simulate how banks create money. This simulation demonstrates how loans can be created and never repaid, without consequence, for a system with one bank. The simulation has a Person, a Car Company, a Bank, and a Store. The Person can sell his Labor, the Car Company can make Cars with Labor, the Bank has Reserves and can make Loans, the Store makes Goods. The simulation runs through one potential path of interactions among these economic agents: The Car Company wants to make a Car, so it borrows money from the Bank. The Car Company pays the Person for his Labor with the borrowed Deposit from the Bank. A car is made with the Person's Labor. The Person uses the Deposit given to him to buy Goods from the Store. Note that the Bank simply transfers the created Deposit around; the Bank does not have to spend any reserves to cover the different purchases made with the Deposit it created out of thin air. Now, say the Person wants to buy a Car. The Person has already spent the Deposit received for his Labor, so the Person takes out a Loan from the Bank. The Bank now has two outstanding Loans; two Deposits have been created by balance-sheet entry. The Person buys a Car from the Car Company for the Deposit borrowed from the Bank. Note that no loans have been repayed, two deposits have been created from nothing, and the deposits are circulating as money between agents in the economy with no strain on the Bank's Reserves. This run of the simulation continues: the Car Company buys more Labor from the Person for the Deposit transferred when the Person bought the Car. The Car Company makes another Car. At this point, I print out the cumulative balance sheets for the Bank, the Person, and the Car Company. The point I wish to make with this simulation: two Deposits have been created by the Bank out of thin air, and the economy has produced two Cars and the Person has bought Goods. No Loans have been repaid. As long as the agents continue to circulate borrowed Deposits among themselves, all banking at the same bank, there are no negative consequences for the Bank. The Bank can create as many Deposits as it likes; as long as everyone uses that Bank, the Bank's Reserves will not decrease if the loans are never repaid. The larger point to consider is that the Fed was designed to make the economy function as if there is one Bank. Note about inflation: if the Car Company raises its prices, the Bank can make a larger Loan to the Person. Once again, there are no negative consequences for the Bank's Reserves, as long as there is one Bank (as the Fed is designed to simulate). --- To conclude, I repeat the final balance sheets of the four agents in the simulation: Bank assets | liabilities ----------------------------- Reserves | Net Worth ---------- | ---------- Loan | Deposit ---------- | ---------- Loan | Deposit | The Bank has created two Deposits by keystroke, and has not decreased its Reserves as the Deposits circulate among the other agents. --- Person assets | liabilities ----------------------------- Labor | ---------- | ---------- +Deposit | -Labor | ---------- | ---------- +Goods | -Deposit | ---------- | ---------- Deposit | Loan ---------- | ---------- +Car | -Deposit | ---------- | ---------- +Deposit | -Labor | | The Person sold Labor for a Deposit, bought Goods, took out a loan to buy a Car, and sold more Labor to end up with a Deposit. --- Store assets | liabilities ----------------------------- Goods | ---------- | ---------- +Deposit | -Goods | | The Store started out with Goods, and sold them for a Deposit. The Store can then use the Deposit to produce more Goods, or spend the Deposit on a Car, or something. However the Store chooses to spend the Deposit, as long as the buyer also banks with the Bank, no Bank Reserves are decremented. --- Car Company assets | liabilities ----------------------------- Deposit | Loan ---------- | ---------- +Labor | -Deposit | ---------- | ---------- Car | ---------- | ---------- +Deposit | -Car | ---------- | ---------- +Labor | -Deposit | ---------- | ---------- Car | | The Car Company took out a Loan and hired Labor to produce a Car; the Car sold for a Deposit, which the Company used to produce another Car. Thus from the money created by the Bank, two Cars were produced and no Bank Reserves were decreased. Money was created as Loans that were not repaid, and there were no negative consequences.