Credit Multiplier & How Banks Create Money

Credit Multiplier & How Banks Create Money: A Reckoning with the Debt System

As someone who’s spent years reverse-engineering the debt system, I’ve come to a simple yet profound realization: banks don’t just lend money; they create it. And it’s not magic – it’s math.

When you borrow from a bank, what do you get? A promise of repayment with interest, of course. But behind that promise lies a web of intricate mechanisms, designed to extract value from your labor and fuel the growth of an economy built on debt.

Let’s dissect this web and reveal its inner workings. By the end of this post, you’ll understand how banks create money, and more importantly, how you can use this knowledge to your advantage.

The Credit Multiplier

In the 1920s, economists developed a concept called the credit multiplier (K) to explain how banks amplify their lending power. It’s deceptively simple:

K = 1 / (r x d)

Where r is the reserve ratio (the percentage of deposits banks keep in reserve) and d is the deposit multiplier (the number of times deposits are multiplied by each loan). The formula looks like this:

Suppose a bank lends $100 to Alice, who uses it to buy a car. That $100 becomes a new deposit in Bob’s account at another bank, which then lends an additional amount based on that deposit.

Assuming the reserve ratio is 10% (the standard rate), for every dollar deposited, only $0.10 goes into reserves; the remaining $0.90 can be lent again and again. This means that with each loan, the total money supply increases by a factor of d = 1 / r.

In our example:

K = 1 / (0.10 x 10) = 10

For every dollar deposited, the bank can lend out $9 more. But here’s the kicker: when those loans are repaid with interest, the original deposit is multiplied by a factor of K, creating new money in the process.

Money Creation Through Velocity and Rate Decay

Now that we’ve got the credit multiplier, let’s talk about velocity (v) – how fast money circulates through the economy. Imagine cash flowing from one person to another like a river; its speed directly affects the total amount of money in circulation.

As v increases, more money is exchanged, and each transaction creates new deposits, which are then lent out and spent again. This process accelerates the creation of new money, fueled by the bank’s initial loan.

But what happens when interest rates rise? Rate decay (R) kicks in – it’s the gradual decrease in the value of the original deposit due to compounding interest.

Suppose Alice borrows $100 at 5% interest and pays back $105 after a year. If she then lends that money at 7%, her new deposit will be worth less than before: $105 becomes $110.75, but the bank keeps only $10.75 in reserves (10% of $107.50). The remaining $96.75 is available for lending again.

Here’s where it gets interesting: as rates rise, v decreases because people start saving more and spending less; they’re less likely to take on new debt at higher interest rates. Meanwhile, R increases due to compounding interest, which erodes the purchasing power of the original deposit.

The Cash-Flow Redistribution Mechanism

Now we’ll explore how banks redistribute cash flows through their lending activities. Imagine a seesaw: when Alice borrows from Bank A, she pays off Bob’s loan at Bank B, who then uses that money to lend to Charlie.

In this scenario:

* Alice’s debt increases (a)
* Bob’s debt decreases (b)
* Charlie’s debt increases (c)

The cash flow redistributes as follows:

a – b = c

Where ‘a’ is the amount borrowed by Alice, ‘b’ is the amount repaid by Bob, and ‘c’ is the new loan to Charlie. As this cycle repeats, banks accumulate more deposits, which are then lent out at higher rates, creating a never-ending spiral of debt.

Breaking Free from the Debt Cycle

Armed with this understanding, you can now see that the debt system isn’t just about getting a loan; it’s about participating in a perpetual motion machine designed to extract value from your labor and create new money for banks.

To break free, focus on building cash reserves and investing in assets that produce cash flow (dividends, interest-bearing accounts). By doing so, you’ll:

1. Reduce your reliance on bank-issued credit
2. Accumulate wealth at a higher rate than the debt-growth rate
3. Gain leverage over banks by creating new deposits through smart investing

Don’t fall prey to the fear-mongering that “you need to budget harder” or “debt is inevitable.” Understand the mechanics behind money creation and use this knowledge to your advantage.

With every dollar you save, you’re not just reducing debt; you’re also fueling a higher rate of return on investment. By redistributing cash flows, you’ll be part of a new mechanism – one that prioritizes wealth-building over debt accumulation.

Join the rebellion against the debt system. Don’t let banks create money at your expense. Create it for yourself.