i’m just going through some basic financial philosophy discussions and i’m just trying to clarify the basics.
how much money is there in total, in the world?
up until yesterday i had assumed that the total amount of money in the world is zero ($0) because what one person has in bank account, another person has in debt at the same time, since money is literally nothing else than a codified form of debt.
now i’m wondering, is this even accurate? if a big bank takes out a loan from the central bank, say, it takes $1B in loan, then it has $1B in money on the account but also $1B in liability at the same time, so the sum is zero. However, there is an interest on the loan, let’s say 2%. Then the bank owes $1.02B actually, while only having $1B on the account. So the total amount isn’t zero, it’s negative. Is this correct?
Fractional reserve banking. You’re assuming a 1:1 ratio of debt to assets. That’s not the case at all. A bank can have $1 mil on hand and lend out $10 mil plus, as long as they have a high enough percentage available for withdrawals.
Banks have an infinite money cheat code. In a way. If person gets a loan from a bank, $10 million, which requires the bank to have $1 million on hand. That person then uses the $10 million to pay people. If those people then go… put their money in the bank… The bank now has the same $11 million on hand they started with, a guy who owes them $10 million plus interest, and could now theoretically loan out another $9 million to another person. At that point they’d have $2 million on hand, 2 guys who owe them $19 million. Still within their 10% cash reserves. But wait… one more thing. I was assuming a 10% reserve as a rule. But in same cases they don’t even require banks to keep any specific percentage on hand. So the debt to assets ratio could become even more insane.
Negative at a 10:1 ratio, maybe even more.
https://en.wikipedia.org/wiki/Fractional-reserve_banking
yeah but they have to pay back the $10M eventually, at least formally, so they have that as debt at the same time. thus the sum is zero, where they were before.
In this example the bank started with $1 million total. Loaned out $10 million. If the guy paid back $10 mil, the bank would have 10x their starting money.
No, because they gave that $10 million to someone else first.
The bank became $10,000,000 in debt, then recovered it (with interest) what the bank gets in the end is the interest above the $10,000,000.
An example would be that a bank goes into $10,000,000 debt on paper, recovers $11,000,000 including interest, now bank has $1,000,000 extra due to it’s risk that the person paid their debt.
Assuming the bank is FDIC insured - If that money wasn’t paid back, the bank would have to sell that debt to a collector to get some of it back. If they did their risk calculations correctly than enough people would pay rather than default that they make a sizeable amount of money. If they didn’t, then the federal government takes over the bank, sells it to someone who can afford to handle the debt/credit load, and covers accounts due any lack of funds.
In theory this means that the bank is still required to keep their risk low enough to maintain their FDIC status. In practice it’s a lot more complicated and sometimes (but rarely) banks don’t get punished for risky bets that don’t pay off.