Saturday, June 9, 2012

Do banks create money out of thin air?

How do banks create money

When I go to a bank to take a loan, where does the bank have the money from?

Do they lend me someone else’s money? Do they create it? Do they get it from the Fed/Bank of England?

No. Many people, thinking of money as of something with inherent value, have problems with thinking that banks simply create money “out of thin air”. However, with our definition of money as contracts for labour (, then it is very easy to see what is happening.

The magic happens here

When I walk into a bank, I take a loan and I sign a piece of paper pledging part of my labour to the bank. I am creating contracts for labour with the bank’s help – and the bank can give me money/bearer contracts now in exchange, because they know that I will work for them to cover those contracts.

So it is I, the guy who will do the labour, that creates the money out of thin air, by declaring that I exist and that I can back the labour contract that I sign with my labour. What the bank creates from thin air is the printouts of the contracts for labour, once as the loan agreement, which then promptly exchanges for bearer contracts emitted by the government (the dollar bills).

The accounting mechanics of it are explained very well here:


  1. What about interest? Does interest come out of thin air?

    1. Interest comes from the profit economic agents create through their activities. Money has a velocity of money, basically how many times the same money is cycled through the system in a year. By circulating 1000 dollars 4 or 5 times through the system in a year, economic agents create profit, and part of this goes back to the lender as interest, paying them back for the risk assumed when they gave you the government money