Paul Dundon’s Weblog

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A little cheese and a little whine

That leverage story in full

Recent conversations about the continuing triumph of Marxism banking crisis elicited an apparent disagreement between myself and an old friend, viz:

  1. I held that banks have to hold about 10% of their deposits in cash; and
  2. He held that bank loans increase the amount of money in circulation by a factor of 7 or 8

In fact we’re both right. Here’s how.

Suppose there’s just one bank, and £100 in cash. We deposit the £100 in the bank. The bank has to hold on to 10% of it. So, they make a loan of the other £90. What, however, does the borrower do with the money? She deposits it in the bank, naturally (or spends it with people who do so). Now the bank has £190 in deposits. They have to hold on to £19 of it, and have already made a loan of £90, so can now make another loan of £81. Which goes back in the bank, giving them deposits of £271.

By the time the music stops, the bank has £1,000 in deposits – ie, there are £1,000 in circulation, 10 times the number that would be in circulation without this process. For British banks, the credit to savings ratio is usually set at about 8%, pushing the final figure up to 12.5 times the initial one. A neat trick, but a clear indication why, once the banks start to lose confidence in each other, we’re in real trouble.

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Filed under: Politics

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My Bookshelf

The Golden Bough
The Value of Nothing
The Fire
A Wolf at the Table
Devil Bones

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