Fractional Reserve Banking

This is my first attempt at a blog so here goes...I'm hoping this will be allot of fun and not drudgery...

OK then, we're going to take a trip in a time machine if you're willing to deposit a one troy ounce gold coin in the slot. Strap yourselves in, this ride might get downright dangerous; after all, we are talking about creating currency out of thin air, not money.

So let us assume that 1,000 of you (one thousand) have each deposited your one troy ounce gold coin in the slot and each one troy ounce gold coin is worth $1,000; so since I control the slot in the time machine, I now have $1,000,000.00 of your gold and you are going for a ride in my time machine. Everyone with me so far?

But since we are going time travelling and 1,000 troy ounces of gold is equal to about 70 pounds, and we don't want to waste the fuel to carry any extra load, we'll just print $1,000,000 of paper to take with us and leave the gold coins at home, OK? Good.

Actually, since we are going time travelling, we don't really need the gold for right now so we'll print an extra $94,000,000 in paper currency to lend out while we're gone and earn the interest on that currency. How can I print $94,000,000 in paper currency when I only have $1,000,000 in gold on deposit you ask? Well that is called fractional reserve banking...ya just need a fraction of what you lend out to keep in reserves in case there is a default in repayment of the loans outstanding.

So let's take a look at what happened to the 1,000 one ounce gold coins we deposited when we strapped ourselves in for this 30 year journey...absolutely nothing happened to them. They remained on deposit at my bank and earned no interest; they just sat in the vault and collected dust as a worthless old relic would do.

On the other hand, the $94,000,000 in currency we created earned 5% per year, each and every year...year in and year out, for 30 years. In fact, after the 1st year that the $1,000,000 in gold coin was on deposit where we created $94,000,000 in currency and loaned that out at 5% interest we earned $4,700,000. We took that $4,700,000 and added it to our $1,000,000 of reserves and we were able to loan out an additional $441,800,000, also at 5% interest; so at the end of the second year of our time machine trip we had $5,700,000 on deposit as reserves (one million of which is gold coin), and $535,000,000 loaned out at 5% interest.

Stay tuned tomorrow to find out what happens to our time travellers...