How Money Actually Works

Because most people do not know how the money system actually works in the real world economy, here is the basic explanation, as summarized from the excellent short-movie Money as Debt:

Money represents actually a PROMISE to pay later

When someone goes to a bank to get a loan (for example for a mortgage, or car-purchase loan, or a simple credit card), the bank actually DOES NOT LEND the borrower any existing money that the bank owned. Instead the bank CREATES the money that it is lending, simply by writing some numbers (the loan amount) into a computer (simply increasing the amount that is written in the the borrower's bank account, without actually transferring any existing money from anywhere).

The bank can legally do this because what is actually happening in the process is that the bank is getting from the "borrower" a PROMISE that he will regularly pay back the "loaned" amount (the PRINCIPAL) plus the INTEREST, and in return the bank is giving the borrower another PROMISE, to pay him the lended money upon request.

This newly-created "credit-money" amount is then transferred to the bank account of the seller of the item for which the loan was needed (for example, the seller of the house, or the seller of the car, or any store in the case of items purchased with the credit card). The account of the seller can be at the same bank, or at a different bank.

1. In case the seller's account is at the same bank, then no real money is actually being transfered. Instead, the numbers written in the buyer's account are decreased, and the numbers written in the seller's account are increased by the same amount. Thus the result is that the seller now has a higher "money" amount in his account (which is actually a "promise" that the bank will pay to him that amount if requested) and the buyer now has the obligation to pay monthly to the bank the portion of the loan, plus the interest.


2. In case the seller's account is at another bank, then there is again no problem for the bank. In that case the first bank will simply "owe" the second bank the specified amount. We can assume that in the same day someone else will most probably get a loan from the second bank, and possibly pay it to someone having an account at the first bank. Thus the second bank will also "owe" a certain amount of money to the first bank.

Thus, as time passes, the banks do not need to transfer any money from one to the other, but simply they need to ballance each-others differences in debts from one bank to the other. The reality is that on the long term the banking system as a whole ACTS AS A SINGLE BANK, and the banks can continue granting loans, with ZERO existing money in the bank.

As you can see from all this, the terms "loan", "lender", "borrower", "deposit", are all misleading. They all rely of the implicit assumptions that people have regarding how they expect the money to work, but instead the truth is completely different. The TRUTH is that when someone gets a loan from a bank, they voluntarilly promise to work for the bank to pay them the INTEREST.

The entire world economy is captive in this monetary system of bank debt

Note that this "someone" who takes a loan from a bank is basically EVERYBODY, because nowadays everyone finances their activities through loans:

• regular PEOPLE get loans to buy houses, cars, and (what's even more stupid) to buy things at the mall! (why don't they just abstain from buying them, and save money, and then later buy them without having to pay interest?!)


• companies (BUSINESSES) get loans to finance their day-to-day operations and investments (if a company decides not to finance it's investments through a loan, it will simply be thrown out of the market by a competing company who does!)


• GOVERNMENTS get loans to finance infrastructure projects, and later they increase taxes to repay their debt plus interest
  (This last fact is the most perplexing: why don't the governments simply CREATE their own money instead of letting the Central Banks, which are private organizations, to create money and then ask the governments to pay INTEREST for it?!)

At present, 95% of all existing money in the world has been created as debt (has been created by the private banks through lending)! So this shows the magnitude of the GLOBAL DEBT.

The negative effects

The fact is that one of the main reasons for INFLATION is actually this continuous debt through new loans. This has the effect that if someone wants to SPEND LESS money, and SAVE MORE money instead, then over time their money will value much less due to inflation.

Also, the results of even a partial collapse of the banking system are that the economy slows down or even starts decreasing, many companies go out of business, people start losing their jobs, the society is enveloped in poverty, hunger, crime, and eventually WAR.

All of this has been seen during the Great Depression and the following World War, and has also been seen during the recent Global Economic Crisis and at the same time the escallating war expenditures on the wars in Irak and Afghanistan.

The Perpetual Debt

But in all this scheme, there is something missing (by design): the amount that is being "lended" (the principal) is created by the bank through the process of "lending", but the interest to be payed back is NOT created through this process. This means that the money for the interest must later come from SOMEWHERE ELSE to be repayed to the bank. Because the money to pay the interest does NOT actually yet EXIST, this means that the only way that the entire world can pay all the interest is through refinancing the old loans, which means MORE DEBT!

The end result is this: the entire world is currently in a state of PERPETUAL DEBT to the International Central Banks, and there is no apparent WAY-OUT OF THE PERPETUAL DEBT.

Solutions?

The solution that some people suggest is that governments (or even the regular people) start creating their own money, INTEREST-FREE, and use that money to finance their needs, instead of getting loans at interest from the Commercial Banks.

To understand better and have a VISUAL representation of the whole process, see here the original Money as Debt movie, and find here some more ideas about alternative currency and sustainable money system