# How fractional reserve banking and M0 work **URL:** \ **Category:** Great Debates\ **Created:** [October 18, 2018, 5:56am UTC](https://boards.straightdope.com/t/how-fractional-reserve-banking-and-m0-work/823134 "2018-10-18T05:56:30Z")\ **Posts on this page:** 20\ **Page:** 5
**Author:** ![mustang19](https://avatars.discourse-cdn.com/v4/letter/m/e19adc/32.png) [@mustang19](https://boards.straightdope.com/u/mustang19)\ **Post date:** [October 18, 2018, 7:00pm UTC](https://boards.straightdope.com/t/how-fractional-reserve-banking-and-m0-work/823134/81 "2018-10-18T19:00:38Z")
> [@beowulff](#): > > Now we are getting somewhere. > Without gaming the system (doing something illegal), there are limits on how much money you can make as a bank. There are always competitors who are trying to steal your customers, and the bigger you grow, the more expenses you have. Attracting new customers becomes a major expense. > This is why NO business grows without bound. Well of course it just gets monopolized in a small nunber of banks that cross-hold and therefore effectively own each other and are a single monopolized entity. ---
**Author:** ![Alpha\_Twit](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/alpha_twit/32/265_2.png) [@Alpha\_Twit](https://boards.straightdope.com/u/Alpha_Twit)\ **Post date:** [October 18, 2018, 7:01pm UTC](https://boards.straightdope.com/t/how-fractional-reserve-banking-and-m0-work/823134/82 "2018-10-18T19:01:31Z")
> [@mustang19](#): > > You already made 1000x instant money so you can just repeat that. Transaction costs are a minor technicality. If you make 0.1% a day with a 10x reserve requirement then you make 2700% a year and will have all the money in the world in 6 years. Either there’s something very wrong with this statement or I know much less about finance that I think I do. I feel like a dog that’s just been shown a card trick. ---
**Author:** ![mustang19](https://avatars.discourse-cdn.com/v4/letter/m/e19adc/32.png) [@mustang19](https://boards.straightdope.com/u/mustang19)\ **Post date:** [October 18, 2018, 7:01pm UTC](https://boards.straightdope.com/t/how-fractional-reserve-banking-and-m0-work/823134/83 "2018-10-18T19:01:41Z")
> [@Slash1972](#): > > I haven’t made ANY money. That $1,001,000 belongs to someone else. It’s not mine. No its yours to invest. You can multiply it into 10x more m1 and invest it or lend it to a shell company to invest for you. ---
**Author:** ![Ravenman](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/ravenman/32/2929_2.png) [@Ravenman](https://boards.straightdope.com/u/Ravenman)\ **Post date:** [October 18, 2018, 7:02pm UTC](https://boards.straightdope.com/t/how-fractional-reserve-banking-and-m0-work/823134/84 "2018-10-18T19:02:55Z")
Do you think banking regulators would notice if a bank somehow made quadrillions of dollars magically appear through the use of shell companies? ---
**Author:** ![Slash1972](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/slash1972/32/6461_2.png) [@Slash1972](https://boards.straightdope.com/u/Slash1972)\ **Post date:** [October 18, 2018, 7:04pm UTC](https://boards.straightdope.com/t/how-fractional-reserve-banking-and-m0-work/823134/85 "2018-10-18T19:04:52Z")
> [@mustang19](#): > > No its yours to invest. You can multiply it into 10x more m1 and invest it or lend it to a shell company to invest for you. Again, you seem to be skipping over some steps. I already stipulated that I’ve invested $1 million in something that returns 5% annually. So after the first year, I have $50,000 and I owe $1 million. That is not “infinite” money. What’s my next step? ---
**Author:** ![Musicat](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/musicat/32/20189_2.png) [@Musicat](https://boards.straightdope.com/u/Musicat)\ **Post date:** [October 18, 2018, 7:05pm UTC](https://boards.straightdope.com/t/how-fractional-reserve-banking-and-m0-work/823134/86 "2018-10-18T19:05:13Z")
> [@mustang19](#): > > I will. Do you promise to throw us a big party with your first million? (You can always reinvest 10% of it.) ---
**Author:** ![Riemann](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/riemann/32/3133_2.png) [@Riemann](https://boards.straightdope.com/u/Riemann)\ **Post date:** [October 18, 2018, 7:11pm UTC](https://boards.straightdope.com/t/how-fractional-reserve-banking-and-m0-work/823134/87 "2018-10-18T19:11:25Z")
Am I the only one thinking of this? [![](https://img.youtube.com/vi/tO5sxLapAts/hqdefault.jpg "South Park Underpants Gnomes Profit Plan") ](https://www.youtube.com/watch?v=tO5sxLapAts) ---
**Author:** ![Little\_Nemo](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/little_nemo/32/3120_2.png) [@Little\_Nemo](https://boards.straightdope.com/u/Little_Nemo)\ **Post date:** [October 18, 2018, 7:16pm UTC](https://boards.straightdope.com/t/how-fractional-reserve-banking-and-m0-work/823134/88 "2018-10-18T19:16:06Z")
> [@tonyfop](#): > > I did not read the original thread, but I am trying to wrap my head around something that I previously read on the Dope. I remember a (conservative) poster on here trying to explain that when a bank makes a loan, it was not actually loaning out the depositor’s money. What this poster said was that banks were actually creating wealth when they wrote a loan, because they just write a check to whomever the home is being bought from. The understanding I got about fractional reserve banking from this person was that a bank had no upper limit on the loans it could write, as long as it kept a fraction of the money (set by law) in reserve. (I guess this is similar to what the OP of the other thread was saying). So taking the bank that **Little Nemo** describes above, with a law of 3%, if a bank has $100 million in deposits, if they keep $3 million on hand, they can make $97 million in loans, but if they keep $30 million on hand, they can actually make $970 million in loans, and if they keep it all on hand, they could make $3.333 billion in loans. This is supported, kind of, by the “Money Multiplier” section of this wiki article. [Fractional-reserve banking - Wikipedia](https://en.wikipedia.org/wiki/Fractional-reserve_banking). The graph basically shows that $100 in cash can generate $900 in “broad money” (M0?) in a 10% fractional reserve environment. Further down, there is a fictional balance sheet for a New Zealand bank that shows that indeed, assets cannot exceed liabilities, as **Pleonast** shows. So what is the wiki saying when it says that a $100 deposit can generate up to $900 “broad money”? That’s a wrong reading of how the reserve works. You don’t take the amount of money in the reserve and then multiply up to a larger amount. You take the total mount of money you have and divide down to the reserve. Let’s call ten percent to keep the math simple. You’re a bank and you receive a hundred million dollars in deposits. You are required to keep a ten percent reserve on hand, so you hold on to ten million dollars and loan out the other ninety million. It’s true that the total amount of money you have is equal to ten times what’s in the reserve. But the total produced the size of the reserve; the reserve didn’t produce the size of the total. If you decided to keep a higher reserve, let’s say twenty million rather than ten million, you wouldn’t change the size of your total assets. Doubling your reserve does not double your assets. The total stays at a hundred million. You’ve just changed it from ten million in reserve and ninety million available for loans to twenty million in reserve and eighty million available for loans. ---
**Author:** ![Bone](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/bone/32/407_2.png) [@Bone](https://boards.straightdope.com/u/Bone)\ **Post date:** [October 18, 2018, 7:18pm UTC](https://boards.straightdope.com/t/how-fractional-reserve-banking-and-m0-work/823134/89 "2018-10-18T19:18:58Z")
> [@Riemann](#): > > Do the banknotes have a gold fringe? I think that’s what distinguishes M0 from M1. > > Ok, I’ll stop taking the piss, but I had a serious point in asking mustang what he thought about the Sovereign Citizens legal arguments. Because it might give him some insight to point out that his “arguments” here resemble theirs in presentation - numerous poorly-grasped ideas placed semi-coherently in proximity to one another in sentences without any real understanding. [quote=“Riemann, post:87, topic:823134”] Am I the only one thinking of this? [/QUOTE] That’s enough. If you want to engage in debate on the merits, go ahead. But since the post about gold fringe, you’ve stopped doing that and are … not exactly trolling, but something akin to it. If mustang19 wants to make an argument, address it on the merits. Sovereign Citizens, etc. is off topic as well as far as I can see so let’s drop that too. [/moderating] ---
**Author:** ![tonyfop](https://avatars.discourse-cdn.com/v4/letter/t/85f322/32.png) [@tonyfop](https://boards.straightdope.com/u/tonyfop)\ **Post date:** [October 18, 2018, 7:23pm UTC](https://boards.straightdope.com/t/how-fractional-reserve-banking-and-m0-work/823134/90 "2018-10-18T19:23:18Z")
> [@Little\_Nemo](#): > > That’s a wrong reading of how the reserve works. You don’t take the amount of money in the reserve and then multiply up to a larger amount. You take the total mount of money you have and divide down to the reserve. > > Let’s call ten percent to keep the math simple. You’re a bank and you receive a hundred million dollars in deposits. You are required to keep a ten percent reserve on hand, so you hold on to ten million dollars and loan out the other ninety million. > > It’s true that the total amount of money you have is equal to ten times what’s in the reserve. But the total produced the size of the reserve; the reserve didn’t produce the size of the total. > > If you decided to keep a higher reserve, let’s say twenty million rather than ten million, you wouldn’t change the size of your total assets. Doubling your reserve does not double your assets. The total stays at a hundred million. You’ve just changed it from ten million in reserve and ninety million available for loans to twenty million in reserve and eighty million available for loans. I understand that. I was just asking someone to explain the concept of th “Multiplier” that is in the wiki in my original post. I know wiki is just a bunch of schmo’s on the street typing whatever they want, but I have seen the concept before, and could not figure out what it meant. If you say it is dead wrong, then I will believe you, but I am thinking that I am just looking at the concept wrong. And I trust the schmo’s on the Dope before I ever trust the schmo’s on Wikipedia. Here is the wiki again: [Fractional-reserve banking - Wikipedia](https://en.wikipedia.org/wiki/Fractional-reserve_banking) ---
**Author:** ![Little\_Nemo](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/little_nemo/32/3120_2.png) [@Little\_Nemo](https://boards.straightdope.com/u/Little_Nemo)\ **Post date:** [October 18, 2018, 7:33pm UTC](https://boards.straightdope.com/t/how-fractional-reserve-banking-and-m0-work/823134/91 "2018-10-18T19:33:17Z")
> [@mustang19](#): > > Offer somebody $1 to deposit $1000 (multiply these numbers by billions if they seem small), all the other banks will keep failing and getting bailed out so you get infinite money. You don’t have infinite money. You have less money than you started with. Because that depositor didn’t give you $1000. It’s still his money and any time he wants he can get his $1000 back. Plus he gets the dollar you gave him. So he ends up with $1001 dollars and you have a dollar less than you started with. The way you come out ahead is that when you have the $1000 you turn around and loan other people $100 and tell them they have to pay you back an extra dollar. So you loan ten people $100 each and they all pay you pack $101. You now have $1010. The original depositor asks for his $1000 back plus the extra dollar you promised him. You give him $1001 and you get to keep the remaining nine dollars. But you never had infinite money. With the $1000 you could loan ten people $100 each. You couldn’t loan fifty people $100 each because you didn’t have the $5000 that that would require. The total amount you can loan out is the amount that’s been deposited with you - $1000 not infinity. If you wait until the first round of loans is paid back, you’ll have $1010 and you can now loan out that much - but still not infinity. All a fractional reserve changes is that instead of being able to loan out the entire $1000, you have to keep $100 of it in your wallet and can loan out the other $900. It’s still not infinity. ---
**Author:** ![zoid](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/zoid/32/336_2.png) [@zoid](https://boards.straightdope.com/u/zoid)\ **Post date:** [October 18, 2018, 7:47pm UTC](https://boards.straightdope.com/t/how-fractional-reserve-banking-and-m0-work/823134/92 "2018-10-18T19:47:07Z")
This is starting to sound like some kind of banking Ponzi scheme. ---
**Author:** ![septimus](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/septimus/32/410_2.png) [@septimus](https://boards.straightdope.com/u/septimus)\ **Post date:** [October 18, 2018, 7:51pm UTC](https://boards.straightdope.com/t/how-fractional-reserve-banking-and-m0-work/823134/93 "2018-10-18T19:51:13Z")
First of all: _ **10%** _, not 3%, is the standard reserve requirement. The 3% rate is just a “loss leader” on the first $X to encourage small banks to apply for federal charters. I don’t know what the reserve requirements are for state-chartered (non-federal) banks. > [@Dewey\_Finn](#): > > And note that fractional reserve banking can operate independently of the Federal Reserve System. A bank can just take in deposits, for which it pays interest, and then lend out money, for which it charges interest. No Federal Reserve needed. In particular, “banks” operating _without regulation_ can loan out ALL their deposited cash if so inclined. (cf. Charles Ponzi et al). Viewed that way, “fractional reserve” is NOT a _privilege_ granted to regulated banks, but rather an _obligation_ they must satisfy for the benefits of being chartered. > [@mustang19](#): > > Example > > Bank 1: $1 m0 and $10 m1 > Bank 2: $1 m0 and $10 m1 > Reserve requirement 10% > > $1 m0 is withdrawn from bank 1. Mint replenished this. > > It is now > > Bank 1: $1 m0 and $9 m1 Stop right there! You’ve got it backwards. When customer withdraws the $1 in cash, the _bank becomes delinquent in its reserve requirement._ The Fed doesn’t give it $1 (let alone the mint give it :smack: ) The bank must deposit $1 of m0 with the Fed to fulfill its reserve requirement. It will be scrambling on the telephone hoping it can use some of its assets as collateral to borrow $1 of m0 from another bank. Now that you know this, try again. ---
**Author:** ![Slash1972](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/slash1972/32/6461_2.png) [@Slash1972](https://boards.straightdope.com/u/Slash1972)\ **Post date:** [October 18, 2018, 8:07pm UTC](https://boards.straightdope.com/t/how-fractional-reserve-banking-and-m0-work/823134/94 "2018-10-18T20:07:46Z")
Dammit, I’m hanging on the edge of my seat awaiting the final steps needed for infinite money, and **mustang19** hasn’t returned! ☹ ---
**Author:** ![mustang19](https://avatars.discourse-cdn.com/v4/letter/m/e19adc/32.png) [@mustang19](https://boards.straightdope.com/u/mustang19)\ **Post date:** [October 18, 2018, 8:56pm UTC](https://boards.straightdope.com/t/how-fractional-reserve-banking-and-m0-work/823134/95 "2018-10-18T20:56:48Z")
> [@Slash1972](#): > > Again, you seem to be skipping over some steps. > > I already stipulated that I’ve invested $1 million in something that returns 5% annually. > > So after the first year, I have $50,000 and I owe $1 million. > > That is not “infinite” money. > > What’s my next step? You dont owe anything. You made $50k with $1k. The $1m is technically a liability but its canceled out by your asset. ---
**Author:** ![mustang19](https://avatars.discourse-cdn.com/v4/letter/m/e19adc/32.png) [@mustang19](https://boards.straightdope.com/u/mustang19)\ **Post date:** [October 18, 2018, 9:00pm UTC](https://boards.straightdope.com/t/how-fractional-reserve-banking-and-m0-work/823134/96 "2018-10-18T21:00:01Z")
> [@septimus](#): > > First of all: _ **10%** _, not 3%, is the standard reserve requirement. The 3% rate is just a “loss leader” on the first $X to encourage small banks to apply for federal charters. I don’t know what the reserve requirements are for state-chartered (non-federal) banks. > > In particular, “banks” operating _without regulation_ can loan out ALL their deposited cash if so inclined. (cf. Charles Ponzi et al). Viewed that way, “fractional reserve” is NOT a _privilege_ granted to regulated banks, but rather an _obligation_ they must satisfy for the benefits of being chartered. > Stop right there! You’ve got it backwards. When customer withdraws the $1 in cash, the _bank becomes delinquent in its reserve requirement._ The Fed doesn’t give it $1 (let alone the mint give it :smack: ) The bank must deposit $1 of m0 with the Fed to fulfill its reserve requirement. It will be scrambling on the telephone hoping it can use some of its assets as collateral to borrow $1 of m0 from another bank. > > Now that you know this, try again. Well yes like I already said its legal ponzi scheme based on fdic bailouts ---
**Author:** ![Lemur866](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/lemur866/32/434_2.png) [@Lemur866](https://boards.straightdope.com/u/Lemur866)\ **Post date:** [October 18, 2018, 9:16pm UTC](https://boards.straightdope.com/t/how-fractional-reserve-banking-and-m0-work/823134/97 "2018-10-18T21:16:32Z")
Dude. Do you really think the only reason banks don’t make infinite money is because they’re too lazy and stupid? Like, I bet there was at least one banker in history who was pretty greedy and wanted more money, and was willing to work hard to rip people off. Not work hard making stuff, that’s just crazy talk, but putting some effort into scamming people? That’s, like, what a bank IS. Again, a fractional reserve is just a requirement that the Feds make banks undertake. They have to keep some of their money in reserve, they can’t lend out all of it. And if they fall under that amount the Feds don’t give them more cash. That doesn’t happen. Instead the bank is obligated to liquidate their assets until they come up with the reserve amount. Yes, you can make money by borrowing money from Peter and lending money to Paul. The way you make that money is by paying Peter a low interest rate and charging Paul a high interest rate, and your profit is the difference between those two rates multiplied by the amount of money in play. But to get the money you lend to Paul you first have to have money. OK, you got the money by borrowing from Peter. You start with $0. You borrow $10 from Peter. But you don’t have $10 now. You have $10, plus a debt of $10 to Peter, which puts you right back to $0. You have $10 cash, plus a $10 debt, which adds up to $0. If you take the $10 in cash and lend it to Paul, then you’ve got a $10 asset in Paul’s debt to you and a $10 debt to Peter, which still adds up to $0. The way you make money is that you’re going to pay Peter back $11 next month, but Paul is going to have to pay you back $12 next month, which means that you made $1. Did that $1 appear out of nowhere? No, because Paul has to actually pay you. And according to the Feds you can’t just lend out $10, you can only lend out $9. So instead of lending $10 and getting paid $12, you have to lend out $9 and get paid $10.80 instead. So instead of making $1, you’re only making $0.80. And of course you’re assuming a risk, because if Paul doesn’t pay you back you still have to pay Peter back. Paul gets hit by a truck, and the money is gone, and you still owe Peter $10. So you better hope that your risk of non-repayment is pretty small. Also, suppose Paul is a bank, and Paul had FDIC insurance. Well, then you’re in luck because now you get paid back. Free money! Except the taxpayers had to come up with that money, which means you and Peter. If instead you have FDIC insurance and Peter needs his money and you can’t pay, then the taxpayers will pay Peter instead of you. Good for you! Except, dude, you don’t get to keep the money. You’re bankrupt. The FDIC doesn’t give you the money, they give Peter the money. And instead of owing Peter the money, you owe the government the money, and they’re going to pick over your financial carcass for whatever scraps are left, which is probably not much. So you lose, Paul loses because he’s dead, the taxpayers lose, and only Peter wins, except he’s a taxpayer too, so he loses that way. ---
**Author:** ![Great\_Antibob](https://avatars.discourse-cdn.com/v4/letter/g/e47c2d/32.png) [@Great\_Antibob](https://boards.straightdope.com/u/Great_Antibob)\ **Post date:** [October 18, 2018, 9:46pm UTC](https://boards.straightdope.com/t/how-fractional-reserve-banking-and-m0-work/823134/98 "2018-10-18T21:46:12Z")
Going back to that bizarre example: Bank 1 M1/M0 Assets: $10 Bank 1: On hand to loan out: $9 Bank 1: Must keep $1 on reserve Total: $10 Customer 1: Withdraws $1 Bank 1: On hand to loan out: $8.10 Bank 1: Must keep $0.90 on reserve Total $9 Bank 1: Hey Fed, we need $1 to replace this $1 this customer took. Send it over! Fed: Heck no! You don’t have anything on reserve with us, so why should we give you money? Bank 1: Hey Fed, can we borrow $1? Fed: Sure. Where’s your collateral? Bank 1: Collate…what? Fed: Collateral. You don’t think we’re going to just loan you money without some assurance we’ll get it back, do you? Just make sure it’s worth more than $1 Bank 1: …uh, sure. How about this shiny pebble? Fed: Nope. They don’t get back up to $10. They might get that loan from the Fed, but they’ll need something to back the loan. And if they “collapse” as part of a scheme, the Fed as a creditor gets something they can exchange for at least that $1, rather than the crooks at Bank 1 running off with it. No money is magically created here, which is the part (repeatedly) mentioned is lacking in the story. > [@Lemur866](#): > > Also, suppose Paul is a bank, and Paul had FDIC insurance. Well, then you’re in luck because now you get paid back. Free money! Except the taxpayers had to come up with that money, which means you and Peter. Small correction. FDIC is not publicly funded (though oversight is there via publicly elected officials). Member banks pay for the insurance from the corporation, which is part of a legitimate bank’s cost of doing business. ---
**Author:** ![Great\_Antibob](https://avatars.discourse-cdn.com/v4/letter/g/e47c2d/32.png) [@Great\_Antibob](https://boards.straightdope.com/u/Great_Antibob)\ **Post date:** [October 18, 2018, 10:00pm UTC](https://boards.straightdope.com/t/how-fractional-reserve-banking-and-m0-work/823134/99 "2018-10-18T22:00:41Z")
Actually, thinking on it, is **mustang19** under the impression that the Fed is compelled to produce money to cover the reserve requirements of each of the banks? I suppose that’s one way this bizarre scenario begins to make sense, but it’s also complete bunk. ---
**Author:** ![Lemur866](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/lemur866/32/434_2.png) [@Lemur866](https://boards.straightdope.com/u/Lemur866)\ **Post date:** [October 18, 2018, 10:03pm UTC](https://boards.straightdope.com/t/how-fractional-reserve-banking-and-m0-work/823134/100 "2018-10-18T22:03:43Z")
That’s true, FDIC insurance is supposed to pay for itself, and in practice the rates for the insurance are really really low, because it’s rarely actually needed. It just isn’t the case that shell banks around the country go bankrupt frequently and their creditors get paid out by the FDIC. And it’s certainly not the case that those creditors are other banks holding thousands of phony shell accounts. Yes, fraud exists, as well as stuff that’s actually legal, like buying a company with borrowed money, having the company borrow a bunch of money, paying the new owners of the company lots of that money, and then the company itself crashes and burns. See Toy R Us and Sears. That’s still not a ratchet that will get you infinite money though, because you actually have to buy the company, and con somebody into loaning the company money. And sometimes people do end up in prison for stuff like this. [Previous page](https://boards.straightdope.com/t/how-fractional-reserve-banking-and-m0-work/823134.md?page=4) [Next page](https://boards.straightdope.com/t/how-fractional-reserve-banking-and-m0-work/823134.md?page=6)