The Star (Nairobi)

Kenya: Banks Loan People Money They Don't Have

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He decided to play a magic trick. He would give more credit than actual gold in the vault. Because the notes holders never came to demand their gold at the same time and since no one other than himself knew what was actually in the vault, he was sure no one would know of his trickery. So he devised to loan ten times the amount of the gold that was in the vault, and no one ever noticed.

He became even more wealthy lending magic money which he created magically by himself from thin air; he just wrote the notes and they took them.

And because of the simplicity of the idea, the people never imagined that anyone would try such an absurd thing; that anyone would have the audacity to lend what they did not have; or to lend what did not exist. But the goldsmith did, and he laughed with joy every day in his own bank.

By the time the people eventually found out about the trickery, the goldsmith had become indispensable to the expanding European trade. And so the practice was adopted and became an official bank practice known as fractional banking; and that's where we are today.

Furthermore, paper money used to be backed by gold and the US dollar is the world's reserve currency. By 1971, the US had printed so much money it could not be redeemed in gold and President Nixon suspended the convertibility of the dollar into gold; the dollar became just a piece of paper. You may wonder if some of that paper is not given out as aid or loans with interest.

Fractional baking today takes over from the goldsmith but with the same trickery; for example (rules may slightly vary country to country) when a hard working farmer goes to deposit Sh10,000 from sale of his produce, the banker can retain Sh1,0000 as readily available reserve and lend Sh9,000.

If the person loaned this Sh9,000 deposits it in another bank, that bank is allowed to retain 10 per cent (Sh900) and thus can lend Sh8,100, and if this is deposited in another bank, that bank retains Sh810 and can loan out Sh7,290, and so on until the farmers original deposit of Sh10,000 has been turned by banks to Sh100,000 (this process would stop if the money is turned into cash).

When you get a loan from a bank, the bank gives you money it does not already have. The papers you sign are what authorize the bank to create credit for you. Technically the bank does not lend you money because it cannot lend what it does not have. The bank is then allowed to exchange that credit with government legal tender. The only real thing of value involved in the transaction is the collateral which you pledge to forfeit if you don't pay. The banker has no money to give, just credit and your debt becomes money.

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