What I didn't realize is that they don't even have to have someone who asks for a loan to create money. As Ellen Brown points out on page 169 of her book, the mechanism is described in the amazing booklet "Modern Money Mechanics" that was published by the Chicago Federal Reserve and has since gone out of print (but fear not, you can still download a pdf copy from here).
...banks are required to maintain reserves equal to only a fraction of their deposits. Reserves in excess of this amount may be used to increase earning assets – loans and investments. Deposit expansion can proceed from investments as well as loans.Yes, that's right. Banks can use the money creation mechanism for their own purposes - not just to lend to other parties. So, when Jerome Kerviel went slightly over the top and ended up accumulating €4.9 billion in losses for Société Générale, I think that we can assume that he was playing with money that he didn't even need to borrow. He just waved the magic wand and the money was there for him to play with. No need to ask anyone outside Société Générale to lend him the money, he was one of the "trusted traders" who have been given the keys to the money creation machine.
Suppose that the demand for loans . . . is slack. These banks would then probably purchase securities. . . . [Most] likely, these banks would purchase the securities through dealers, paying for them with checks on themselves or on their reserve accounts. These checks would be deposited in the sellers’ banks. . . . [T]he net effects on the banking system are identical with those resulting from loan operations.
Every now and then, then banks have to show that their total exposure doesn't exceed some ratio of their real deposits. But what happens in the meantime is probably completely up to the people inside the bank.
How much money do banks "create" for their own purposes? It's almost certainly impossible to get accurate figures on this, but Ellen Brown says the following (p170).
How much of a bank’s allotted “reserve balance” is invested rather than lent? Carmen Pirritano (in an article called "Money and Myths") cites “ Federal Reserve Statistical Release (H.8)” detailing the assets and liabilities of domestic banks, which puts the ratio of loans to investments at 7 to 3. Thus in the hypothetical given by Murray Rothbard, in which $10 million was created by the Fed and was fanned into $100 million as the money passed through the banking system, the $100 million would have created $70 million in loans to customers and $30 million in investments for the banks.This is truly jawdropping. How can we have let such a totally insane system come into being? I really can see no difference between this and having a situation where commercial banks are allowed to have a printing press in the basement that they can use for printing their own money.
If there is anyone out there who thinks that they can give a justification for this insanity, would you like to leave a comment on my blog?