Because lending money costs a bank absolutely nothing, banks are fundamentally unlike any other business in some ways.
Yes, lending money costs the banks nothing. Think about it: Thanks to fractional reserve banking, the banks get to create the fiat currency they lend to others out of thin air!
Fortunately for the bankers, that puts them in a different situation than anyone else. Here’s how:
When a productive business (i.e., not a bank) lends or invests money, they need the purchasing power (i.e., the value) of the principle and interest they receive in repayment to exceed the purchasing power (i.e., the value) of the principle they lent or invested. If they fail to do this, then they lose money. Do that over a long enough period and the business will be forced to shut its doors.
Then there are the banks. As I stated earlier, the cost for them to create that fiat currency is zero. Therefore, the banks earn cash as long as the number of fiat dollars they receive in the repayment of principle and interest are greater than the number of fiat dollars they lent. As a result, they can completely ignore the value of the fiat currency that they lend and receive. That, in turn, allows the banks to completely ignore the value of that fiat currency when they’re calculating their profits and losses.
So the banks can look at the other side of the lending process, namely default. If there is a greater chance that the banks will receive repayment of principle and interest during inflationary periods, then they also have an incentive to want inflation.
It’s true … if the banks were confident that all of their borrowers would repay their loans in full, then there would be a slight advantage in receiving repayment in non-inflated dollars because there is overhead that needs to be covered such as salaries and other operating expenses. But for banks, those costs are relatively small compared to the cost of not balancing the books — and that requires the loans being paid back. Here’s why: The difference inflation makes in a repayment may be 1% or 2% of the fiat currency lent, but the losses from a loan default can be 90% or even higher.
The key is the bank is not actually a creditor. It does not care about the value of the principle eroded due to inflation because the principle is not the bank’s money. After all, the principle lent out comes from thin air. In fact, the bank is a debtor just passing the principle along to the end borrower.
In reality, the actual creditor is the public, whose diminished purchasing power funds the loan. However, since the temporarily printed money is destroyed at a lower value than when it was created, the public pays the banks for not only the time value of money but also pays the banks for the inflation losses on that money during that time. If time value of money is 3% and inflation is 0% then banks extract from the public $3 on every $100 they loan every year. On the other hand, if inflation spikes to 20%, then the same banks extract from the public the original $3 plus $20 — or $23 for every $100 they loan every year.
No matter how you slice it, the public loses. And the banks win.
Yeah … it’s quite a racket.
Photo Credit: public domain
Fractional banking is such a complex thing for most people to begin to understand. They do that on purpose though. Thanks for explaining this in easy to understand terms.
I still don’t understand it!
When you try to explain to people how this works, they tend to look at you like you are nuts..”NO WAY they do that”…..everybody thinks the bank keeps this big pile of cash in the vault and makes loans out of what people put in……you know, the way common sense would dictate.
It’s amazing how many people think that the bank dutifully holds every penny they deposit with them. This stuff should be taught in a high school freshman economics class. Wait … do public schools even teach economics any more?
Now I get it! Thanks
Banks loved the adjustable rate mortgage. They really got people with it.