Blog von fugaL

First of all, what is money? It is anything that is widely accepted as a medium of exchange. Here in the USA it's paper fiat, aka the dollar bill and its many derivatives. If I buy bread from you, and you buy eggs from Jon, and finally Jon buys apples from me, then it's a three way trade. We all accept money, so any two corners of the triangle don't have to concern themselves about the last and such trades and infinitely more complex trades can be accomplished smoothly without involving all suppliers and consumers in complex negotiations. Hence we have money.

How does money multiply? Well, it's kind of like shared libraries. When you use shared libraries it's like you have more memory. You don't really, but more of your programs fit into memory as if you did. Same thing with money, there's not really more of it, but it's as if there was. I have an ounce of gold in a bank. I want a laptop. I trade my gold for a laptop, but instead of physically handing over the gold, it is simply deducted from my account and applied to the laptop guys account. Meanwhile the bank doesn't actually have my gold, it just promises to provide it for me should I ask for it, same now holds for the laptop guy. The gold is out making interest for the bank. It's as if the bank has it's own gold and I have my own, too, but it's the same gold.

At any time there is a certain amount of total actual money in circulation, and a percentage of that money is double dipping, far more than double in fact. Remember how the bank didn't actually have that gold? It's in the hands of some investor making interest. Well the investor doesn't have it either, at least not all of it. Some of it is invested in Green Sparks Bubble Gum, making interest. Well Green Sparks doesn't have it either, not all of it. Some of it bought the cutters for the wrapping machine. And so on, et cetera, ad nauseum.

There's a simple mathematical formula for figuring out just how much total multiplication ensues. First we have x deposited somewhere. On average y is the percentage loaned out. First round, x + x*y. Second round, x + x*y + (x*y)*y, and so on. This works out to x * (1 + y + y2+ y3+ y4... + yinf). The part in parentheses is a geometric series, and works out to 1 / (1 - y). In economics, that (1-y) is referred to as the reserve ratio, and measures the money kept in the bank rather than what is loaned out, we'll call it r. If you didn't follow all that math, no worries. Suffice to say that for x real dollars, there are x * 1/r virtual dollars. An r you can expect to see in the wild might be 75% or so. The Federal Reserve with its monopoly on money makes possible a 10% reserve ratio, which we actually have. That makes the money multiplier a whoppin' 10! So when the Fed loans out $2 trillion, it ends up expanding to $20 trillion. This system of holding very small actual reserves is called fractional reserve banking. Without help it falls apart very quickly. With the help of the Fed and things like the FDIC it thrives and bustles.

So, why can't your money multiply? It does. You just don't get to keep it.