Definitions
For starters, we have to establish some definitions. Historically, lending had to come from actual money; when it didn't bad things happened. By that, I mean that lending came from money set aside for that lending. So, when you wanted to buy a house, you went to a rich man and begged to borrow money, which he lent to you with interest. That money was wholly and completely owned by the lender, and, once he signed it over to you, he no longer had it. This is classical lending.
At some point, the rich men turned into bankers and started writing notes for money rather than hand out money itself. This was quite a bit of an improvement, as you only had to carry around a paper note, the note was backed by real money and it was normally directed to someone making it harder to steal than physical money, commonly gold or silver at the time.
Anyway, bankers took deposits and made payments on behalf of their clients. A draft drawn on one banker might be submitted to another banker as payment. Then they would settle accounts later, reducing the amount of physical money that had to be transferred between banks. At this time, bankers for bankers came to be, who dealt primarily with reconciling banks.
Anyway, a given bank would have a large amount of money it didn't expect to be redeemed. Since it primarily passed around paper notes and it had become fashionable to not actually redeem the notes, the bankers decided they could write some notes beyond the amount they actually had on hand. This allowed them to make more money than they could otherwise do. This is called 'fractional reserve banking'.
How it works: consider a banker. We'll call him Hank. Hank has exactly 100 gold bars that has been given into his custody. On a monthly basis, when he reconciles with other banks, he finds that he seldom has a turnover of more than one gold bar, meaning he's almost always either had to pay a single gold bar or gotten a single gold bar.
Doing some quick math, he decides that he can lend out up to half his gold reserves and still have a nice cushion in case everyone demands their money. He's been lending at, say, 10%, meaning that for each gold bar that he has that someone has allowed him to lend on, he's making a tenth of a gold bar a year in simple interest.
Supposing he has two gold bars he can lend, as the people who have given him those have agreed to not redeem them in exchange for some interest payment from him, say 5%. Off those two, he gets a tenth of a gold bar per year, his clients get a tenth, and he increases his lending ability by a tenth. He has a further gold bar that is his, for another tenth a year.
Well, he figures that even those two gold bars are part of his 'reserve', so he can lend a further five gold bars without paying anyone interest. On those, he gets another half a gold bar a year. This means he is now getting eight tenths of a gold bar off an actual investment of just one gold bar of his and two of his clients. He still only pays out one tenth of that to his clients, so he is now getting seven tenths of his own. He's gone from a return on his personal investment of about 20% to 70%. This is very good for him.
Initially, it's good for society as well, apparently, as those five extra gold bars in loans mean much more work available. As we shall see, long term, it's not so good. Initially, the loans are paid off, and all is well. As we shall see, later on, the payments will start drying up as he has to chase ever worse loans to keep the lending flowing.
Fast forward many, many years, and now we have the modern era where money has no backing whatsoever. Further, loans need not even come from actual monetary backing. The fractional reserve above is about 66%, meaning that, for the outstanding loans, Hank has 66% actual gold to back it. These days, apparently, the reserve percentage is something like 3 to 5%. Hank's bank is actually not loaning out more money than he has, while the modern bank loans out as much as twenty times as much money as it has. This is the era of 'quantitative easing'.
So, why is this bad?
We've only talked about the banker's side of things. It's been great for Hank. He's never made so much money. His accumulation of money has allowed him to grow the business of loaning and thus make even more money. In the modern era, bankers don't even have to have much money to start; they only have to qualify as a bank.
Anyway, we'll consider what happens in our fake economy. We'll pick, say, 100 people, one of whom will be a banker. Our economy will only discuss the purchasing of cars. They get distributed income to make things easy, so each person gets, say, $100 per month. Our banker starts with, say, $1000 and each car costs $1200.
Normally, each person would have to save at least twelve months to get a car. With 100 people buying cars without banking, that means around 100 cars sold per year. We like easy to work with numbers.
Since the cars move so well, the car companies keep around 20% extra capacity, or twenty cars, on hand as inventory. A banker comes to a car dealership and offers to finance those twenty cars to people with good credit. The terms are fifteen months' pay for a car, but you get it today. The banker is financing the $1000 and getting back $1250.
What happens is that twenty people buy those cars immediately because they get to keep their savings and will have to pay back in the future. This means that twenty cars are retired early or that they buy an extra car. Either way, there are more cars than used to be necessary.
Over the next fifteen months, the banker will get the savings that would have been put towards the car . The banker simply wrote notes for the cars, at the 20 to 1 ratio, meaning that he's making 2500% return on his investment. At the end, he goes from having $1000 to having $6000.
Since the car purchasing wiped out several months of normal car purchases, meaning that the only way more car purchases can be made is to make more loans, so the car dealerships ask if they can keep selling on loans, to maybe less reliable payers. He agrees but requires 18 months repayment for those buyers. For the remaining 11 months, the car sellers sell their normal yearly allotment of 100 cars, not building inventory, at the new terms. We're going to wave hands a bit and say that, at the end of the year, the banker has gotten about nine new loans a month. At the end of the year, he has received $70,200. More importantly, each and every resident is now indebted to him and isn't saving anymore. When all the loans are repaid, he will receive $79,200 in real money. He ends up loaning for all sorts of different things so he can get more money. He has to make more and more marginal loans to even be able to make loans.
What I'm getting at is that each loan that a person takes out leads to them not saving, not spending as much and buying earlier than they otherwise would. As you can see, 119 cars were sold rather than the 100 that normally would be sold. Car manufacturers will have to scramble to increase their production, initially by hiring more people, then by making less reliable cars. This is a classical bubble in cars.
As this progresses, the banker comes to hold ever more a portion of the wealth of the society, as well as more and more of the earnings. Eventually, he can control everything but the staples like food, energy and utilities. Oddly, this means that, for the short term, productivity goes up as everyone works like lemmings to pay for everything, but this is observable in modern society, as we are all working longer hours just to stay even.
This explains everything
As I said above, we work more to stay ahead. Productivity has soared in the last hundred years or so, but most people are still barely scraping by. We also see the so-called 1% gain ever more control of the economy. We see an increased spread in wealth distribution, where the rich control ever more of the economy. All of this is predicted by our model and all of it is caused by fractional-reserve banking coupled with quantitative easing that allows banks to get money from the Federal Reserve Bank for low or no interest, allowing them to loan money they don't have.
What we have allowed is certain well-connected people to get money for which they have not worked and for which they have no claim, and it makes me so mad I can't see straight. Fixing this is easy; simply get rid of the Federal Reserve. That would, unfortunately, lead to a massive depression caused by massive deflation as a result of a contraction of the money supply and the need to clear all the malinvestments from the economy.
Malinvestments are things that were done that would not have been done if money hadn't been so free, things that don't necessarily make sense and might even be things nobody wants. A malinvestment is more than just lost money; it's lost opportunity to produce. Each and every person working on one of these pink elephants is not making tooling or fixing cars or whatever people really need and want, meaning that while they are off making things people don't want, they are competing for things people do want and generally driving up prices.
Clearing out those malinvestments will wipe out an awful lot of money from the system and make money scarce. This will raise the prices of nearly everything, causing defaults on loans, which will make money even scarcer. To protect yourself in such a situation, you need cash reserves, but it's a difficult call, because the bureau does not expect any politician will let such a situation develop, especially since it would hurt their buddies the bankers. If you keep cash and hyperinflation sets in, you are going to be wiped out.
So, the only option really available is to acquire things of substance, as an inflationary regime will make them appreciate in value and a deflationary regime won't wipe out their value compared to other things. Of particular worth is farmland, because people always have to eat. Also useful, as has been pointed out before, is owning a small business with good people.
Of course, none of this is economic advice; these are all the musings of a few admittedly odd individuals. You must do your own thinking when it comes to your own money.
