Fractional reserve banking is a system in which banks hold only a fraction of their depositors' funds as reserves while lending out the remainder. 

Let's illustrate this with an example. 

Imagine a bank with $1,000 in deposits from its customers. This bank is subject to a 10% reserve requirement, which means it must keep $100 as reserves and can loan out the remaining $900.

Now, consider a new customer named John, who wants to borrow $500 to buy a new bike. The bank approves the loan and adds $500 to John's account. John then withdraws this $500 and uses it to purchase the bike from a local shop.

The bank still holds $1,000 in deposits from its customers, but its available lending capacity has decreased to $400 (since it has lent out $500 to John and must maintain a $100 reserve).

Here's where it gets interesting: The bank has created new money in the economy. John's bike purchase has injected an additional $500 into circulation. This $500 only existed when the bank issued the loan. And due to fractional reserve banking rules, the bank could lend out another $400 of its reserves.

Initially, the money supply was only $1,000 in this small economy of banking customers. However, because the bank can lend out 90% of its deposits, the total money supply could nearly double to $1,900.

Fractional reserve banking increases the money supply by allowing banks to lend out a significant portion of their deposits rather than keeping all deposits as reserves. When banks issue loans, they effectively create new money in the economy, which can lead to inflation as the money supply grows faster than the supply of goods and services, causing prices to rise. Additionally, the devaluation of banking customers' deposits occurs because the value of their money diminishes in real terms due to inflation, potentially eroding their purchasing power over time.

Now imagine this process repeatedly occurring with the bank continuing to lend money, except it charges interest to anything it loans. 

Result? 

The bank gets richer and dilutes the money supply. 

Which means the money in circulation is now worth less. 

To be fair, banks offer returns in the form of interest to their customers who have deposited their money. 

However, customer deposits are devalued over time if inflation exceeds bank interest rates. 

This process continues if the bank can lend excess reserves and maintain enough funds to meet the required reserve ratio. 

However, when too many customers withdraw their deposits simultaneously or default on their loans, the bank may not have enough reserves to meet its obligations, potentially leading to a bank run or even a financial crisis. 

Now that hasn't happened before, has it? 

Oh, wait.

It happens all the time. 

These financial crises happen on average every 8-10 years, but here are just some of the major ones of the past century.

1. Panic of 1907 (1907)
2. Great Depression (1929-1933)
3. Savings and Loan Crisis (1980s-1990s)
4. Black Monday (1987)
5. Japanese Asset Price Bubble (1989-1990)
6. Swedish Banking Crisis (early 1990s)
7. Asian Financial Crisis (1997-1998)
8. Russian Financial Crisis (1998)
9. Dot-com Bubble (1995-2000)
10. Argentine Financial Crisis (1999-2002)
11. Global Financial Crisis (2007-2008)
12. Dubai Financial Crisis (2009-2010)
13. European Debt Crisis (2009-2011)
14. Chinese Stock Market Crash (2015)
15. COVID-19 pandemic-induced recession (2020)
    

Long story short.

Fractional reserve banking creates an unstable financial system prone to crises and economic inequality. 

This system encourages banks to lend out money they don't have, leading to a boom-bust cycle of inflated economic growth, followed by a painful recession when the bubble bursts. 

What typically happens in a financial crisis? 

The banks go bust or receive a government bailout, paid for by taxes on the population, and the cycle repeats.

Never has this concept been so perfectly depicted as in one of my favourite films of all time. I highly recommend you check it out if you have not seen it.

It explains the 2008 crisis expertly. 

The Big Short.

https://www.youtube.com/watch?v=Nmxox3oqRZo&ab_channel=TradersArcade 

NB: the book is also a good read, but unfortunately, I saw the film first.

See what I mean when I say it's just one big game?

This system disproportionately benefits the wealthy, who can better access credit and investment opportunities while leaving the poor and middle class behind.

Okay, so if it's a game, how do I play it to my advantage?

That's a great question!

Essentially, you must learn how to create money and wealth for yourself. You need to understand the tools that the wealthy used to get rich. 

The first step to creating wealth is to get your time back. 

Now, some of you might be thinking. 'I could choose not to play this game', and that's a fair notion, but unfortunately, we, as a global society, don't currently have a feasible alternative, which leaves you with three options.

1. Remain poor in a job you don't like that probably doesn't pay very well working until you are 65/70 when you’re ‘allowed’ to access your own money in the form of a pension…  
2. You live like a hermit in the forest, away from all civilisation and technology and live off the land.

OR 

3.You learn how to get your time back, make money, and build wealth and the lifestyle you want for yourself and your family.