Why is the fractional-reserve banking not a Ponzi scheme?
"They're not at all the same. A Ponzi scheme is a fraudulent investment method that pays off early investors with deposits from later ones. Fractional reserve banking is the practice of keeping only a fraction of a bank's demand deposits on reserve, while lending out the rest.  The reserve requirement is how central banks limit the amount of money that can float around in commercial banks. In the latter case, there is no ""later investor"" somewhere down near the bottom of a money food chain.  Every dollar, regardless of whether it was created fresh from one of the federal reserve banks or created via several chained loans, is worth the same.  If the dollars depreciate for whatever reason, they do so for everyone. Now, if you want a good example of a Ponzi scheme that is actually legal, look at Social Security. Edit: A ""debt-based society"" is separate from fractional-reserve banking.  If the Fed creates $1,000,000, the total amount of money that can float around is still capped based on whatever the reserve requirement is.  (For a 10% reserve requirement, it's something like $10,000,000.)  We have unsustainable debt increases because of lack of self-control on the part of our leaders.  The fractional-reserve process helps it along, but it's not the culprit.  It's an enabler." "You are forgetting one crucial point regarding the money supply.  The US Federal Reserve increases the money supply, meaning some of the money is not really loaned, it just appears out of nowhere.  At first glance this seems even worse: over the short term, the Fed changes the money supply to help the economy in whatever way it sees fit.  But over the long term, the money supply increases to reflect economic growth.  As new technology is introduced, more can be accomplished with the same labor and resources, and thus the money supply needs to be increased.  Money is really just a convenient replacement for the barter system, so if there are more things to barter ""for"" (goods and services) then there should also be more things to barter ""with"" (money). Also keep in mind inflation.  The cost of goods and services goes up over time due to the inflation of currency, and so the money supply must also be increased so that those goods and services do not artificially increase in value, which would be very bad." The fundamental underlying difference between a bank and a Ponzi scheme: When a bank lends money and charges interest, people can do things with that borrowed money which are worth it. (Building factories, starting businesses, or just enjoying the comfort and warmth of a single-family home instead of paying rent). This is why fractional-reserve banking is able to work. People may also do things which do not necessarily turn a financial profit (financing large purchases on a credit card) but are worth it in terms of an expenditure. They may also do stupid things (financing useless purchases on a credit card and wasting their money) or otherwise dispose of the money poorly (the new business fails, the home's value plummets, etc). A Ponzi scheme never really bothered to do useful things with the money. Social Security has been mentioned. Part of social security's setup involves the current population of workers paying the current population of retirees; their own retirements will have to be financed by the next generation. This design is not intrinsically a Ponzi scheme: both the population and the economy ought to remain growing for the intermediate future, so there will be at least as much money (and probably much more) for them to pay those bills. Unlike a Ponzi scheme, the idea that it will continue to attract new money to pay out existing claims is a realistic one. The real questions of its sustainability are a matter of specifics: is it collecting enough money to remain functional in the future, or is it outpacing the growth of the economy and the population? "The Ponzi/Madoff schemes were closed loops, so the only source of the so-called ""interest"" on the money was the contributions of future investors. The economy is more like a living thing, and the availability of capital allows people to develop new ways to do things in a more productive way. Agriculture is a great example -- for most of human history the overwhelming majority of human labor was dedicated to producing food. Now that proportion is dramatically smaller -- the descendants of farmers 100 years ago are doctors and computer programmers... professions that could not exist. Fractional reserve banking makes the economy more efficient by putting capital that would otherwise be hoarded in circulation. Money is a medium of exchange, so the more it turns over, the better it is. Genoa and Britain pioneered this concept centuries ago, and were able to defeat larger rivals in large part because of the economic advantages that the practice brought to bear.  That's not to say that banking doesn't come with its warts as well. I'd suggest reading ""A Free Nation Deep in Debt"", which does a good job of explaining how we got to where we are today." No, fractional reserve banking isn't a scam. A simple exercise: replace dollars with time. You're trading some time now for time in the future, plus a bit of extra time. This is only a problem if you promise your entire life away, which we've helpfully outlawed. Once you realize that wealth is the result of human labor, and that money is simply a unit of account for it, it becomes far easier to see how simplistic models don't match reality. "It is possible to pay down debt (including interest) without issuing new debt money to pay for it. I think this is the heart of your question. Let me present a highly contrived example in which society has four people and one bank. Here is a bank with $100 in initial deposits. Total money supply in this society is $100. (We assume there is no currency circulating, since you're interested in debt money.) This bank lends out $90 to Bob at 1 year maturity and 10% APR. Bob spends this $90 with Charlie to buy raw materials. Charlie deposits $90 in the bank. The money supply just grew from $100 to $190. Bob does something with the raw materials and adds some kind of value, eventually selling the finished goods for $110. In our little silly economy, the only people who have money are Adam and Charlie, so we must assume that between the two of them they buy $110 worth of goods from Bob. Let's say Adam buys $60 and Charlie buys $50 -- the actual amounts don't matter. Bob deposits this money at the bank. Still $190 of money supply. At the end of 1 year, Bob instructs the bank to transfer payment from his deposit account to his loan account. The bank wipes clean his debt and the money remaining in Bob's account represents his return. Who is this David guy? He's the owner of the bank. He grosses $9 in interest from the loan to Bob, and he pays $5 to Adam as interest on Adam's deposit. The remaining $4 is the profit to the bank's owner. Money supply decreased from $190 to $100 after Bob pays off his loan. I realized after writing this, the one thing I left out is, ""where does Adam get $100 to start with?"" Presumably Adam starts off with some kind of currency, either fiat money or commodity money. (IOW, debt money can't be created out of nothing, it has to be expanded on top of some kind of currency.)" Your question contains two different concepts: fractional reserve banking and debt-based money.  When thinking of these two things I think it is important to analyze these items separately before trying to understand how the whole system works. Fractional Reserve Banking As others have pointed out fractional reserve banking is not a ponzi scheme.  It can be fraudulent, however.  If a bank tells all its depositors that they can withdrawal their money at any time (i.e. on demand) and the bank then proceeds to loan out some portion of the depositors' money then the bank has committed fraud since there is no way they could honor the depositors' requests for their money if many of them came for their money at one time.  This is true regardless of what type of money is deposited - dollars, gold, etc..  This is how most modern banks operate. Debt-based money Historically, the Fed would introduce new money by buying US Treasuries.  This means Federal Reserve Notes (FRN) are backed by US Treasuries.  I agree that this seems strange.  Does this mean if I take my FRNs to the Fed I could redeem them for US Treasuries?  But US Treasuries are promises to pay FRNs in the future.  This makes my head hurt.  Reminds me of the definition for recursion: see recursion. Here is an experiment.  What if we wanted to recreate FRNs today and none existed?  The US government would offer a note to pay 100 FRNs in one year and pay 5% interest on the note.  The Fed would print up its first 100 FRNs to buy the note from the US government.  The US government would spend the FRNs.  The first 100 FRNs have now entered into circulation.  At the end of the note's term the Fed should have 105 FRNs since the government agreed to pay 5% interest on the note.  But how is the US government going to pay the interest and principal on the note when only 100 FRNs exist?  I think this is the central point to your question.   I can come up with only two answers: 1) the Fed must purchase some assets that are not debt based 2) the US government must continue to issue debt that is purchased by newly printed FRNs in order to pay back older debt and interest.  This is a ponzi scheme. The record debt levels seem to indicate the ponzi scheme option was chosen.
"Some of it is very simple but almost all of it is very non-intuitive. Imagine that Donald Trump owns a lot of property that is valued at $1bn. So he puts that up as collateral to buy some gold worth $2bn dollars. A little while later the banks discover that the properties are only worth $100mm.   In this case $900mm has suddenly disappeared and moreover the banks are in deep shit because the Donald owes them $2bn and has posted collateral worth $100mm.   When they try to rough up Donald he tells them that instead if they go along with his ponzi scheme they might be able to sell his new $2bn property to someone else for $4bn, this way the banks will get their money bank and Donald will make a nice little profit. So the banks lend him some more money.   This scheme only works until people start refusing to buy these properties at Donald's prices. This is a nutshell what has happened. Property prices were much higher than they should have been and Banks had derivatives which weren't worth as much as they claimed. When the market/people wised up to this fact the prices came crashing down and money ""disappeared""." This article talks about State controlled banking, before 1913 - the power of printing money and all that was under control of the State (Congress). If they shut down the Federal Reserve, they would then be able to eliminate the fractional reserve banking method and government wouldn't have to pay intertest to borrow in their own currency. &gt; Actually, the thing they need is debt, not depositors money.  I was trying to explain how a bank could be a ponzi scheme.  But on second thought, even the example I provided is wrong.    Depositors are creditors to the bank.  Ponzi schemes are paying out returns to investors or equity holders and has nothing to do with paying out liabilities to creditors.  No matter how the bank sourced the assets, paying returns of interest to depositors (creditors) can't be deemed a ponzi scheme. The problem is, I don't understand, how such sites work. Is that scam or not? Some of my friends told me that they've actually received the revenue after they deposited a bit of money to similar sites, and I don't have any evidence not to trust them. Yes there are scam. Stay away. Quite likely people got real money back into Bank Account. Or more likely it shows that there is more [notional] money in the sites account.  If such sites really 'work', then how and why? These sites work, because there are quite a few people who believe in free / easy money. The site could be classic pyramid / Ponzi scheme. They could also be involved in some kind of Money Laundering. Why would anyone trust them so much to give them money for absolutely no reason? Okay, I'm not so clever, but they can't make profit only because of stupid people, can they? The same way you did, at times just for fun to experiment. At times because they believe there is easy get rich way. There is a reward that works so that if you see 120 you start believing in it. If you try and withdraw, there will be quite a few obstacles; under the pretext of holding period, withdrawal fees etc... but mostly they will encourage you to keep depositing small amounts and see it grow. This of it this way; if one can make 20% day on day ... one does not need someone else's money. The power of compounding would mean very quickly $ 100 would become 88 BILLION in 120 days! It's too poorly designed. The fact that it forces deflation in the long run means that it can never really serve the purpose of money. That is, it can never be a universal medium of exchange. Then there's the fact that it has proven insecure, because it can be robbed. And it has proven to be primarily an object of speculation rather than exchange, means that the value of bitcoin relative to other moneys is too volatile. "Wrong. Business lending has boomed under QE.. does the term ""cov-lite"" sound familiar? That's because there's so much liquidity, that they're willing to lend to companies with little to no restrictions. There is so much credit to go around, that a ""High Yield Bond"" can price at L+800 bps.   When you're taking all the risk of a HY issuer, and maxing your return at 8.5%-9%, it's not too appealing. Instead, you could take a bit more risk, but also get all of the potential upside of equities.   1.  Fed buys assets, injects money into banks.   2.  Banks, flush with liquidity, need to put their balance sheet to use and begin lending to everyone.   2.  Bond market flooded with supply, causes bond yields to drop to historic lows.     3.  Investors don't enjoy limiting upside for incredibly low returns, and begin flooding equity markets to get some sort of yield.    Business lending is booming, making equities the only place to get larger returns." Empirial evidence for the second scenario: Can banks individually create money out of nothing? — The theories and the empirical evidence. Excerpt: It was examined whether in the process of making money available to   the borrower the bank transfers these funds from other accounts   (within or outside the bank). In the process of making loaned money   available in the borrower's bank account, it was found that the bank   did not transfer the money away from other internal or external   accounts, resulting in a rejection of both the fractional reserve   theory and the financial intermediation theory. Instead, it was found   that the bank newly ‘invented’ the funds by crediting the borrower's   account with a deposit, although no such deposit had taken place. This   is in line with the claims of the credit creation theory. Thus it can now be said with confidence for the first time – possibly   in the 5000 years' history of banking - that it has been empirically   demonstrated that each individual bank creates credit and money out of   nothing, when it extends what is called a ‘bank loan’. The bank does   not loan any existing money, but instead creates new money. The money   supply is created as ‘fairy dust’ produced by the banks out of thin   air. "In the presence of a central bank, fractional reserve doesn't mean very much. In practice, the central bank bank supplies reserves, at some cost, in whatever quantity is demanded by the system. Reserves are just a cost of doing business for a bank, not something they'll run out of in any ""ponzi"" sense. I don't believe it's a case of people being duped.  I think sustainability is threatened not by fractional reserve and central banking but by the degree to which narrow banking has been mingled with more speculative finance."