These are two different points-- they're both important but maybe we should just talk money supply first and then get to bank regs after.
Sometimes it takes effort to get a handle on money supply-- I got an "F" on my first exam in Econ 101 although I got better later. If you're willing to give it another chance, I think I can explain how money is created, so long as we can first agree on just what money is. We need to talk about money and wealth as two different things --after all, someone can borrow $100, thus getting money, even though he also gets a debt in the process. Wealth is the assets that are left over when all the debts are paid off -- but right now let's focus on just money. Let's say that money is that stuff that can buy something --say, five $20 bills that I can use to buy a new stereo.
OK, suppose I'm the only guy in town that's got money, and I go put all my money ($100) in the bank. The banker will hurry up and loan it out to some guy on the next block because that's what bankers do. Now, if you have some religious convictions that prohibit loaning or borrowing money then we can stop here. If you don't, then let's agree that the banker is an OK guy because we're not getting into fractional reserves yet. Let's say maybe the borrower is mortgaging a house with equity up the yingyang.
That guy on the next block now has $100 (in five $20 bills) that he can use to buy a stereo, but maybe you still want to buy a stereo too. You can go to the bank and borrow $100 if you want. You can use your account as collateral. If you do, then you'll have five $20 bills that you can take to Circuit City. The town now has $200, even though it began the day with just $100.
If you're worried about who printed up those $20 bills then we can talk about the Bureau of Engraving-- but bear in mind that currency is a tiny fraction of the total money supply. If you're worried that the newly created money will cause inflation then we can talk about how the fed tends to make borrowing difficult whenever prices need to go back to normal.
So are we together on how money is created?
We're good here. No problems yet.
That guy on the next block now has $100 (in five $20 bills) that he can use to buy a stereo, but maybe you still want to buy a stereo too. You can go to the bank and borrow $100 if you want. You can use your account as collateral.
This is where I have a problem. You deposited the only $100 in town in your account. The bank loaned it to the other guy for whatever reason. The bank no longer has the only $100 in it's vault. How can they loan me $100 that they do not have? That is fractional reserves. The banks is now earning interest on $200 when they only had "title" to $100. That is what I consider immoral.
Lets assume for a minute that physical gold was the only permissible currency. You deposit 100 gold coins. The bank then loans 100 gold coins to the stereo buyer. The bank's vault is now empty. It has no more gold to lend. It can only earn interest on the coins lent.
Under fractional reserve rules, bankers profits are expanded greatly by allowing them to earn interest on money that it doe not have title to. Money that didn't even exist until they made the loan.