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The Wise Investor

this, however, business continued as normal.
The ultimate irony, the man thought with a satisfied smile,
was that customers often deposited gold in his vault, and
then later he would lend them back their own gold, and
charge a higher fee.
In effect, they were simply giving him money for free.
The man lay back in his chair and smiled. It was a pleasant
John stopped speaking and looked at Kate. She was, he
realised, shellshocked. Hardly surprising, as he was certain
that she had never thought through the true nature of the
banking system. He sat in silence, watched the birds flying
through the trees, and waited for Kate to compose her
"John," Kate said timidly, "this is an interesting story. But
banks don't work like this these days, do they?"
"I'm afraid they still work in exactly the same way,
Kate," John replied. "A bank simply channels money from
one place to another. When you deposit money with them,
they promptly lend it out to someone else at a higher rate of
When you borrow money from a bank, you are not
borrowing money 'from the bank', you are really borrowing
money from the bank's customers. The bank is simply the
half-way house that manages the whole transaction.
Don't get me wrong, Kate, banks performs may useful
functions. They combine a mix of depositors with the mix of
borrowers, so you can deposit money for any period of time
and lend money for any period of time.
They provide a place to store your money when you are
not using it. The banking system is the backbone of our
financial system, and provides the main opportunity for the
public to borrow and lend money."
John paused again, watching Kate's face. She was still a
little stunned.
"But what about the depositors, surely everyone could
withdraw their money if they wanted to?"