Very few people understand how the modern banking system really works.They have in their heads a model they learned from text books in which banks take deposits from customers, then lend out those deposits as loans. In reality, banks fund their loans by borrowing in the interbank market.Once a bank has agreed to make a loan, it then borrows the same amount of money in the interbank market at a slightly lower rate. The lending comes first, the borrowing to fund the loan comes afterwards. This is why so many loans are pegged to LIBOR : Banks charge borrowers rates that are set to levels at some point above what the banks themselves pay to borrow.A very similar misconception applies when the government spends and borrows. People imagine that the government must first collect taxes or borrow money in order to have funds to spend. In reality, the government just spends what it wants, and then collects taxes in order to balance out the effect the spending has had on the money supply.In short, banks lend first, fund later. Governments spend first, fund later.There's a great discussion of this in the Harvard International Review's interview with Bill Mitchell, the research professor in economics and the director of the Centre of Full Employment and Equity at the University of Newcastle, Australia. Mitchell is one of the founders of a school of thought called "Modern Monetary Theory" (MMT).
Read the rest at CNBC, How the Banking System Really Works by John Carney
(h/t Scott Fullwiler)
Of course, Carney rather botches the job, but, hey, it's a start.