Using a Monopoly Game Set to Teach Fractional Reserve Banking
Banking in the 21st century is based on a fractional reserve banking. In this system, banks are allowed to lend money that is already promised to their depositors. This leads to a number of inherent, systemic problems including the possibilities of insolvency, bank runs, and lack of available credit.
The key components of the Monopoly set used to teach fractional reserve banking are the money, the tokens, and the properties.
The Saver
Begin with only one player who has ten $10 bills and is the Saver.
This person does not need the money at the moment and would like to keep it safe.
The Bank
A second player offers to run a bank as a bank President. This is not "the bank" as if the board game were being played, but a real world fractional reserve bank, that starts with nothing, and "lends money into existence".
The bank accepts all ten $10 bills, and in exchange, gives the Saver a slip of paper (any paper will due) on which is written "$100 on deposit in the bank". The bank keeps a very similar piece of paper, on which is written "$100 owed to Saver".
The Borrower
The bank President know that there are expenses and bills that must be paid, so the President must do something to make money.
This is where the real learning begins.
In the USA and elsewhere, the rules of banking allow the bank to do whatever it wants with MOST of the cash it has, even though that cash is owed to the Saver. In the USA, for large banks, the banks are allowed to lend 90% of the money in the checking accounts of the banks. (There are ways to exceed this 90%, but we'll leave that for another article.)
The bank President knows that, according to the rules, only 10% of the cash must be held by the bank, so the President looks for the Borrower.
The Borrower is the third player in the game. The Borrower is interested in buying something, but does not have enough money. So the Borrower goes to the Bank President and asks for a loan. The President has the Borrower sign a piece of paper with a promise that goes something like this... "I promise to pay the bank back $90, plus interest, all of which will be paid back in one year." This promise is replicated for the Borrower, and given to the Borrower along with the $90 in cash (nine of the $10 bills).
Money Creation
This is a good time to stop and talk about how much money there is at that moment.
* Saver -- $0 Cash
* Bank -- $10 Cash
* Borrower -- $90 Cash
* Total -- $100 Cash
(Notice, the rest of the Monopoly money can remain put away and untouched for quite a while as the simulation plays out. This is very important because it needs to be clear that the amount of physical cash stays the same while the amount of money increases.)
Next, consider how much money each player things they have.
* Saver -- $100 on deposit in the bank, that can be withdrawn, used for a check, or with debit card
* Bank -- $0 -- The bank has $10 cash and a $90 promise which is balanced by the $100 liability to the Saver.
* Borrower -- $90 of cash in hand.
* Total -- $190
A discussion can then begin regarding how much money there really is. Is there really $100 or is there $190... or some other amount? If there is $190, where did the other $90 come from?
The answer is both. Money can be counted different ways. In the USA, the $100 is called the "monetary base" or M0. The $190 is called M1, which includes all deposit money.
Another good discussion is how the Saver can use the $100 of deposit money, and how that would work to pay others. (In most cases, checks simply "transfer" funds from one account to another, and no cash is necessary.)
The Seller
It is now time to introduce the fourth player, who can be called the Seller.
The Seller has one of the Monopoly properties for sale, perhaps one of the light blue properties. This is the same property that the Borrower was planning to purchase.
The Borrower and Seller trade the $90 for the property.
The Fractional Reserve Problem of Backing
This is another good opportunity to take a very close look at each of the four players situations, and most especially, the situation of the Borrower.
The Borrower owes the bank $90 plus interest, which must be paid within the year. A discussion of the difference between "secured" and "unsecured" debt can follow on from this. The Borrower also owns a property which was purchased for $90 but for which the sale price is unknown.
Several scenarios can be examined:
* What if the Borrower is unable to pay the Bank?
* What if the Borrower can't pay, and is unable to sell for the amount owed to the bank?
* What if the Borrower stops paying?
* What if the Borrower dies?
These lead to the idea that the Bank no longer has enough assets to back the deposit of the Saver, and what might happen in that situation.
Extension
This game or simulation can be continued to add more banks, borrowers, sellers/savers, to show how the money supply expands and expands, and how the number of loans increases, which in turn ends up introducing more and more risks into the system.
Reasons for interbank lending can be illustrated as a way to prevent illiquidity.
The purpose of the government guarantee on bank accounts, such as the FDIC $250,000 guarantee in the USA can be discussed.
Very interestingly, as more difficult situations are illustrated, the idea of a central bank can be introduced. With the Monopoly set, the "drawer of money" can be used to represent the central bank. It should be very clear that while the money in the drawer has been printed, it has NOT been issued, since it is not available to anyone for spending. The central bank, though, can do a number of things, such as lending money to any bank, buying things from any of the banks, etc.
Conclusion
Helping people understand the inherent flaws in the fractional reserve banking model can be done effectively by using an everyday Monopoly board game.
The flaws in the system are many and lead to unsolvable problems. Other banking systems, such as "full reserve" or "full-reserve on checking only" can be modeling in this way as well, to discover the relative strengths or flaws of each system.
The Monopoly Board Game
http://en.wikipedia.org/wiki/Monopoly_(game)
Additional Notes
The proceeding article was written on the same day that I attempted this simulation myself, ending after over an hour with four banks, four savers, three borrowers, and a central bank.
My intention is to create a series of short videos using the Monopoly game set to illustrate and explain the points above.
While using a children's board game may seem a very limited way to examine monetary issues, I've found that working out these concepts by reading a book, watching a video, or even working things out on paper, do not provide as effective a mental illustration, nor the ability to quickly test out different scenarios, and identify the issues with the system.
The key components of the Monopoly set used to teach fractional reserve banking are the money, the tokens, and the properties.
The Saver
Begin with only one player who has ten $10 bills and is the Saver.
This person does not need the money at the moment and would like to keep it safe.
The Bank
A second player offers to run a bank as a bank President. This is not "the bank" as if the board game were being played, but a real world fractional reserve bank, that starts with nothing, and "lends money into existence".
The bank accepts all ten $10 bills, and in exchange, gives the Saver a slip of paper (any paper will due) on which is written "$100 on deposit in the bank". The bank keeps a very similar piece of paper, on which is written "$100 owed to Saver".
The Borrower
The bank President know that there are expenses and bills that must be paid, so the President must do something to make money.
This is where the real learning begins.
In the USA and elsewhere, the rules of banking allow the bank to do whatever it wants with MOST of the cash it has, even though that cash is owed to the Saver. In the USA, for large banks, the banks are allowed to lend 90% of the money in the checking accounts of the banks. (There are ways to exceed this 90%, but we'll leave that for another article.)
The bank President knows that, according to the rules, only 10% of the cash must be held by the bank, so the President looks for the Borrower.
The Borrower is the third player in the game. The Borrower is interested in buying something, but does not have enough money. So the Borrower goes to the Bank President and asks for a loan. The President has the Borrower sign a piece of paper with a promise that goes something like this... "I promise to pay the bank back $90, plus interest, all of which will be paid back in one year." This promise is replicated for the Borrower, and given to the Borrower along with the $90 in cash (nine of the $10 bills).
Money Creation
This is a good time to stop and talk about how much money there is at that moment.
* Saver -- $0 Cash
* Bank -- $10 Cash
* Borrower -- $90 Cash
* Total -- $100 Cash
(Notice, the rest of the Monopoly money can remain put away and untouched for quite a while as the simulation plays out. This is very important because it needs to be clear that the amount of physical cash stays the same while the amount of money increases.)
Next, consider how much money each player things they have.
* Saver -- $100 on deposit in the bank, that can be withdrawn, used for a check, or with debit card
* Bank -- $0 -- The bank has $10 cash and a $90 promise which is balanced by the $100 liability to the Saver.
* Borrower -- $90 of cash in hand.
* Total -- $190
A discussion can then begin regarding how much money there really is. Is there really $100 or is there $190... or some other amount? If there is $190, where did the other $90 come from?
The answer is both. Money can be counted different ways. In the USA, the $100 is called the "monetary base" or M0. The $190 is called M1, which includes all deposit money.
Another good discussion is how the Saver can use the $100 of deposit money, and how that would work to pay others. (In most cases, checks simply "transfer" funds from one account to another, and no cash is necessary.)
The Seller
It is now time to introduce the fourth player, who can be called the Seller.
The Seller has one of the Monopoly properties for sale, perhaps one of the light blue properties. This is the same property that the Borrower was planning to purchase.
The Borrower and Seller trade the $90 for the property.
The Fractional Reserve Problem of Backing
This is another good opportunity to take a very close look at each of the four players situations, and most especially, the situation of the Borrower.
The Borrower owes the bank $90 plus interest, which must be paid within the year. A discussion of the difference between "secured" and "unsecured" debt can follow on from this. The Borrower also owns a property which was purchased for $90 but for which the sale price is unknown.
Several scenarios can be examined:
* What if the Borrower is unable to pay the Bank?
* What if the Borrower can't pay, and is unable to sell for the amount owed to the bank?
* What if the Borrower stops paying?
* What if the Borrower dies?
These lead to the idea that the Bank no longer has enough assets to back the deposit of the Saver, and what might happen in that situation.
Extension
This game or simulation can be continued to add more banks, borrowers, sellers/savers, to show how the money supply expands and expands, and how the number of loans increases, which in turn ends up introducing more and more risks into the system.
Reasons for interbank lending can be illustrated as a way to prevent illiquidity.
The purpose of the government guarantee on bank accounts, such as the FDIC $250,000 guarantee in the USA can be discussed.
Very interestingly, as more difficult situations are illustrated, the idea of a central bank can be introduced. With the Monopoly set, the "drawer of money" can be used to represent the central bank. It should be very clear that while the money in the drawer has been printed, it has NOT been issued, since it is not available to anyone for spending. The central bank, though, can do a number of things, such as lending money to any bank, buying things from any of the banks, etc.
Conclusion
Helping people understand the inherent flaws in the fractional reserve banking model can be done effectively by using an everyday Monopoly board game.
The flaws in the system are many and lead to unsolvable problems. Other banking systems, such as "full reserve" or "full-reserve on checking only" can be modeling in this way as well, to discover the relative strengths or flaws of each system.
The Monopoly Board Game
http://en.wikipedia.org/wiki/Monopoly_(game)
Additional Notes
The proceeding article was written on the same day that I attempted this simulation myself, ending after over an hour with four banks, four savers, three borrowers, and a central bank.
My intention is to create a series of short videos using the Monopoly game set to illustrate and explain the points above.
While using a children's board game may seem a very limited way to examine monetary issues, I've found that working out these concepts by reading a book, watching a video, or even working things out on paper, do not provide as effective a mental illustration, nor the ability to quickly test out different scenarios, and identify the issues with the system.