Analyze the economic reasoning presented in the following policy proposal. Based on your understanding of how commercial banks operate, identify the primary flaw in the proposal's core assumption and explain why it is incorrect.

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The fundamental causal relationship in the creation of bank money is that loans create deposits. A commercial bank does not need to have received prior deposits from customers to be able to issue a new loan. Instead, the act of approving and disbursing a loan is what brings a new deposit into existence.

Causality of Money Creation: Loans Create Deposits

A commercial bank approves and issues a new $100,000 loan to a customer for a home renovation. Which statement accurately describes the immediate result of this single transaction on the bank's financial position?

A commercial bank's ability to issue new loans is primarily constrained by the total amount of deposits it has already collected from its customers.

A common belief is that commercial banks act as simple intermediaries, taking in deposits from savers and then lending that same money out to borrowers. Based on your understanding of how bank money is created, critique this view and explain the actual causal relationship between loans and deposits.

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