How Banks Create Money And Why Governments Should Too: Part 5

Written by Derryl Hermanutz

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What is Money?

There are all kinds of competing opinions and theories about what money "is" and where money "comes from". We will start this discussion with a number of learned statements on the subject.

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"What is money? If money is viewed simply as a tool used to facilitate transactions, only those media that are readily accepted in exchange for goods, services and other assets need to be considered transactions money."

{Federal Reserve Bank of Chicago, Modern Money Mechanics: A Workbook on Bank Reserves and Deposit Expansion (first published 1961; last updated 1994)} 

"...the liabilities of banks and other depository institutions have the peculiar characteristic that they are money. ...There is no question of the public's accepting the liabilities of depository institutions... The public accepts them because they are accepted as money by others."

{Shearer, Chant, Bond, Economics of the Canadian Financial System: Theory, Policy & Institutions Third Edition (1995); from a section titled, Banks and Deposit Creation, p. 565; italics in original} 

"Most money in the modern economy is in the form of bank deposits, which are created by commercial banks themselves."

{Bank of England, Money in the Modern Economy (2014)} 

"The process by which banks create money is so simple that the mind is repelled."

{John K Galbraith, Money: Whence it Came, Where it Went (1975)} 

"...banks can create book money just by making an accounting entry"

{Deutsche Bundesbank Eurosystem, How money is created (2017)} 

"In short: Nationalize money but do not nationalize banking. In fact the present demand to nationalize banking would fade away if only the control of money were recaptured by Government. Moreover, in my opinion, almost all of our complicated and vexatious banking laws could be repealed if once we made this separation between money creation and money lending. The insurance of bank deposits would become unnecessary, because there would be no reason for runs on banks."

{Irving Fisher, 100% Money and the Public Debt (1936)} 

"Money creation in practice differs from some popular misconceptions - banks do not simply act as intermediaries, lending out deposits that savers place with them, and nor do they 'multiply up' central bank money to create new loans and deposits."

{Bank of England, Money Creation in the Modern Economy (2014)} 

"The study of money, above all other fields in economics, is the one in which complexity is used to disguise truth or to evade truth, not to reveal it."

{John K Galbraith, Money: Whence it Came, Where it Went (1975)} 

"We have noted several advantages of the 100% plan...the unification of our two sorts of money by making deposit money into genuine money in trust so that the average man can understand the money system."

{Irving Fisher, 100% Money and the Public Debt (1936)}

There are all kinds of competing opinions and theories about what money "is" and where money "comes from".

The Chicago Fed and the textbook authors cut through all that confusion by defining money in terms of what it is used for.

We use money as our payments media, to pay each other.

The productive economy produces goods, provides services (including employees' work of all kinds), and builds or makes assets, for sale.

Goods, services, and assets are bought-sold for money in the money-using financial economy. It is the buy-sell, spend-earn, payer-payee money economy.

Buyers of goods, services and assets ("stuff") pay money to sellers of the stuff.

Paying money in a buy-sell, payer-payee transaction transfers ownership of goods, services or assets from sellers of stuff to buyers of the stuff. 

"As long as people accept it as money, it is money."

The payer-payee part of the transaction transfers ownership of the money from buyers who pay money to sellers who are paid the money.

"Money" is whatever kinds of payments media people who sell stuff for money accept as money payment from people who buy the stuff and pay with money.

As long as people accept it as money, it is money.

All kinds of worthless trinkets - shells, beads - have been used as money.

We use banknotes, coins, and bank deposits as our money.

Today a few people use numbers in Bitcoin accounts ("Bitcoins": Bitcoin account balances) to pay each other. Bitcoins are electronic digits in Bitcoin accounting software. Bitcoin balances are originally created by Bitcoin miners, by typing on their computers. Within the Bitcoin "blockchain" payments system, payment is debited (subtracted) out of the payer's Bitcoin account balance and credited (added) into the payee's Bitcoin account balance.

To use Bitcoins, you need a Bitcoin account. But almost nobody has a Bitcoin account, so almost nobody can pay and get paid Bitcoins.

Almost everybody has a bank account, and everybody can use cash money. Which is why bank deposits and currency are overwhelmingly our main forms of money.

Money is not "theoretical". It actually exists. We use it every day.

There is an in-place monetary system that creates the money we use.

We have already seen where the currency and bank deposits come from. Commercial banks issue the bank deposits to fund their bank loans and bond purchases. Central banks sell banknotes to commercial banks who sell the cash money to us. 

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Gary Anderson 1 month ago Contributor's comment

One would think banks would want the Fed to issue helicopter money so people can pay down debt. But banks would rather be bailed out by government AND get the properties back. Eventually that weakens or destroys the middle class.