Written by Derryl Hermanutz

<< Part 1: How Banks Create Money And Why Governments Should Too

<< Part 2: How Banks Create Money And Why Governments Should Too

<< Part 3: How Banks Create Money And Why Governments Should Too

<< Part 4: How Banks Create Money And Why Governments Should Too

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.

"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 Moreover, in my opinion, almost all of our complicated and vexatious banking laws could be repealed if once we made this separation between money creation and money lending.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. 

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

So we don't have to "theorize" about what money is or where it comes from.

We simply have to look at what money is used for (a spendable, investible, savable payments medium); see what we use as money (banknotes, coins, and bank deposits); and see from whence the money comes. With the very minor exception of government-issued coins, the money comes from banks.

Money is a payments medium, not an exchange medium.

We don't trade tin pots for wool coats in a village marketplace. We don't produce our own stuff then "exchange" stuff that has economic value for other stuff that has economic value in a barter/exchange economy.

We buy-sell stuff for money in a buy-sell for money economy.

Buyers of stuff pay money to sellers of the stuff. There is no "exchanging" stuff for other stuff. There is paying money to buy stuff and getting paid money for selling the stuff.

The productive economy does not produce its own exchange media (tin pots and wool coats).

Banks create the economy's payments media: banknotes and bank deposits - the money.

The 3 roles of money

People say money has to perform 3 roles:

1. a unit of account,
2. a medium of exchange, and
3. a store of value. 

"Money is a payments medium, not an exchange medium."

The money we use (banknotes, coins, and bank deposits) is spendable and investible, which makes it a medium of exchange; or, more accurately, a payments medium.

Money can be saved and then spent or invested later, which makes it a store of value. 

[Consumers spend money buying consumer goods, services and assets for their own use and enjoyment.

Investors spend money buying investor goods, services and assets that investors use to try to earn more money.

In both cases, whether the money is spent or invested: buyers of the stuff pay money to sellers of the stuff.]

Money is numerical (one hundred; one thousand), and is denominated in the various national currencies (dollars, pounds, euros, yuan, etc), which makes money a unit of account: e.g. one hundred dollars.

So the money we use satisfies all of the requirements of "money".

Producing currency and creating bank deposits

Physical banknotes and coins are "produced", and have a monetary and economic cost of production. It takes work and resources to produce banknotes and coins; and the people who do the work and supply the resources are paid money for their contributions to the productive process.

It costs more than one cent to produce a penny, whose money value is one cent. It costs about 4 cents to produce a nickel, whose money value is 5 cents. Coins are a tiny, almost insignificant fraction of the total money supply.

It costs about 17 cents to produce a US$20 banknote or a US$100 banknote. So $19.83 of additional money is created by printing $20 banknotes; and $99.83 of additional money is created by printing $100 banknotes.

It costs a few keystrokes for a commercial bank to create a $300,000 bank deposit: a mortgage loan - $300,000 of newly-created bank account money.

It costs a few more keystrokes for a commercial bank to create a $10,000,000 bank deposit in the government's bank deposit account, to fund the bank's purchase of $10,000,000 of newly-issued Treasury debt.

Physical money - coins and banknotes - is produced by minting coins and printing banknotes. The production cost of the banknotes is a small fraction of the money value of the paper currency.

Bank deposits are created by typing numbers in bank accounts. It is just as easy for a bank to create a new $1000 bank deposit as a new $100,000 bank deposit. There is virtually no production cost to typing numbers into bank accounts.

Money is numbers

Money is a numerical payments medium, which means money is numbers.

Money is numbers with a $ or Pound Sterling or euro or Yen sign in front of them.

The number indicates "how much money".

Putting the $ sign in front of the numbers indicates they are "money". 

"There is virtually no production cost to typing numbers into bank accounts."

Numbers stamped on metal discs are coins. Numbers printed on slips of paperlike material are banknotes. Numbers in commercial bank deposit accounts are bank deposits. Numbers in shadow bank cash accounts are cash balances. Numbers in central bank reserve accounts are bank reserves.

And numbers in commercial bank loan accounts are debts, which are negative money.

In each case, the $numbers are the money.

The money value of the money has nothing to do with the economic value of the materials the numbers are displayed on or in.

Aside from their small recyclable metal content, the coins are economically worthless. Paper banknotes have no use at all other than their use as money. Bank deposits - our main form of money - are electronic digits in banking system computers. Bank deposits have no physical existence at all and no economic use value at all.

The coins, banknotes and bank deposits are "money" because we use them as money: because sellers of stuff accept payment in currency and bank deposits as payment "in money".

"Money" is a convention, a technology, a way of doing things. We use money so we can have a buy-sell for money economy where stuff is bought-sold for money, instead of being limited to having a barter economy where stuff is traded for other stuff.

Money is numbers with a $ sign in front of them. The $numbers are created, not produced.

Somebody has to create the money. And somebody has to pay the new money into circulation in the money-using economy.

The monetary system creates the money.

In the present monetary system, commercial banks create the money to fund their loans; then borrowers spend the new money into circulation. Payees have all the money. Borrowers owe it all back. But borrowers can't pay it back because payees have all the money.

Financial crisis means unpayable debts

In this series we are seeing why this kind of monetary system systematically creates unpayable debts.

The system creates a financial crisis of creditors' uncollectable money that is owed as debtors' unpayable debts. 

"borrowers can't pay it back because payees have all the money."

Financial crisis means unpayable debts: debtors can't pay their loan account debts owed to their creditor-banks; and banks can't pay their deposit liability debts owed to their creditor deposit account customers - the payees' who accepted payment in bank deposits as payment "in money". 

"In Booms and Depressions (1932), I have developed, theoretically and statistically, what may be called a debt-deflation theory of great depressions..."

{Irving Fisher, The Debt-Deflation Theory of Great Depressions (1933)} 

"The most outstanding fact of the last depression is the destruction of 8 billion dollars - over a third - of our "check-book money" - demand deposits."

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

When debtors default on paying their unpayable loan account debts, banks can't collect their interest-earning assets. But banks still owe their payable deposit liability debts.

Banks are share-issuing business corporations. When a corporation's payable liabilities exceeds its collectible assets, the corporate balance sheet is "insolvent". If the insolvency can't be quickly resolved - by adding assets or reducing liabilities - the corporation is "bankrupt".

Most bank credit is created to debt-financed borrowers' asset purchases - like stocks in the 1920s and real estate in the 2000s. Bank loans create new buy money in debtors' bank deposit accounts, which debtors spend buying assets.

Adding buy money into the assets for sale markets enables asset owners to ask higher prices for the supply of assets that they offer for sale. Debtors buy the assets and pay the inflated prices with their borrowed deposit account money. Asset sellers are paid the new deposit account balances, which are their banks' new deposit liability debts.

When a bank makes an "asset-secured" bank loan, the bank purchases the borrower's new interest-bearing loan account balance as the bank's new interest-earning asset. The bank purchases the stocks or real estate as its collateral asset: the bank's security against the possibility that the borrower may default on paying the bank's interest-earning asset - the debtor's loan principal plus interest payments. 

"Solvency is restored by equally reducing both sides of the balance sheet."

Bank loan payments are "blended" principal and interest payments. E.g. if the monthly mortgage loan payment is $2000, then $1500 of that total might be loan principal repayment, and $500 is interest payment. Banks earn the interest payments as their business income, which is why debtors' bank loans are banks' "interest-earning" assets. The loan principal payments (deposit account balances) are extinguished, to extinguish an equal amount of the loan account debt balance. So the $2000 mortgage loan payment extinguished $1500 of deposit account money and $1500 of loan account debt; and paid the bank $500 of business income.

If the debtor defaults on paying the money, the bank seizes ownership of the collateral asset and sells it to get deposit account money (loan loss capital) paid into the bank's own bank deposit account. Then the bank writes off the loan loss capital on the liability side of its balance sheet, to write off the uncollectable interest-earning asset (the debtor's defaulted mortgage loan or margin loan) from the asset side of its balance sheet. Solvency is restored by equally reducing both sides of the balance sheet.

Banks' asset-secured bank loan money creation system adds buy money into the assets for sale markets, which systematically inflates the buy-sell prices of assets.

Speculators - and financially naive home-buyers and investors - see the price of assets rising, so they borrow money from banks to buy into the price inflating asset market.

Homebuyers believe they must buy now before they are permanently priced out of the price-inflating real estate market. And they believe they can sell the houses in the future, for more money than they paid to buy them today. So getting a high ratio mortgage loan to buy a price-inflated house does not seem like a high-risk investment. It seems like an opportunity to earn future capital gains.

Speculators expect to sell the assets for more money tomorrow than they paid to buy the assets today. Speculators can repay their bank loans, and earn a nice capital gain, by using borrowed money to buy low, then sell high.

Bankers also see asset prices inflating, and feel their high ratio mortgage loans or margin loans are well-secured by the inflating prices of the collateral assets: the real estate or stocks. 

"Speculators expect to sell the assets for more money tomorrow than they paid to buy the assets today."

When debtors and their creditor banks stop adding new buy money into the assets for sale markets, asset owners find it is no longer possible to sell their assets at inflated prices.

Heavily indebted speculators need to sell their assets to get money to repay their bank loans.

But when credit-inflated asset price inflation turns to debt-burdened bust, there are very few buyers and very many sellers.

So heavily indebted asset owners reduce their ask price, and reduce it again, and again, in a futile effort to get at least some money to pay their bankrupting burden of mortgage debt.

When asset owners reduce their ask prices, the buy-sell price of assets deflates.

Banks owe far more payable in cash deposit liability debts than they have realistically collectable interest-earning assets (debtors' loan payments) to get money to pay their debts.

This means banks' balance sheets are deeply, hopelessly insolvent. The banks are technically bankrupt.

Financial crisis is historically "resolved" by writing off payees' bank deposit account balances to relieve the insolvent commercial banking system of its unpayable deposit liability debts.

That's what bankruptcy Trustees did in the 1930s. And it's what the Dodd-Frank debt-for-equity swaps program (depositor bail-ins) plans to do this time, by less obvious means. 

"The banks are technically bankrupt."

Financial crisis is not a problem of not producing enough stuff that has economic value. During Depressions, the businesses, workers and suppliers are still "there" ready to go to work producing everything that everybody needs and wants.

But the people who need to buy the stuff have no money to pay the people who need to earn money by producing and selling the stuff.

So the productive economy just sits there doing nothing, for want of the money-spending that puts the productive economy to work producing stuff for sale to earn the buyers' money-spending.

The debt-bound people, businesses and governments of the world cannot "produce their way out of debt", because producing more stuff for sale does not produce any more money.

Bank lending creates all the money.

You cannot forever pay down total debt with money that is created by new bank loans. They add equally more new debt as they add new money.

Paying down debt owed to banks - by borrowing more bank-loan money - is logically and arithmetically impossible. 

"The debt-bound people, businesses and governments of the world cannot "produce their way out of debt", because producing more stuff for sale does not produce any more money."

The only kind of money that can pay down total debt is debt-free money that is not created as loans and is not owed back to the money issuer as payment of borrowers' debts.

"Debt-free" helicopter money is the only kind of money that can actually pay down debtors' total debts; without simultaneously and equally reducing payees' deposit account money supply...

...either by payees spending down our bank account balances and debtors earning back, paying back, and extinguishing the deposit account money to extinguish their loan account debts;

...or by mass debtor defaults that technically bankrupt the banks; followed by debt-for-equity swaps where bank regulators bail in our bank deposit account balances (buying us newly issued equity ownership shares in our bankrupt banks). Then banks write off the deposit account credit balances to reduce the banks' payable deposit liability debts down to the reduced level of their still collectible (i.e. not already defaulted) interest-earning assets. This restores solvency to banks' balance sheets to keep them operating as going concerns in the credit-debt creation business.

---

[Banks are still legally liable to pay their deposit liability debts in cash money. But banks are under no obligation to pay back the money we "invested" buying shares from the banks.

By using our money to pay for newly issued bank shares, bank regulators and banks convert banks' payable in cash deposit liability debts into non-payable shareholder equity. "Debt-for-equity."

Instead of "having money in the bank", we will "own shares in our (bankrupt) banks".]

Or, if the insolvent banks are formally bankrupted, bankruptcy Trustees will write off the uncollectable deposit account credit balances as bankrupt banks' unpayable deposit liability debt balances.

It doesn't make any difference "how" the debt reduction is accomplished. Within the banks' present "balance sheet" money creation and un-creation system, payees' deposit account credit balances must be reduced equally as debtors' loan account debt balances are reduced. Banks' payable deposit liability debts must be reduced equally as banks' collectable interest-earning assets are reduced.

As long as the banks' monopoly over money creation stands, these outcomes are arithmetically inescapable.

Government money

For governments to issue debt-free money requires breaking the banks' long-standing monopoly over debt-based money supply issuance.

This is technically easy, but so far has proved to be politically impossible ... largely because almost nobody knows that it is commercial banks, not governments or central banks, who issue the money supply of nations.

Widely and deeply held "popular misconceptions" about where money comes from ("The government prints the money!" "The economy produces the money!"), and about what banks do ("Banks are financial intermediaries who get money from depositors then lend out savers' money!") are a big part of the problem.