Money is created when a bank creates a loan, by starting with nothing and then splitting that nothing into a credit in one account (the borrower’s checking account, usually) and a debit in another (the borrower’s loan balance). From there, most transactions are digital where an ACH transfer or similar results in some numbers being subtracted from one account and added to another.
Almost all of this happens on computers, and even before computers it just happened literally on a paper ledger, with paper checks.
You might ask, “wait where does the bank get its money from to be able to allow money to be withdrawn or transferred to another bank?” If the bank doesn’t have the liquidity to do so, it can always borrow money from other banks or the government, with the last resort in the United States being the federal reserve banks, who by the way also print all the paper currency. So having that backstop is important for regular banks to have the power to create money, but the actual creation of money happens digitally to begin with, regardless of whether the bank later needs to distribute paper bills or borrow from the federal reserve.
It’s how all of it works. Money is just balances on double-entry bookkeeping, and the paper currency essentially is a piece of paper that the bearer of that paper is good for moving the balances in that ledger system.
By that logic any bank could grow arbitrarily large by just underwriting more loans. Then there’d be no competition between any of them and my job would be so much easier.
Yes, the limit to commercial bank lending is creditworthiness and default risk (because the bank is left holding the bag when a borrower doesn’t repay), and the cost of maintaining liquidity (the bank can borrow against the loans it owns, but it may cost a higher interest rate than they’d earn on the cash they’ve lent out). This paper lays it out pretty clearly, and is basically the near unanimous view among macroeconomists.
Or, in some regulatory environments, banks are required to maintain a minimum fractional reserve, which limits the total amount of loans it can lend out with its underlying assets.
But the money is created when the loans are created, and destroyed when the loans are repaid. The other stuff behind the scenes to give the system stability is important, but doesn’t actually create or destroy money.
Exactly. The bank can borrow, for which they need collateral, which sufficiently proves that what you’re saying is wrong.
They have to manage their balance sheet actively, and your original statement was in the lines of ‘it’s all made up and they have infinite equity supply’.
Read my original comment again. I explicitly talk about banks borrowing to maintain liquidity. It’s an important limit on their ability to create money, and nobody said anything about infinite money supply.
But it doesn’t change the fact that the act of money creation is caused by a bank creating a loan, and the money comes into being without a single physical act of manufacturing: it happens on a computer, and before computers it happened on paper.
So without claiming that money was unlimited, I did point out that money itself is overwhelningly digital in the modern age. And the limits don’t come from any physical constraints.
Sure. Empty statement though. I can withdraw all I own and turn it into gold or pebbles if I like. That’s what currency is always meant for. Technology made it easier.
Money is created when a bank creates a loan, by starting with nothing and then splitting that nothing into a credit in one account (the borrower’s checking account, usually) and a debit in another (the borrower’s loan balance).
That’s wrong and that’s also not what the paper is implying. Banks don’t have an unlimited balance sheet. Your ‘nothing’ is an expansion of the balance sheet and you’re grisly misrepresenting double entry bookkeeping. The borrower provides an asset (collateral) and the bank provides an asset (savings from third parties). If the borrower spends that loan, on e.g. food, real money is moving around. Finally you’re also misrepresenting capital adequacy regulations.
From there, most transactions are digital where an ACH transfer or similar results in some numbers being subtracted from one account and added to another.
Who cares what percentage of the transactions are digital? That’s where loro and nostro accounts are for. The underlying cash exists and is tangible.
Almost all of this happens on computers, and even before computers it just happened literally on a paper ledger, with paper checks.
Oh my god, computers? Like sand and electricity? Voodoo I say. Don’t trust that.
You might ask, “wait where does the bank get its money from to be able to allow money to be withdrawn or transferred to another bank?” If the bank doesn’t have the liquidity to do so, it can always borrow money from other banks or the government, with the last resort in the United States being the federal reserve banks, who by the way also print all the paper currency. So having that backstop is important for regular banks to have the power to create money, but the actual creation of money happens digitally to begin with, regardless of whether the bank later needs to distribute paper bills or borrow from the federal reserve.
You can’t borrow money from the government. That’s not how central banks work. You still need collateral, which you can’t pledge multiple times.
I can withdraw all I own and turn it into gold or pebbles if I like
You don’t turn it into anything. You spend it to buy something else. You can spend it without withdrawing any kind of physical representation of the currency, too, with just plain old electronic payment systems.
The borrower provides an asset (collateral) and the bank provides an asset (savings from third parties).
Plenty of loans are made unsecured, where the borrower doesn’t pledge the asset. The act of money creation through lending is the same regardless of whether it’s secured or unsecured loans. And even secured loans don’t change the underlying ownership and control of the collateral, unless a foreclosure happens.
That’s not how central banks work. You still need collateral, which you can’t pledge multiple times.
Yes, but the collateral can be the loans that they’ve extended, which, again, were created by creating a loan balance and a deposit balance. So they can extend a loan for $100, let the borrower spend $100, and then borrow against the original borrower’s loan balance.
No, it can’t be done infinitely, but I never claimed that it could be. I’m just saying that the process itself is entirely ephemeral, through written or electronic records alone.
Fitting username. Explaining this to people irl who respect and listen to me is hard; can’t imagine trying to inform someone online who’s simultaneously trying to win the conversation you’re having
Not exactly. The central banks acting as a lender of last resort encourage the commercial banks to create money in this way, but be assured that the actual creation occurs whether the bank needs to borrow money or not. The definition of money supply looks to the balances in checking accounts, and creating and disbursing a loan increases the balance in a checking account (while simultaneously increasing the negative balance in a loan account, but loan balances don’t shrink the money supply), and as that money is spent it increases balances in someone else’s checking account.
Not how it works. a bank can’t just magically issue loans in a vacuum without caring about liquidity, because the second a borrower spends that money, the bank has to cough up real central bank reserves to settle with another institution or go broke.
So the question becomes, does the money get created when it is put in a deposit account balance, or when it gets spent outside the bank for the first time?
The textbook answer is that the money is created as soon as the deposit balance is created, not when the account holder spends it down enough to where the bank needs to borrow to maintain liquidity. It’s how the Fed counts M1, for example.
The bank’s need to actually run a viable business, and central bank regulations, prevents it from going nuts with this, but that’s beside the point of what I’m saying: a bank doesn’t need the central bank’s permission or approval to create money by extending loans. In the aggregate, central bank policy affects the way all the different banks do this, but the end result is that the banks can create a shitload more money than there are reserves (and the reserves don’t need to be physical currency, either, since they can just be balances in accounts with other financial institutions).
We already have mostly digital currency.
Money is created when a bank creates a loan, by starting with nothing and then splitting that nothing into a credit in one account (the borrower’s checking account, usually) and a debit in another (the borrower’s loan balance). From there, most transactions are digital where an ACH transfer or similar results in some numbers being subtracted from one account and added to another.
Almost all of this happens on computers, and even before computers it just happened literally on a paper ledger, with paper checks.
You might ask, “wait where does the bank get its money from to be able to allow money to be withdrawn or transferred to another bank?” If the bank doesn’t have the liquidity to do so, it can always borrow money from other banks or the government, with the last resort in the United States being the federal reserve banks, who by the way also print all the paper currency. So having that backstop is important for regular banks to have the power to create money, but the actual creation of money happens digitally to begin with, regardless of whether the bank later needs to distribute paper bills or borrow from the federal reserve.
That’s not how any of it works though.
It’s how all of it works. Money is just balances on double-entry bookkeeping, and the paper currency essentially is a piece of paper that the bearer of that paper is good for moving the balances in that ledger system.
And almost all of those ledgers are now digital.
By that logic any bank could grow arbitrarily large by just underwriting more loans. Then there’d be no competition between any of them and my job would be so much easier.
Yes, the limit to commercial bank lending is creditworthiness and default risk (because the bank is left holding the bag when a borrower doesn’t repay), and the cost of maintaining liquidity (the bank can borrow against the loans it owns, but it may cost a higher interest rate than they’d earn on the cash they’ve lent out). This paper lays it out pretty clearly, and is basically the near unanimous view among macroeconomists.
Or, in some regulatory environments, banks are required to maintain a minimum fractional reserve, which limits the total amount of loans it can lend out with its underlying assets.
But the money is created when the loans are created, and destroyed when the loans are repaid. The other stuff behind the scenes to give the system stability is important, but doesn’t actually create or destroy money.
Exactly. The bank can borrow, for which they need collateral, which sufficiently proves that what you’re saying is wrong.
They have to manage their balance sheet actively, and your original statement was in the lines of ‘it’s all made up and they have infinite equity supply’.
Read my original comment again. I explicitly talk about banks borrowing to maintain liquidity. It’s an important limit on their ability to create money, and nobody said anything about infinite money supply.
But it doesn’t change the fact that the act of money creation is caused by a bank creating a loan, and the money comes into being without a single physical act of manufacturing: it happens on a computer, and before computers it happened on paper.
So without claiming that money was unlimited, I did point out that money itself is overwhelningly digital in the modern age. And the limits don’t come from any physical constraints.
Okay, let’s break it down yeah?
Sure. Empty statement though. I can withdraw all I own and turn it into gold or pebbles if I like. That’s what currency is always meant for. Technology made it easier.
That’s wrong and that’s also not what the paper is implying. Banks don’t have an unlimited balance sheet. Your ‘nothing’ is an expansion of the balance sheet and you’re grisly misrepresenting double entry bookkeeping. The borrower provides an asset (collateral) and the bank provides an asset (savings from third parties). If the borrower spends that loan, on e.g. food, real money is moving around. Finally you’re also misrepresenting capital adequacy regulations.
Who cares what percentage of the transactions are digital? That’s where loro and nostro accounts are for. The underlying cash exists and is tangible.
Oh my god, computers? Like sand and electricity? Voodoo I say. Don’t trust that.
You can’t borrow money from the government. That’s not how central banks work. You still need collateral, which you can’t pledge multiple times.
You don’t turn it into anything. You spend it to buy something else. You can spend it without withdrawing any kind of physical representation of the currency, too, with just plain old electronic payment systems.
Plenty of loans are made unsecured, where the borrower doesn’t pledge the asset. The act of money creation through lending is the same regardless of whether it’s secured or unsecured loans. And even secured loans don’t change the underlying ownership and control of the collateral, unless a foreclosure happens.
Yes, but the collateral can be the loans that they’ve extended, which, again, were created by creating a loan balance and a deposit balance. So they can extend a loan for $100, let the borrower spend $100, and then borrow against the original borrower’s loan balance.
No, it can’t be done infinitely, but I never claimed that it could be. I’m just saying that the process itself is entirely ephemeral, through written or electronic records alone.
Fitting username. Explaining this to people irl who respect and listen to me is hard; can’t imagine trying to inform someone online who’s simultaneously trying to win the conversation you’re having
Well only central banks can create it out of thin air. Normal banks lend other people’s money (fractional reserve banking)
Not exactly. The central banks acting as a lender of last resort encourage the commercial banks to create money in this way, but be assured that the actual creation occurs whether the bank needs to borrow money or not. The definition of money supply looks to the balances in checking accounts, and creating and disbursing a loan increases the balance in a checking account (while simultaneously increasing the negative balance in a loan account, but loan balances don’t shrink the money supply), and as that money is spent it increases balances in someone else’s checking account.
Not how it works. a bank can’t just magically issue loans in a vacuum without caring about liquidity, because the second a borrower spends that money, the bank has to cough up real central bank reserves to settle with another institution or go broke.
So the question becomes, does the money get created when it is put in a deposit account balance, or when it gets spent outside the bank for the first time?
The textbook answer is that the money is created as soon as the deposit balance is created, not when the account holder spends it down enough to where the bank needs to borrow to maintain liquidity. It’s how the Fed counts M1, for example.
The bank’s need to actually run a viable business, and central bank regulations, prevents it from going nuts with this, but that’s beside the point of what I’m saying: a bank doesn’t need the central bank’s permission or approval to create money by extending loans. In the aggregate, central bank policy affects the way all the different banks do this, but the end result is that the banks can create a shitload more money than there are reserves (and the reserves don’t need to be physical currency, either, since they can just be balances in accounts with other financial institutions).