posted on 09 August 2016
Written by Derryl Hermanutz
John K Galbraith, Money: Whence it Came, Where it Went (1975):
Cutting Through the Fog of Obfuscating Complexity that Surrounds "Money"
In 2014 the (central) Bank Of England published a little pdf, Money Creation in the Modern Economy, describing in 12 plain language pages the simple process by which commercial banks create virtually all of the economy's money supply on their balance sheets as deposit liabilities issued to purchase debt assets: credit-money owed as repayment debt. Here is a summary video:
The paper begins,
The financial blogosphere erupted in outrage against the British central bank's 'misrepresentation' of where money comes from. "Everybody knows" the government issues the money, and all monetary failings are the government's fault or the central bank's fault.
The B of E described the simple process by which commercial banks issue the money supply as linked pairs of debt-assets and deposit liabilities. But rather than embrace this as an opportunity to learn the truth about commercial bank money issuance from the oldest central bank in the business, critics clung to their false opinions and theories and refused to believe the truth.
Truth has no power to inform your thinking; not until you "believe it". And use it to replace old false beliefs with new true beliefs.
Money and Debt
As Galbraith observed in the opening quote, "money" is surrounded by such a fog of obfuscating complexity that few people see the simple truth that commercial banks create the world's money supply as "loans". Which means the world owes its money supply back to banks as loan repayment debts.
Money and debt increase and decrease in lockstep, as the two sides of a single balance sheet accounting equation. Balance sheet expansions increase the world's total money supply and the world's total debt owed to banks. Bank loan repayments reduce the world's money supply and reduce the world's debt owed to banks, in balance sheet reductions.
When people are exposed to the simple truth that private businesses (banks) -- not governments -- issue the money supply of nations, many people's minds are repelled. They don't believe it. They can't believe it. They refuse tobelieve it. "There must be some deeper mystery." But there isn't.
Money Creation Through Deposit Expansion
Beginning in 1961, and last updated in 1994 (still available online), the Federal Reserve Bank of Chicago published,Modern Money Mechanics: A Workbook on Bank Reserves and Deposit Expansion, describing in 50 somewhat more technical pages the same process by which commercial banks create the economy's money supply by deposit expansion.
The Fed workbook focuses on the role of reserves in macro-managing changes in the deposit-money supply, and adopts the modern "functional" view of what money "is". Money is whatever people accept as a "transactions" medium. If people accept it as payment, then "it is money".
Money Payment System
Most (about 97%) of modern money exists as electronic digits in banking and financial system accounting software. Account money is paid (spent or invested) by debiting payer accounts; and the same money is received (earned) by crediting payee accounts. We spend money -- and payees earn money -- by debit card and online banking.
We spend and earn "money" without ever "touching it". We "see it" as our account balances; and we see our spending and earning as the numbers in debit and credit columns in our account statements. Spending is a debit. Earning is a credit. Spending reduces our deposit account balance. Earning increases our deposit account balance. The deposit account balance "is the money". It is our bank's balance sheet "deposit liability". But it is our spendable/investible or savable "money".
Money Exists for the Payment of Debt
Money is just "numbers". Money "works" by the simple arithmetic of adding (crediting) and subtracting (debiting) numbers in bank accounts. A positive account balance is "money". A negative deposit account balance (or a positive loan account balance) is "debt". The negative numbers of debt are payable in the positive numbers of money.
You can convert numbers in your bank account (your deposit balance) into numbers on printed paper-like material (banknotes) and numbers stamped on metal discs (coins). Your bank debits your account balance (account money) in the amount of your cash withdrawal (cash money; currency). The money value of the account balances, banknotes and coins is the "numbers": $100, or 5 cents, etc.
Though virtually everything in the modern economy is bought and sold for money, the economy doesn't "produce" the money numbers. Banks "create" the money as loans, along with the loan repayment debts.
The world cannot "produce its way out of debt" by producing stuff that has economic value. Value is bought and sold for money. But producing value produces no "money". Within the present monetary paradigm, commercial banks exercise a near absolute monopoly over issuing "the money". Credit-money owed as repayment debt. Zero sum money and debt.
Zero Sum Balance Sheet Money and Debt
Commercial banks issue the money (and debt) of nations by expanding their balance sheets: issuing new deposit liabilities to purchase new interest-bearing debt assets.
The deposit liabilities "are the money". In the current system there is virtually no other money.
Example: A bank begins with $0 (ignoring required capital reserves, which come from another layer of debt created money). This is $0 debt assets; also $0 deposit liabilities on its brand new balance sheet. To make a $1000 loan the bank divides $0 into a +$1000 deposit account credit and a -$1000 loan account debt.
A balance sheet always "balances" to $0. Assets owned - Liabilities owed = $0. $1000 of debt assets = $1000 of deposit liabilities. $1000 of the economy's money supply = $1000 of the economy's debt owed to banks. There is nearly zero "real" money, if we use the term "real" to indicate money that is not owed as debt repayment.
By adding 3 more zeros to the numbers, the bank can create $1,000,000 of new money to purchase $1,000,000 of new debt.
Note: More exactly, the total of all balance sheets must equal zero. An individual may have a positive net worth (more assets than liabilities) but somewhere in that monetary system there must exist balancing negative net worth(s).
Money in the World Today
The world's commercial banks have collectively created 10s of trillions of new dollars, pounds, euros, yen, yuan and other currencies, to purchase equal 10s of trillions of debts owed in those currencies. The money remains in existence only as long as the debts remain unpaid.
A deeper mystery seems only decent. But that's really all there is to it.
Banks issue new money to purchase new debts. Non-banks issue debt to get spendable/investible money from the banks. Commercial banks are the original source of virtually all the money that exists in the world today. And it's all owed back to banks as private debtors' loan repayment debts and government debtors' bond redemption debts.
Money that is spent or invested by one party, is "earned" by a counterparty, in every invest-earn, buy-sell, spend-earn, payer-payee, money transaction. Earners cannot "earn money", unless somebody else "pays" (spends or invests) the money. Spenders/investors no longer "have" the money. Spending recipients -- payees; earners -- now have the money.
A financial "transaction" involves one party paying money, and the other party being paid the money. "Ownership" of the money changes hands, from payers to payees. Usually something else -- assets, goods, services, labor, etc -- changes hands from payees to payers.
"Buyers" (payers) pay money to acquire ownership of 'stuff'. "Sellers (payees) sell stuff to acquire ownership of the buyer's money. Buyers pay money to get stuff. Sellers sell stuff to get money.
Savers hold money out of circulation from the economy's buy-sell, spend-earn stream. Savers earn money then don'tspend or invest it. To "be" a saver -- to "have money" -- you have to earn money that somebody else spent, then hold onto the money rather than re-spending it or investing it.
Most direct money savings are held in the form of deposit account balances in banks and other financial services businesses.
"Debtors" originally spent all of the bank-created loan money "into" the money supply; and owe it all back "out" of the money supply as their bank loan repayments.
The money was originally spent into the economy be a debtor where the new money circulated in the economy's spend-earn stream. A series of money-spenders spent the money, and a series of money-earners earned the money, and invested some of their earnings, re-spent some, and saved some. Eventually "savers" will have earned most of the money and are holding it out of circulation: not spending or investing the money back into the spend-earn stream where the next payee can earn the money.
Debtors Left in the Lurch
But debtors need all the money to remain in circulation, so they can earn their borrowed money back and pay it back to the banks that created the money in the first place, as the debtors' "loans". The trillions of money that savers "have", is the same trillions of money that debtors "owe". If savers don't spend or invest their savings, debtors cannotearn their borrowed money back. So debtors cannot repay their bank loans, and banks cannot collect their loan payments.
Within a zero sum balance sheet money supply system: savers' savings make debtors' debts arithmetically unpayable. A zero sum credit-owed-as-debt money supply system cannot accommodate savers' accumulation of financial wealth in the form of long-term money savings.
Saving crashes the commercial banking system. Money saving -- the legitimate desire to build up personal or corporate financial security in the form of money savings -- requires a positive sum money supply, not a zero sum money supply, or financial crashes are inevitable.
But the Savers Lose As Well
Savings/debts imbalances -- between savers who "have" most of the money supply and aren't spending it; and debtors who "owe" all of the money supply back to banks but can't earn it back; make debtors' debts arithmetically unpayable, which makes banks' loan account assets arithmetically uncollectable; which bankrupts debtors and their creditor-banks; which reduces savers' bank account savings in the depositor bail-ins, and ultimately extinguishes savers' bank account savings in the bank bankruptcies.
It happened in the 1930s, and we're still using the same arithmetically deficient zero sum money supply system that cannot accommodate money-saving.
Financial collapse is built into the macro money accounting arithmetic of a zero sum bank balance sheet money supply system.
The Financial Crisis of Banks' Uncollectable Credits Owed as Debtors' Unpayable Debts
I know this is a hard thing for people to get their head around, but the arithmetic is dirt simple.
The $1000 begins in a debtor's bank account and ends up in a saver's bank account. The debtor owes the money back to the bank, but the saver who earned the money and now owns the money isn't spending it, so the debtor "can't" earn the money back. So the debtor can't pay the bank, and the bank can't collect its loan payments.
Multiply that by 100s of millions of global debtors and 100s of millions of global savers and thousands of global banks, and you begin to see why savers' savings make debtors' debts arithmetically unpayable; and how these savings/debts imbalances crash the commercial banking system.
Debtors could earn every dollar (and pound, euro, yen, yuan, etc) that is being spent or invested, and use that money to repay their loans, and debtors would still owe unpayable debts = savers' unspent savings.
This negative effect of savings has been recognized since antiquity, although the problem was usually phrased as one of savings reducing aggregate demand. See The Fable of the Bees and Keynes' Paradox of Thrift.
The ongoing "financial crisis" is a crisis of debtors' unpayable debts owed to banks, and banks' uncollectable loan account and bond credits owed by effectively bankrupt debtor households, businesses and nations.
This situation is sometimes called a savings glut. But that is quite misleading because even a small amount of savings which is not invested qualifies as a glut. The current system simply will not work id any money at all is saved.
The Simple Solution ...
The simple arithmetic solution to the crisis is to "add money", to make debtors' unpayable debts payable, which makes creditor-banks' uncollectable credits collectable, which eliminates the need for bail-ins and bankruptcies that extinguish savers' savings.
The crisis cannot be solved within the commercial bank zero sum money supply issuing system. Adding more bank balance sheet money adds equally more unpayable debt.
... Basic Universal Income
The crisis can be solved by adding net positive sums of government/central bank-issued debt-free "fiat money". "Helicopter money", dropped into citizen bank accounts by a fiscal payments program such as a Basic Income would break the log jam caused by savings.
Almost all citizens are "debtors" who owe mortgage debts, car loan debts, student loan debts, credit card debts, lines of credit and overdraft debts, etc. Many of those debts are unpayable, or barely payable. By adding a monthly Basic Income deposit into every adult citizen's bank account, most of their bank loan debts become payable, which makes their banks' defaulting balance sheet debt-assets collectible, which restores solvency to banks by paying down their debt assets to equal the deflated value of their collateral assets (mortgaged real estate, mainly; and national bond debt in the eurozone).
Implementing Helicopter Money
Commercial banks are integral to the money system and are at the center of the present financial crisis. And within the existing legal and monetary infrastructure, commercial banks would be an integral part of the fiat money-issuing program, along with governments and central banks.
So, within a modern central bank-backed commercial banking system, here's how (effectively) debt-free fiat money could be created at essentially zero cost:
The government now has fully reserve-backed deposits in its commercial bank accounts, to pay the Basic Income into citizen bank accounts. If Adair Turner's idea (overt monetary financing or positive money) is implemented, those new reserves will be isolated from the banks' ordinary business, and will be statutory -- required, not excess. Which means the new reserves would not support any new bank credit/debt creation.
To make the Basic Income payments: the banks debit the government's deposit accounts, and credit the citizen/payee's deposit accounts. The new 100% reserve-backed deposit money -- let's just call it "fiat money" -- has now been paid out of government bank accounts and into citizen bank accounts.
The banks then debit their customer's deposit accounts to make their overdue loan payments. The government could authorize automatic debits out of its accounts and automatic payments into Basic Income payee accounts. Debtors and their banks could set up automatic debits to paydown debtors' debts. Such payments could be required by some formula until debts are repaid.
Helicopter money is an orderly debt paydown program, to prevent the otherwise inevitable disorderly credit/debt reduction-by-bankruptcies. The purpose of the program is to restore solvency to insolvent debtor households and their equally insolvent creditor-banks. A condition of the program would be that all overdue loans have to be paid first, before a Basic Income payee can "spend" any of the new money.
Indebted households who are current on their loan payments could use their Basic Income to voluntarily accelerate paydown of their underwater mortgages and other debts, which benefits both the debtor households and the creditor-banks who are still holding those debt-assets at full value on their balance sheets, even though the sellable price of the collateral real estate has heavily deflated.
Most household debt (and student debt, etc) would rapidly be restored to "current" status, by the program. People would be able to paydown their debts, and banks would be able to collect their loan and interest payments.
The fiat money is created by permanently expanding central bank balance sheets with perpetual debt assets (the government's new perpetual bonds) and perpetual reserve liabilities (the commercial banks' new statutory reserve account balances).
The debt-backing of commercial banks' deposit liabilities is reduced (paid down) and the money backing of the banks' deposit liabilities is increased (with the banks' new reserve account balances). Banks -- and their debtors -- "deleverage" from insolvent heights down to solvent and stable levels.
The "fiat money" begins in government bank accounts, so monetary, fiscal and financial policymakers and administrators would decide how to allocate the money to the most critical needs. A monthly Basic Income credited into every citizen's bank account addresses a crisis of household debt, but that is not the only or most critical problem in every nation.
In the eurozone, national governments would issue consols and sell them to eurobanks, and the banks would sell the bonds to the ECB who would issue euro reserves into the banks' reserve accounts (national central banks could be included into the equation, by more complicated accounting arrangements).
The Greek government could directly pay the new money to the German and French banks who are holding "distressed" Greek bond debt as their balance sheet assets. The new money extinguishes the old debt; and the banks' distressed debt-assets are replaced with new money-solid ECB reserve assets. The banks are restored to solvency, and Greece is released from debt bondage.
There are no printed bonds on gilt-edged paper. The whole process is accomplished "by typing": by typing numbers into computerized bank accounts. Many people are surprised to learn that almost all of the world's money has never existed in any form other than numbers typed into accounts.
From the government's perspective, zero interest perpetual bonds are a form of no-cost, non-repayable "debt"; a "debt-asset" that central banks can add to their balance sheets and pay for by issuing central bank money liabilities: new reserves to back the commercial banks' new deposit liabilities.
Central bank-issued base money is the "gold-backing" of modern commercial bank credit-money creation. All other forms of money are ultimately payable in central bank-issued reserves and central bank-issued banknotes. Physical banknotes (and government-minted coins) are the closest thing to physical gold as the modern money system's currency: its physical cash money.
But unlike the bad old days when commercial banks held fractional reserves of physical gold in their vaults to "back" their banknote printing and "checkbook money" deposit creation -- so banks went bust and holders of the bank's credit-money lost all their money when the "fraud" of fractional reserve credit-creation revealed that the bank-issued money was not really "gold-backed" after all; central bank-issued reserves and banknotes are an expandable sum base money system.
This is how Ben Bernanke et al stopped the 2008 cascading collapse by "issuing base money" to back commercial bank credit-money. You can thank Ben Bernanke that your bank account balance still "works" as "money".
As the originator, the source, the fount of the system's "money", central bank balance sheet "liabilities" are an accounting nicety, not a binding monetary constraint.
The central bank is "liable" to convert the reserve deposits (account money) it issues into the banknotes (cash money) it issues. And liable to convert the cash money it issues into the account money it issues -- if central bank account holders (commercial banks, governments, and other nations' central banks) want to make cash deposits into their central bank account.
As long as it has a keyboard and a printing press, the central bank can "issue" any quantity of base money the system needs.
We can "do arithmetic" - even when the numbers have a $ sign in front of them.
We do not have to let a zero sum macro money supply arithmetic equation burn down our money savings and bankrupt commercial banks and bankrupt our money-driven productive businesses and sentence our buy-sell money economies to debt deflation Depression.
We can "add money", to convert the financially deficient zero sum money supply equation into a financially sufficient positive sum equation.
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