Banks create money, but it's less impressive than it sounds - <AUTHOR> https://www.attejuvonen.fi/money-out-of-thin-air/ <comment><USER2> This is a fantastic page. I just have an issue with one of his points though:

> That banks do not have any special powers in relation to money creation

They most definitely do though: FDIC insured accounts have legal government backing—a random IOU from me can't achieve that, no matter how much anyone trusts me. Put another way, a bank deposit seems less like an "IOU" and more like a "WeOU"—"we (the bank or the government) owe you". That seems like quite a fundamental difference, no? It seems to distinguish "fake" and "real" money (or banks).

<comment><AUTHOR> Hey, author here. Your criticism is correct. Deposit insurance is a fundamental difference between bank IOUs and non-bank IOUs. So it's incorrect for me to say that banks have _no_ special powers (still not even close to central bank's power though).

<comment><USER3> How confident are you on that point? I don't have a reference on me right at this moment but I expect it is illegal for a non-bank entity to hand out IOUs at scale. People would be arrested.

I'm thinking of things like [https://en.wikipedia.org/wiki/Liberty_dollar_(private_curren...](https://en.wikipedia.org/wiki/Liberty_dollar_\(private_currency\)) which ended in FBI raids.

<comment><USER4> That's what corporate bonds are. In the extreme, every as-yet-unpaid invoice on 30 or 90 terms creates a debt and "creates money".

Full Tilt Poker created a small closed e-money system which was seemingly legally fine; it was the _gambling_ that got them raided, because only mob bosses in politically connected US states are allowed to profit from gambling and the US will go after gambling providers in other countries.

Liberty reserve were facilitating money laundering. This is the difficult bit - if you provide an electronic facility for easy transference of ownership of debts or e-money, the authorities want access to the paper trail.

<comment><USER5> >That's what corporate bonds are. In the extreme, every as-yet-unpaid invoice on 30 or 90 terms creates a debt and "creates money".

No, there's a big difference, in that you don't have the right to redeem ("put") the corporate bond any time at face value.[1] You do have that right for the IOU that is your bank account. This allows two people to carry on as if they both are full owners of the dollar in the bank account (both the depositor and the business it was lent to), and that mechanism is what allows the money supply to increase.

When you don't have that right, you, as the corporate bond holder, know that you can only get the money out early by selling the bond at its current market rate, whatever that is, which may force you to take a discount. This expectation -- and the necessity to redeem it for someone else's dollars on the market -- prevents it from being money creation.

[1] There are "puttable bonds" where you can do something like this, but it's over specific intervals and times, not immediate. [https://en.wikipedia.org/wiki/Puttable_bond](https://en.wikipedia.org/wiki/Puttable_bond)

</comment></comment></comment></comment></comment><comment><USER6> The article doesn't adequately cover the role of central banks in fractional reserve banking.

Back in the days of the gold standard you used to be able to redeem a set weight of physical gold from the central bank for a dollar / pound of paper cash or minted coin. This conversion ratio was set by the central bank and acted as a final brake on inflation. When the gold standard was abolished and the dollar and pound became free floating fiat currency, it only became worth something because the government says it is. The "I promise to pay the bearer x pounds/ dollars" is just a hangover from the gold standard days when you could redeem money for gold directly from the central bank rather than through a private gold dealer. Now you can only redeem an equivalent amount of fiat currency at the central bank if day your dollar / pound note becomes damaged.

Banks can create deposits / reserves at the central bank out of nothing, they just have to promise to pay the central bank back at a later date, plus an equivalent amount of interest equal to the central bank set interest rate. This is how the central bank regulates the interest rate in the economy. If a bank charges another bank a higher level of interest for lending than the central bank, that bank can just go to the central bank instead and get charged the lower central bank interest rate. This acts as a brake on maximum inter-bank interest rates and ultimately what interest rates are charged by end consumers. The same is true for cash deposits, the central bank acts a floor / minimum interest rate for deposits as the central bank will pay interest at the central bank interest rate for deposits held at the central bank.

<comment><USER7> > it only became worth something because the government says it is

That's the only nitpick I have against your otherwise excellent comment: it's not that government says it is, it's the societal consensus that it's worth it.

Of course, government is usually a pretty big entity it the country's economy, and since it uses the currency for all of it's transactions, currency acquires some value at least from these transactions alone; however, if the society as a whole loses trust in the currency, government will not be able to define it's worth. And when it tries, it just leads to black market, barter-based economy and even deeper economical collapse.

<comment><USER6> That's where the term legal tender comes from. Society is legally mandated to accept whatever is determined by the government as legal tender for the settlement of debts. However, this does not include everyday transactions, only the settlement of debt. A trader can accept or deny any currency or form of barter as long as it is not for the settlement of debt.

This is why the Scots are wrong to get in a fuss about shops not accepting Scottish bank notes, as shops are not legally obligated to accept them as legal tender does not apply in this case. Also, Scottish bank notes are not actually legal tender anyway.

<comment><USER8> >That's where the term legal tender comes from. Society is legally mandated to accept whatever is determined by the government as legal tender for the settlement of debts.

This entirely depends on the legal framework in a given country. Some countries have legal tender but no necessary obligation, absent a contract, to accept coins or notes in general as payment of the contract.

Moreover, in the context that a person is likely to not accept the government mandated currency as payment, they're not likely to accept debt either. Such situations are common in times of hyperinflation for instance.

If governments could legal mandate that their fiat currencies have value, there would be no such thing as hyperinflation. There is such a thing as hyperinflation. Therefore, governments cannot legally mandate that their fiat currencies have value.

But they can make them highly valuable by demanding and collecting taxes. If you have to pay 20c in tax every time you buy a chicken for a litre of milk (because the government values a chicken at $1 and charges a 20% GST), then you're going to need some source of dollars - even though all your private transactions are denominated in litres of milk (or bitcoins or whatever).

As for Scots getting into a fuss, they are right to get into a fuss if they're treated less equally than other British people. You can say "oh, but the legal situation is thus" but that doesn't make the legal situation _or_ the social situation right. It merely means it exists (not, I suppose, that a person who attacks Scots could understand the is-ought distinction).

No English person would be hurt if every English person accepted Scottish notes at par; as you observe, the Scots are not hurt. Therefore, by putting up a barrier to free trade, they hurt their neighbors for no beneficial reason.

<comment><USER9> > No English person would be hurt if every English person accepted Scottish > notes at par;

This is true up until the point one of the banks goes bankrupt, especially if they were found to have printed a whole lot of notes not backed by central bank reserves.

In practice, I strongly suspect the government would step in and accept the notes directly if that ever happened.

</comment></comment></comment></comment></comment><comment><USER10> I found this paper from the Bank of England very enlightening when it comes to the actual mechanisms of money creation and their limits.

The paper is short and concise enough and the diagrams are very helpful to the uninitiated.

Money Creation in the Modern Economy: [https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...](https://www.bankofengland.co.uk/-/media/boe/files/quarterly- bulletin/2014/money-creation-in-the-modern-economy.pdf)

<comment><USER11> Thanks for sharing!

Would be cool to make it even more accessible. Something that can be shared virally via WhatsApp by my aunt. :D

</comment></comment><comment><USER12> > Welcome to fractional reserve banking!

I don't think that is fractional reserve banking.

FRB is the system where a bank is required to have a reserve of X% before it can issue money, while in the current system the banks first emits money and then (in the US) it attempts to get a reserve[0] for that (and in the EU, it doesn't either, tho there are liquidity requirements).

[0] [https://en.wikipedia.org/wiki/Reserve_requirement](https://en.wikipedia.org/wiki/Reserve_requirement)

<comment><USER13> So you think this is not fractional reserve banking because instead of having the fractional reserve of X% beforehand they get the fractional reserve of X% right afterwards?

<comment><USER14> According to Steve Keen[1] based on research by Kydland & Prescott[2] it's up to a year before the fractional reserve catches up.

[1] [https://www.deflation.com/Articles/The-Roving-Cavaliers- of-C...](https://www.deflation.com/Articles/The-Roving-Cavaliers-of-Credit)

[2] [https://researchdatabase.minneapolisfed.org/concern/parent/b...](https://researchdatabase.minneapolisfed.org/concern/parent/b2773v855/file_sets/0p096701c)

<comment><USER13> Thanks for the reference.

Edit: I've just briefly skimmed it [1], but "The creation of credit money should happen after the creation of government money." would be true if the system was working at capacity. The fractional reserve requirements are not really a limiting factor, the banking system in aggregate is operating well below that limit if I remember correctly.

[1] The 2012 article, for a few seconds; I didn't look at the 30-year-old paper beyond noticing the date in the cover

<comment><USER14> He first published that article in 2009 right after the markets imploded with the GFC. He's also generally acknowledged as one of the few who predicted the crash which he predicated on the buildup of private debt.

His articles make for interesting reading even now given his general rejection of mainstream models being inadequate.

[https://theconversation.com/i-predicted-the-last- financial-c...](https://theconversation.com/i-predicted-the-last-financial- crisis-now-soaring-global-debt-levels-pose-risk-of-another-84136)

</comment></comment></comment></comment></comment><comment><USER15> > _For example, when you make a bank transfer to another bank, the bank can > not simply send over money created by itself._

Uhh, yes it can. That's what LIBOR is (supposed) to represent - short term unsecured lending between major banks. I.e. they can agree that the sending bank is now slightly more indebted to the receiving bank. It depends on what the involved banks agree on.

And because such things are based on trust they do blow up sometimes. For example during the panic in March there was a pretty wide gap between FRA rates (unsecured lending) and OIS rates (secured lending). FRA was quite a bit higher.

Edit: let me just add that this does not invalidate the rest of the article.

<comment><AUTHOR> Thanks for this feedback. I have now updated the article substantially. The new version covers the possibility of banks lending money to each other as opposed to settling a transaction with cash/reserve deposits. Diffs: [https://github.com/baobabKoodaa/blog/commit/c2f7fef53d621acc...](https://github.com/baobabKoodaa/blog/commit/c2f7fef53d621accee110f3b40510c15e9cdc061)

<comment><USER15> Sure!

The various types of money usually have interest rates associated with them, and those rates tell you about the relationships between the types of money. For example there is an interest rate differential between the central bank money and the US treasuries (which are equivalent to USD money for most people most of the time), captured by the repo rate minus IOER. This differential blew up quite recently (in 2019), showing a temporary divergence between tbills and "real money".

In the past, before central banks, each region of the US had their own money, and merchants had conversion tables. They would literally tell you that, for example, Boston money is worth for me only 80 cents on the dollar. Much like today we quote prices on bonds.

Robert Shiller has some really good finance lectures on YouTube. The one about central banking:

[https://m.youtube.com/watch?v=_SpIaGTq0u8](https://m.youtube.com/watch?v=_SpIaGTq0u8)

</comment></comment></comment><comment><USER16> I think "fundamental" is a treacherous concept for explaining money creation.

Both this article and the stuff Atte is responding to end up with "X is merely Y" explanations. The (arguable, but widely accepted) reality of macroeconomic and monetary dynamics is that it is not merely microeconomics. A layer of emergence separates the two.

It's true that what banks do is not _fundamentally_ different to what full tilt poker did. Even the "bank run" parallels the many bank runs in history, and associated monetary collapse.

You can find other parallels too. My favourite is employees. Say you have no money. You hire 10 people clean pools, with salaries due at the end of the month. They work. You get paid. If you get paid enough, you can pay salaries on time and make profit.

This is the same principle as monetary stimulus, where a government makes loans to stimulate economic activity. We do call that money creation, but it's not _fundamentally_ different to what every employee does.

IRL, a poker site or pool cleaning business will (almost) always hit a point of reversal. Expansion becomes deflationary rather than inflationary. Further growth requires capital, rather than generating it. The business models that don't do reach levels where their money creation starts to have macro-scale effects. These tend to join the financial sector (eg, the stock market), where they are regulated in some fashion to curb monetary inflations and deflations.

What makes banks qualitatively different is stability. They can do this long term, continuously increasing scale, without bank runs. Quantity is a quality of its own. If banks expand mortgage lending, real estate will inflate... either with higher prices or with more building. This isn't money that was redirected from one sector to another. It's new money.

This is why monetary policy isn't just central banking. It's regulators. The regulator controls this sort of activity (eg mortgage lending) in order to regulate the supply of money.

</comment><comment><USER17> It's not the wild west, though. The Central Bank do know how much these banks are issuing; and also differentiate between the different kinds of money. And not only banks issue money, other financial institutions do also issue some kind of money. From Wikipedia ([https://en.wikipedia.org/wiki/Money_supply](https://en.wikipedia.org/wiki/Money_supply))

        - M0: In some countries, such as the United Kingdom, M0 includes bank reserves, so M0 is referred to as the monetary base, or narrow money.[20]
        - MB: is referred to as the monetary base or total currency.[17] This is the base from which other forms of money (like checking deposits, listed below) are created and is traditionally the most liquid measure of the money supply.[21]
        - M1: Bank reserves are not included in M1.
        - M2: Represents M1 and "close substitutes" for M1.[22] M2 is a broader classification of money than M1. M2 is a key economic indicator used to forecast inflation.[23]
        - M3: M2 plus large and long-term deposits. Since 2006, M3 is no longer published by the US central bank.[24] However, there are still estimates produced by various private institutions.
        - MZM: Money with zero maturity. It measures the supply of financial assets redeemable at par on demand. Velocity of MZM is historically a relatively accurate predictor of inflation.[25][26][27]

You can see the M0, M1 and M2 money supplies at Trading Economics: [https://tradingeconomics.com/united-states/money- supply-m2](https://tradingeconomics.com/united-states/money-supply-m2)

By the way, you can issue money too. Let's say you buy a computer for $1.000 and promise the seller that you are going to pay him $1.050 by next year. You just issued $1.050 of M2.

Counter-intuitively, this money supply system is helping developed countries control inflation. In some developing countries, inflation is harder to control because people _are issuing money_ on their own.

</comment><comment><USER18> I'd recommend 'Money As Debt' if you're interested in this subject. It's done as a cartoon but makes it really easy to understand why the world works like this and what the big problems are with it.

Namely that if money is created only when you lend it to people, but they have to pay back what you created + interest, there is never enough money to pay all debts back. So bankruptcy is built into the system. It's like musical chairs. It has to happen.

<comment><USER19> Paying back all debt would mean there was no more money! What would that even look like?

It was years since I saw 'Money as Debt' but I remember it as quite flawed in its arguments.

Let's say there's a silly town with a single evil bank. The good people borrow a hundred dollars in total. Horror! The evil bank is now owed one hundred and ten dollars. This can never be repayed, there is not enough money!

Except the good janitor at the bank has his wage of ten dollars credited to his account by the bank for the value created by his labour. He pays the grocer, the landlord and so on and now the silly town people can pay all their loans, should they ever want to.

And then the old grocer dies and his estate defaults on its debts. And it turns out the bank overvalued his house. The banks is now down ten dollars on its loan assets. But the bank still has its liabilities to the other good town people the grocer paid when he took out the loan. Suddenly the town can pay back all their debts and still have ten dollars left owed to them by the bank! The evil bankers are foiled.

'Money as Debt' goes to all this trouble to explain that money is debt. Then we are supposed to be shocked by the fact that debt can be created by no more than signing a paper! It's stupid.

<comment><USER18> Well I, like many people. was very surprised money is created that way. And your fictional town doesn't seem to work much like anywhere else. All the banks seem to be doing fine just fine. Houses usually go up in value not down so when someone defaults on a loan the bank makes money rather than loses it. With the exception of the credit crunch (where we all just gave the banks our hard earned money instead)

<comment><USER19> Yes, it's quite strange at first when you come to this topic with the understanding of money as something more tangible. I really struggled with the concept at first, but there are good resources to help with this. It clicked for me with the help of Khan Academy unit on Money, banking and central banks. The Bank of England paper linked elsewhere in this thread is also good. I had to draw up balance sheets and make examples for myself to really get it.

And regarding the silly example, don't sweat the details. Try to think of the concept of what my example is trying to get across. Let's say the grocer died and a house fire and he hadn't payed for his insurance.

<comment><USER18> Hey thanks for the extra reading.

I understand the example, but surely these are outliers? Banks won't give you a mortgage without insurance, and most people do pay their insurance. So banks can't be taking that much of a hit except under extreme circumstances. Most of the time they do pretty well out of defaults. They just take the house and sell it. They'll only lend to you in the first place if you have reasonable collateral (again 2008 housing crisis is a lesson they learned on that) but they still ultimately got the asset + all the money paid in interest up to that point. Am I missing something?

<comment><USER19> No, you're not missing anything. The point is just that it's not a vice of mathematically assured doom because of the fact that money is debt. Banking can be a really good business and bankers have been really good at lobbying, but that is not what the Money as Debt scare is about.

In the end, debt is a type of relation between people. And banking is a business with its own costs and risks.

</comment></comment></comment></comment></comment></comment><comment><USER20> > If you have an argument why these IOUs should not be considered money, I > would love to hear it. Otherwise, let's conclude that non-bank corporations > can sometimes create money out of thin air.

It comes down to the definition of money. Yes non-financial intermediaries are very similar to banks and "create money" but money is defined as the amounts on bank's balance sheets so by definition non-financial intermediaries cannot create "money", but they are doing something very similar.

Also Nonintermediated debt is probably a better example. If you own a CD from a AAA corporate its effectively money but technically isn't.

<comment><USER11> For my own clarification, are financial instruments "money"? I think common people, like me, have a hard time to distinguish money from cash and cash- equivalents.

A bond from an AAA corporate might not be money, but it's so liquid that it's as good as cash to me. :D

<comment><USER21> They're not. There are actually multiple different definitions of "money" in use, because it's complicated to define exactly what distinguishes money from a financial instrument, but corporate bonds aren't included in any definition I'm aware of.

</comment></comment></comment><comment><USER22> _" There's a lot to unpack here. First, Werner claims that banks are special due to their ability to create money out of thin air. Second, Werner claims that the first claim is proven conclusively with empirical evidence.

Werner's second claim is patently false, because the "evidence" he presents in his paper only describes banks' ability to create money out of thin air — he presents no evidence for non-bank entities' inability to create money out of thin air. Thus, he presents no evidence that banks possess an ability non- banks do not possess. And yet, he claims to have done the opposite."_

This is awful semantic gaming to "prove" that a false claim was made. If the definition of "money" is fuzzy and there are different kinds of money, if "bank IOUs" and "private IOUs" are materially and legally different from one another, then the strongest interpretation of Werner's words must be taken: He is talking about the sets of money that do _not_ include IOUs from random private entities.

Clearly, banks _are_ special in this regard and the amount of bank-created money on the money supply is enormous, whereas the impact of private IOUs is so minor that we can disregard it.

<comment><AUTHOR> It sounds like you are referring to "claim one", not "claim two". I noted in the article that Werner is (only) technically correct on claim 1, essentially due to the reasons you described. Claim two is about presenting empirical evidence for claim one. You might think that empirical evidence is not needed. That's fine. It still was not presented, so claiming to have presented it was a false statement.

<comment><USER22> You ask for empirical evidence that "private entities have the inability to create money out of thin air", but this rests on a definition of "money". You brought up the example of a private IOU (the Poker Site).

If we remove the distinction between private IOUs and bank IOUs, indeed you would have an example of a private entity creating money out of thin air, for a more loose definition of money. However, as we established, removing this distinction is unwarranted, bank IOUs are treated quite differently both legally and materially.

If we _maintain_ the distinction between private IOUs and bank IOUs, then your example becomes simply irrelevant. Any IOUs that may be issued by private entities that are materially and legally different from bank IOUs have no bearing on Werner's claims.

I believe the empirical evidence for private non-bank entities not being able to create bank IOUs is that _they 're not banks_. Am I missing something?

<comment><AUTHOR> > I believe the empirical evidence for private non-bank entities not being > able to create bank IOUs is that they're not banks. Am I missing something?

That's not what "empirical evidence" means. Empirical evidence is something we observe in the world. If we set a definition "all murder is illegal" and then we conclude "legal murders do not exist", do we have "empirical evidence" that legal murders can not exist? Of course not. We can conclude the claim is true by definition. That's not empirical evidence.

> You ask for empirical evidence ...

I never asked for empirical evidence for non-banks' inability to create money out of thin air. Werner claimed to have empirical evidence for this, and I merely pointed out that he does not have empirical evidence for this, contrary to his claim. If Werner had instead said "due to accounting conventions, we declare banks' IOUs to be money and non banks' IOUs to not be money", I wouldn't have any problem with that.

<comment><USER22> > That's not what "empirical evidence" means. Empirical evidence is something > we observe in the world. If we set a definition "all murder is illegal" and > then we conclude "legal murders do not exist", do we have "empirical > evidence" that legal murders can not exist? Of course not.

Hmm, you're right...

> We can conclude the claim is true by definition.

...which means we don't even _need_ any empirical evidence to say that banks are different and unique from non-bank entities!

> I never asked for empirical evidence for non-banks' inability to create > money out of thin air. Werner claimed to have empirical evidence for this.

No, he doesn't. He claims that he has empirical evidence for _banks creating money out of thin air_ , nothing more.

> If Werner had instead said "due to accounting conventions, we declare banks' > IOUs to be money and non banks' IOUs to not be money", I wouldn't have any > problem with that.

Doesn't that go without saying, considering that non-bank IOUs, such as poker website deposits, aren't considered part of the money supply under pretty much any definition?

<comment><AUTHOR> > ...which means we don't even need any empirical evidence to say that banks > are different and unique from non-bank entities!

That's correct, and I said so in the article. I said that (although there is no empirical evidence) the underlying claim is true on a technicality.

>> Werner claimed to have empirical evidence for this.

> No, he doesn't. He claims that he has empirical evidence for banks creating > money out of thin air, nothing more.

Here is a direct quote from Werner's paper: "We now know, based on empirical evidence, why banks are different, indeed unique … and different from both non-bank financial institutions and corporations: it is because they can individually create money out of nothing."

When Werner claims to have empirical evidence that banks possess a unique ability to create money out of nothing, he is technically making 4 claims:

1\. Banks possess said ability

2\. Non-banks do not possess said ability

3\. Empirical evidence shown for claim 1

4\. Empirical evidence shown for claim 2

Claim 4 ("empirical evidence shown for claim 2") is patently false.

<comment><USER22> Again, this is an uncharitable misreading of one sentence of the paper.

This is a more reasonable reading:

Banks are different because they create money out of thin air. That has been generally accepted so far, but where is the _empirical evidence_ for banks creating money out of thin air? It's in the paper. That's the contribution of the paper, to show _empirically_ how new money is created.

We don't need evidence (empirical or otherwise) for non-banks _not_ creating money, because that would be proving a negative.

If you want to attack the strong interpretation of the claim, you would have to show how non-banks _do_ create money, which you didn't, because as we already agreed, deposits at non-bank institutions are not considered money.

I implore you to apply the principle of charity (steelmanning) instead of wasting your time on semantic disputes.

<comment><AUTHOR> Hmmh, I can see how you might take a more charitable interpretation of that claim, and maybe this does fall in the category of semantic disputes.

> we already agreed, deposits at non-bank institutions are not considered > money.

...due to a technicality / accounting conventions. Yes, I conceeded that already in the original revision of the article. Nonetheless, I made a pretty good case why the IOUs created by Full Tilt Poker could be considered money, even though they were created by a non bank institution. Yes, the IOUs created by banks are "more like money", but in my view, the difference is not that large.

</comment></comment></comment></comment></comment></comment></comment></comment><comment><USER23> > The main argument presented here is that banks do not have central bank-like > special powers in relation to money creation; the process in which banks > create money is entirely pedestrian.

I think this is wrong in a subtle way. Regular banks have a reserve requirement that limits their ability to create money. They must hold a certain number of federal reserve notes to meet the reserve requirement. The Federal Reserve can create federal reserve notes.

<comment><USER24> Reserve requirements haven't mattered in US banks for a long time. One way to think about it is that reserve requirements constrain bank behavior, but the optimal strategy for banks would be the same regardless of whether that requirement were removed.

The requirement was removed in the US in March 2020 but has been a formality for most banks for a long time.

[https://www.federalreserve.gov/monetarypolicy/reservereq.htm](https://www.federalreserve.gov/monetarypolicy/reservereq.htm)

<comment><USER25> Right; the hard limitation on money creation is that banks exist in order to earn profits for shareholders, and there is only a finite pool of profitable lending opportunities at any given time. With no reserve requirement a bank could theoretically create unlimited amounts of money but it would eventually go bankrupt as it would take massive losses on bad loans.

<comment><USER26> It's more complicated than that.

Even without laws requiring reserves, banks still want to hold some precautionary reserves to eg settle interbank transfers or to serve cash withdrawal requests.

But those precautionary reserves can be very small without causing much trouble. In Scotland in the 19th century they had about 2% gold reserves and where doing fine.

What's more important are equity cushions to take the blow of losses before the depositors do.

Scottish banks typically had about 30% equity cushions because that's what depositors demanded. (These days laws require about 8%. Depositors don't care much anymore, because government deposit insurance numbs them.)

</comment></comment></comment></comment><comment><USER27> After starting to read this article, I had several random thoughts:

* What makes this author's explanation credible?

* Does anyone actually understand how money works, or are people trying to rationalize what we already have?

* All that really matters (to me) is the value is relatively stable and it doesn't create a crazy imbalance of power.

* Money does an okay job maintaining a stable value for some stuff (e.g. food), but an incredibly lousy job for other stuff (e.g. land).

That got me to thinking about a game I was recently playing and frustration with it's two in-game currencies, neither of which have anything to do with external transactions (such as obtaining DLC). One of those currencies could fluctuate in value based upon supply and demand (actually, how much you were trying to sell). Now that leaves me wondering if the game developers discovered that it was impossible to balance the game with a single currency (i.e. avoid an imbalance of power through the fluctuating value of currency).

In other words, did art avoid emulating reality because the premise of reality is fundamentally flawed?

<comment><USER16> >* Does anyone actually understand how money works, or are people trying to rationalize what we already have?

I would say, no.. considering the divergence of expert opinions. Limited consensus have formed around high profile economists (eg Keynes, Friedman) but generally erodes as history throws up new examples that don't fit neatly into popular theories.

Monetarism is still the working understanding behind most central banking, but japanese staglation and later events (arguably including the current covid economy) have demoted it from "a theory of the truth about money" to "a method of doing central banking."

I do think that since pure fiat currency became the norm in the 70s, our understanding of money has improved. We are forced to conclude that "the truth about money" can only be found in financial systems, because there is nothing else anymore.

It's not really a question academics are trying to answer, atm. One reason is that trying to answer "what is money" is associated with all sorts of ideological quackery with a bad reputation. Another reason is that high prestige economics deals with a more pertinent question: "what should central banks and regulator do."

The economist who answers this question becomes the next JM Keynes or M Friedman. At the least, he becomes a central bank governor. This limits the field of search to stuff a central bank can do. Economic understandings are also generally curbed by what can be measured, and this also limits the field of search.

> * All that really matters (to me) is the value is relatively stable and it > doesn't create a crazy imbalance of power.

> * Money does an okay job maintaining a stable value for some stuff (e.g. > food), but an incredibly lousy job for other stuff (e.g. land).

These are not universally agreed to be products of monetary systems. Stability is, under the current theories used by central banks (mostly monetarism) but the others are explicitly "out of theory."

<comment><USER28> > I would say, no.. considering the divergence of expert opinions.

I would disagree and think it needs more details. There is difference between just 'how money works' and 'how economy works'. The first question 'how money works' is mostly just insitutional and legal knowledge of existing processes of central and commercial banks.

OTOH, 'how economy works' is empirical field of knowledge about complex emergent phenomenon - the economy, and contains questions like how would economy reacts on specific monetary policies. That is what macroeconomic theories like keyensianism and monetarism are about.

<comment><USER16> Keyensianism and monetarism are essentially "how money works."

Microeconomics is "how the economy works," and while there are still divergent opinions, there's stability in that divergence. Ricardo is still foundational when it comes to trade, for example.

The premise of macroeconomics is that how money works is different to that. That started with keynes, and continues through keynesianism. Monetarism literally refers to "a theory of money."

The point is that it _isn 't_ mostly just institutional and legal knowledge of existing processes of central and commercial banks. Those things regulate and affect money, but how it works is macroeconomics.

</comment></comment></comment></comment><comment><USER29> I recommend reading "The creature from Jekyll Island". This book opened my eyes up to the question "what is money?" and it's especially relevant today, given we are living through the largest wealth transfer in human history. But it also talks about how smaller banks work, and this notion of IOUs, credit and loans.

<comment><USER30> From wikipedia, about the author: 'He is an HIV/AIDS denialist, supports the 9/11 Truth movement, and supports a specific John F. Kennedy assassination conspiracy theory.[2] He also believes that the Biblical Noah's Ark is located at the Durupınar site in Turkey.[6]'. I would recommend learning from different sources.

<comment><USER31> I agree. And the book does off into crazy land about the 1/2 through to the end of the book.

BUT I think the first part is actually a pretty good approachable explanation of the Federal Reserve and how our money works.

</comment></comment></comment><comment><USER32> 'Richard Dawkins said in an offhand comment in The Selfish Gene that "Money is a formal token of delayed reciprocal altruism."'

(from: [https://nakamotoinstitute.org/reciprocal-altruism-in-the- the...](https://nakamotoinstitute.org/reciprocal-altruism-in-the-theory-of- money/))

I was just thinking about the immutability debate in the Ethereum blockchain world, where the community split due to a difference of opinion/interests on whether their system of money should allow a transaction reversal due to unintended effects of a certain contracts code on the state of the system ([https://en.wikipedia.org/wiki/The_DAO_(organization)](https://en.wikipedia.org/wiki/The_DAO_\(organization\))).

Those who were in the "code is law"/"immutability despite errors/malicious behavior" faction insisted that no change should take place, resulting in the loss of money/decreased action (state change) potential for the original holders affected by the unintended state change.

The more popular/valuable (by market cap) system of money (ETH) was the one where this change took place, though this was a one-time event. The state of the system was since not adjusted to reverse effects of hacks, accidental transfers/state changes of smaller impact (still millions of dollars equivalent).

Reversible systems need adjudicators which determine if a reversal should take place, and since this is a complex, subjective consensus issue, they pretty much must be humans, resulting in unpredictable and possibly unstable sociopolitical processes.

Fiat money derives its value through its utility (widespread acceptance in the exchange for goods) and its contractual enforcement ability provided by a states monopoly on violence (resulting in working contract law) and as the primary means of paying taxes.

An (unbacked) IOU has less value than central bank (digital or cash) money, because whether it results in delayed reciprocity is more uncertain (credit default risk, bank runs). In the same way, more irreversible money/settlement systems (like cash [https://en.wikipedia.org/wiki/Real- time_gross_settlement](https://en.wikipedia.org/wiki/Real- time_gross_settlement)) carry less of this type of uncertainty and risk but more of others (legal, last resort to violence to enforce state/or even consenus change, large losses due to mistakes).

<comment><USER33> Ethereum and Defi products are now creating money as well through lending.

Lock some amount of ETH up, get some amount of stable dollars out, which inflates the total amount of money in the system.

</comment></comment><comment><USER34> _> Suppose you have $100 in cash..._

Now if you realize that that $100 is a mere IOU from the U.S. of A. you may get a feeling you are onto something...

<comment><USER35> IOU for what?

<comment><USER34> For your goods, services... The U.S. of A. is a debt hub. Banks are also debt hubs but on a smaller scale and dependent on their sovereign.

<comment><AUTHOR> This sounds more like am argument for USD's utility/value. That doesn't make it an IOU.

</comment></comment></comment></comment><comment> globular-toast There's an organisation in the UK called Positive Money which has a lot of great information about this. See, for example: [https://www.youtube.com/watch?v=Rd9Pf3Bqp20](https://www.youtube.com/watch?v=Rd9Pf3Bqp20) They also have a series explaining how banking works: [https://www.youtube.com/playlist?list=PLyl80QTKi0gPBcb32paMv...](https://www.youtube.com/playlist?list=PLyl80QTKi0gPBcb32paMvXxcq7UUeJskV) This is one of those things where learning it completely changed the way I saw the world.

</comment><comment><USER36> But the bank hasn't made any money?! It just wants back "more" than it "gave". Am I missing something? The one who is forced to "create" the money is the one who has to pay back the 1$ extra in interests (which previously did not exist). But he is not allowed to create any! So he has to create anything of value and sell that for money, so he can pay back the money and the interest. But that just moves it to the next poor fellow.

Doesn't this create a feedback loop?

<comment><AUTHOR> > But the bank hasn't made any money?! It just wants back "more" than it > "gave". Am I missing something?

Let's take the example where the bank loans out $10 and wants back $11. The money created in this example is not $1 (when the loan is eventually paid back and the bank makes $1 profit), it's $10 (when the loan is initially given out).

Let's imagine that the bank does not want to make a profit and only wants back $10. Even in this example the bank is creating $10. If you sum up how much money everybody has, people have $10 more money the moment the loan is given out.

</comment></comment><comment><USER37> I've done extremely well obtaining goods and services by operating under my unpopular perceptions of the world, including how banks make money and the purpose of money and currency. My unpopular perceptions have consensus with the people that matter (banks, lawyers, accountants, regulators, courts) but they just won't get very far on web forums if you try to tell people something that doesn't match their understanding.

The primary cognitive dissonance with other people comes from tying morality to prosperity. Or put simply "some people deserve money and when that criteria is not satisfied it is controversial", but what they _really_ mean is that "someone should have the ability to have goods and services more than others", with the money itself only being a reductive surrogate to make that happen.

The further you abstract yourself away from that, the easier it becomes to operate and see opportunities, or how to exchange time for more food and shelter in a more efficient way. How to have enough resources that the money itself looses additional utility, no different than how an abundance of oxygen looses its utility while a known upcoming absence of oxygen will redirect all of your thoughts and resources into making sure that doesn't happen.

Yes, it should not be a mystery how banks can create money.

<comment><USER38> Would love to know more about your unpopular opinions. Too many people think the same way about money.

<comment><USER37> Some of my currently unpopular opinions:

The universe of investible assets available for the central banks are small, they need your help in providing a service to them in the primary market (credit markets, corporate bonds). Direct issuances were always going to happen, if it wasn't the pandemic it would have been something else. Anything that slowed down China's growth would have resulted in the same outcome. There is no transparency in direct issuances, you just need to appear or structure your offering as credit worthy. There are no consequences. Some people are ready for this specific outcome, if you think you can steward money better (or just want a lot of it for whatever reason), you should structure an offering for this.

Central Bank direct and primary market operations are going to continue as their universe of investible assets is small, their monetary policy is not able to achieve the behaviors of market participants that they want as it requires associated fiscal policy changes from legislature and results. Central bank's stated goals for their monetary policy is disingenuous as they do not care about inflation targets or GDP numbers, but they do factor them in. They are just tools to alter and manage the yield curve as they just buy bonds from their friends at a profit.

Yield curve based monetary policy doesn't work to its stated goals due to a fundamental misunderstanding of what people want. Dropping yield curves don't cause as much growth in the real economy because people just don't want to give random entrepreneurs their money. People are willing to pay to not do that. Negative interest rates are therefore not controversial and can go much steeper than any central bank has experimented with. People would be willing to pay to keep their money.

Fed and Central Bank balance sheets should not be seen as a threat or overhang to the markets, as it doesn't need to sell credit assets, it just holds them to maturity. It and other sovereign wealth funds have an infinite time horizon.

Conspiracies about central banks and their ownership structure are irrelevant. Orphaned entities like trusts are common structures. There is a lack of transparency in some areas either way.

Don't just pay attention to the Fed, ECB and BOJ. There are plenty of Central Banks on the periphery of the EU who must react and expand their universe of investible assets before or after the ECB/Fed.

In smaller markets you can have a lot of influence as an individual. As in, you can get the ear of a regulator or the upper echelon, or even the stewards of a central bank, just by having a good idea and understanding their needs, interests and psychology. Compared to attempting to earn a pedigree you weren't born into.

The Swiss National Bank is amazing for Swiss people, but it should probably be considered a national security threat to the US markets. Since it is not, it is more likely that the SNB is part of a coordinated stock market growth arrangement with the US, as their stock purchases of individual companies with newly created CHF is not something the Fed is authorized to do, yet.

I wish more central banks were publicly traded like the SNB.

Liquidity of the currency shows the tolerance of distribution. Think of inflation like corporate stock dilution, if the market is liquid then you can create more without undermining confidence in that market. Think of government currency like shares of a country/economic union. People are uncomfortable with the idea of analogies that show the similarities between private organizations and states formed to serve the people.

Hyperinflation is not as big of a threat when all major currencies are doing it at the same time. Coordinated inflation masks hyperinflation of any individual currency as their value relative to each other stays similar while the supply of all of them is increasing. The price of individual consumptive goods can still increase dramatically, but the price of the currency and confidence in the currency is not shaken, so the credit markets remain resilient. Countries outside of the economic union who have freely adopted the currency have much bigger issues to reconcile.

Market signals are missing in the real estate market. A few hundred thousand playing with historically low interest debt (due to central bank activity) is a distraction, real estate agents and mortgage underwriters getting "so much business" should not be trusted, indeed this is all they see. Several million people defaulting is a bigger and looming issue.

<comment><USER4> This is good stuff. I see negative rates as the "stability tax", which is why the leader is Switzerland. As you say, the real work has to be done in fiscal policy.

<comment><USER37> Denmark and Poland and Sweden also have a Central Bank and unique distortions in the credit markets. Very few people pay attention to them, getting information is tricky. The nordic credit market is its own animal centered in Norway, but all the countries want business. They are trapped because the Eurozone is a behemoth and the yield curve distortions there are like a gravity well, and the cultural sentiment of speculators or general people is the same or has the same inputs, so they must go steeper in negative yields faster or expand their universe of investible assets faster.

Pay attention to the corporate credit market. The steeper the yield curve goes, the more it drags down the cost of credit for corporate issuers. Getting aggregate corporate credit information in these markets is hard but rewarding, you can predict what to expect - investment grade corporations bonds yielding 0% possibly issued at 0% - but it is hard to confirm the market appetite. This is where we are right now in market efficiency.

</comment></comment></comment></comment></comment><comment><USER39> Fun fact: Bank of England bank notes, denominated in £ sterling, still have printed on them:

"I promise to pay the bearer on demand the sum of <value> pounds"

Signed by the Chief Cashier of the BoE

<comment><USER40> The UK is like that, banks have their own notes, still.

<comment><USER4> The BoE ones are the "real" government-issued ones. The interesting ones are the genuinely private ones by the Scottish and Northern Irish banks. Including my favourite ever, the Northern Bank portrait-format space shuttle: [http://www.polymernotes.com/northireland.html](http://www.polymernotes.com/northireland.html)

The current legal basis is the Banknotes (Scotland) Act 1845: [https://www.scotbanks.org.uk/history/banknote- history.html](https://www.scotbanks.org.uk/history/banknote-history.html)

<comment><USER41> Of course, in 2004 Northern Bank was acquired by Denmark-based Danske Group. So now, you have Northern Irish banknotes, which are UK pounds (GBP), with Dankse Bank written on them!

[https://danskebank.co.uk/about-us/bank-notes/ten-pound- note](https://danskebank.co.uk/about-us/bank-notes/ten-pound-note)

</comment></comment></comment></comment><comment><USER42> There is a fantastic book that covers this topic called "The End of Alchemy" by Mervyn King who was Governor of the Bank of England during the 2007 crisis: [https://www.goodreads.com/book/show/30231791-the-end-of- alch...](https://www.goodreads.com/book/show/30231791-the-end-of-alchemy)

It explains how banks work today in a patient and and accessible way that helps you really "get" it.

</comment><comment><USER30> In the first example, is it possible to repay all the debt? The bank has $100 cash and $11 promised. Customers have $10 cash and $100 promised. Assuming the person with $100 withdraws the money and wants to share it with the other person to pay off his loan, they end up with $99, but they started with $100. If they started at $0 they would be at -$1. How is this resolved in a real banking system?

<comment><USER43> The customers started with $100 and the bank started with $0. By the end, the customers have between them paid the bank $1 for their services.

</comment></comment><comment><USER44> Personal finance podcast clued me into this at some point.

Every time a loan is used to pay for goods or services, some fraction of that goes back to "the bank" where 90% of it can be loaned out again. Best case, where all money is moved electronically and instantly, I keep seeing that 100 dollars go out and come back a little smaller over and over and over again. The tenth time I see it I can write a loan for about $30.

<comment><USER45> The language used to describe fractional reserve is pretty misleading. Banks don't increase the total supply of money, all fraction reserve does is keep more of it in circulation. If a bank takes a $1,000,000 deposit one customer, and lends $850,000 of it to other customers, there isn't $1,850,000 worth of money all of a sudden. There is $850,000 worth of debt held by customers, and another customer with a $1,000,000 balance, which on the banks books will be represented by $150,000 or cash reserves and that $850,000 of debt.

The thing that seems to confuse people is the abstraction mechanism by which the $1,000,000 depositor doesn't see any of the $850,000 debt, and the by which they can withdraw the $1,000,000 without being involved in any debt transactions themselves. Fractional reserve banking doesn't create money out of thin air, it's just a system that allows for deposits to be put to productive use. The alternative is that deposits are entirely withdraw from the economy completely until the depositor wants to use them, which would be the economic equivalent of hoarding all your money under the mattress.

The rest of it also doesn't really "go to the bank", it's money that they must have on hand to service withdrawals, and absorb defaults and other losses.

<comment><USER46> So the depositor put $1,000,000 in the bank and the bank loans $850,000 to a small business so it can buy more inventory. The small business goes to the widget manufacturer and writes a check which the manufacturer deposits into the bank. So now the bank has 1,850,000 in deposits and 850,000 in loans.

The bank takes the new deposits and loans out 85% of it ($723k) to another small business. This small business goes and uses it to pay its employees and they all deposit the money in the bank. Now the bank has $2.573m in deposits.

The employees and the manufacturer can all withdraw the money at any time. So I struggle to see how this isn't creating money.

The fractional reserve system lets the bank loan the same dollar out multiple times. How isn't this creating dollars? If the bank takes one dollar and loans 85 cents to you and 73 cents to me, isn't there more money?

<comment><USER45> Because doing it one time, or 10 times, or 1,000 times doesn't change anything about how it works. If everybody pays all their debts, it all adds back up to $1,000,000 in cash (plus interest for the bank(s)).

<comment><USER46> No it doesn't. In my example the bank loaned out $850k to the first small business and $723k to the second. That's $1,573,000. The bank started with $1million.

It absolutely matters how many times the dollars come back to the bank because that is the pathway that lets the bank loan the same original dollar out multiple times.

<comment><USER45> I think you're forgetting the bit where the business that took the $850,000 loan is left with $850,000 debt and $0 balance after they spend all of it. Every time it passes through the system the amount recirculated simply decreases by the reserve %. It all still adds up to the original amount (plus interest).

In your example though, the bank has a different problem of offering unsecured loans, which could lead to some losses for them.

</comment></comment></comment></comment></comment></comment><comment><USER47> Excellent article.

Yesterday, I read about the role of banks, I found two quotes:

"Banking was conceived in iniquity and was born in sin. The Bankers own the earth. Take it away from them, but leave them the power to create deposits, and with the flick of the pen they will create enough deposits to buy it back again. However, take it away from them, and all the great fortunes like mine will disappear and they ought to disappear, for this would be a happier and better world to live in. But, if you wish to remain the slaves of Bankers and pay the cost of your own slavery, let them continue to create deposits." [1]

"Give me control of a nation's money and I care not who makes the laws." [2]

[1] [http://libertytree.ca/quotes/Josiah.Stamp.Quote.69BB](http://libertytree.ca/quotes/Josiah.Stamp.Quote.69BB) [2] [http://libertytree.ca/quotes/Mayer.Amschel.Rothschild.Quote....](http://libertytree.ca/quotes/Mayer.Amschel.Rothschild.Quote.8BED)

</comment><comment><USER25> Money is defined as a commonly accepted medium of exchange. Yes, anyone can create IOUs which satisfy the abstract idealization of money as a "numeraire", but if these IOUs are not commonly accepted for commercial transactions then they aren't money. This is an empirical definition, which is perhaps less useful for theoretical arguments.

Banks which participate in a central banking scheme (such as the Federal Reserve System) have a license to create IOUs which are authenticated by the government which sponsors that central bank. In other words, such banks can create IOUs that are backed by the full trust and credit of the government, not merely their own trust and credit as a business enterprise. I'm not sure I would characterize this as "impressive", but it is most certainly a privileged and unique position over the rest of us.

</comment><comment><USER48> Alice is a customer of ABank Bob is a customer of BBank.

Alice asks ABank for a $100 loan at 10% interest to buy some fidgets from Bob Bob asks BBank a $100 at 10% interest to buy some doodads from Alice

ABank creates a $100 credit line for Alice, and creates an asset of $110 future revenue payments. BBank creates a $100 credit line for Bob, and creates an asset of $110 future revenue payments.

Bob and Alice make their deals each paying with their respective debit cards.

ABank and BBank settle their transactions with a net 0 transfer.

Alice and Bob both repay $100 to their outstanding loan.

Both ABank and BBank now own $10 in future revenue from Alice and Bob respectively. You can argue that 'technically' ABank and BBank didn't 'create' the money, they _merely_ created the legally backed first row claim to that money that will be created.

</comment><comment><USER49> In my humble opinion, the article is too complex and the topic at hand could be explained in an easier way:

-banks can create money when they issue a loan, because, if all things go well, the created money will create wealth.

-banks cannot create money when they return money to depositors, if they don't have that money, because if they did the created money would not correspond to created wealth.

I.e. fractional reserve banking exists because what can be created with money, i.e. the actual wealth, can come after money is created, and not before: first money is created out of thin air, then that is used to pay people, which create wealth. The old system with the gold standard was limited because it depended on the amount of gold that existed.

<comment><USER50> No. Money creation through fractional banking is neither directly related to, nor dependent on, wealth creation.

</comment></comment><comment><USER51> There's another paper by Richard W that I happened to read yesterday which seems to contradict this article and is not refuted or addressed in it, basically that a combination of accouting practices and "client money rules" distinguish bank loans from "random IOUs", basically anyone can issue an IOU but anyone other than a bank has to draw down their accounting assets when they disburse it, and undisbursed IOUs are not spendable.

[https://www.sciencedirect.com/science/article/pii/S105752191...](https://www.sciencedirect.com/science/article/pii/S1057521914001434)

<comment><USER52> I think what the author would take issue with is this notion of "has to." His point is that non-bank corporations can empirically create money (ie people will treat the IOUs as money), even if they may not be legally permitted to do so.

<comment><USER51> I think it's splitting a very meaningless hair in a way that's totally misleading to say that "anyone can create money", when you mean "anyone can theoretically create money, they'll just land in jail fairly quickly"

It's like saying that nation-states don't have a monopoly of force, because I can shoot my neighbour, or that I support abortion but I think you should be jailed afterwards.

Only banks can create money without getting locked up in jail.

That's the important point, and this article adds or takes nothing, other than a very weird dodge with the justification that somehow legality isn't a primary consideration.

It's as interesting as saying you don't have to pay your taxes, (small print: because you can choose to go to jail instead).

</comment></comment></comment><comment><USER53> US dollar is the national currency of Ecuador [https://en.wikipedia.org/wiki/Currency_of_Ecuador](https://en.wikipedia.org/wiki/Currency_of_Ecuador)

OPEC sells Oil exclusively in US dollars [https://en.wikipedia.org/wiki/Petrocurrency](https://en.wikipedia.org/wiki/Petrocurrency)

</comment><comment><USER54> In general this is a half decent way of explaining how fractional reserve banking is presented in econ 101 text books. This is very different to how commercial banks operate in the real world. Reading the piece however is a reasonable exercise for people to understand how a bank may not retain the same amount of liquidity as their deposits may demand.

</comment><comment><USER53> As of August 5, 2020, there was $1.95 trillion worth of Federal Reserve notes in circulation [https://www.federalreserve.gov/faqs/currency_12773.htm](https://www.federalreserve.gov/faqs/currency_12773.htm)

</comment><comment><USER55> This article misrepresents just how much of the economy it's made up of these IOUs. If you deposit $100 and there's a 10% reserve requirement, that doesn't mean the bank can loan out $90. Rather, they can loan out $1000 since the $100 is 10% of that.

<comment><AUTHOR> The article did not make any claims about how much the money supply can expand within a specific regulatory environment (such as the 10% reserve requirement you mentioned). I felt like that was outside the scope and would not be possible to present with a simple example.

</comment></comment><comment><USER56> The way I like to explain this is to start from an intensional definition of money as "something that has no value by itself but can be potentially exchanged for something of that value". And total amount of money in economy is the total amount of these things at a given point in time.

So when somebody creates an IOU trusted enough so it could be resold, they have effectively created "money" according to the above definition, because now that IOU can be traded _independently_ of the thing it was originally exchanged for.

I think what confuses lot of people about this is that creation of money is a 3-sided transaction, and we are conditioned to think of a market economy as a sequences of 2-sided transactions.

Also, what I find very funny, some libertarians want to impose government to only create money backed by a commodity, like a gold standard. Yet their fundamental axiom is to allow any two parties to enter (almost) any contract, in particular, allow them to create and resell IOUs. However, if the government has to enforce any contract that two parties can come up with, this is already giving too much freedom for the money to be created regardless of the actual commodities in existence, and regardless what the government does.

<comment><USER57> To me, commodity money (gold/silver) is only required when the trust in the gov't enforcement of money creation doesn't exist.

and this isn't the case (yet) with the USA - despite the rampant increase in money supply. Unlike other hyper-inflating economies such as Venezuela, the USA gov't isn't printing money to meet it's obligations, but instead turning illiquid assets (such as bonds and treasuries) into liquid assets (cash), that can then be used to grease more commerce and transactions. I don't believe this can cause hyper-inflation that many fear (and thus turn to buy gold/commodities), because the money is backed by debt, which has to still be paid pack.

</comment></comment><comment><USER58> I found this video very informative - an effective eli5 about how the economy works with an emphasis on debt: [https://m.youtube.com/watch?v=PHe0bXAIuk0](https://m.youtube.com/watch?v=PHe0bXAIuk0)

</comment><comment><USER59> The modern banking system does not use fractional reserve lending.

Highly recommend this video to understand and this channel in general: [https://youtu.be/K3lP3BhvnSo](https://youtu.be/K3lP3BhvnSo)

Skip to 1:14.

</comment><comment><USER60> Every time you use your credit card you create money as instead of pulling $20 out of your pocket you still have it to spend.

Of course you sterilize (cancel out) that creation when you pay the credit card bill.

<comment><USER61> When you use your credit card, the bank fronts your spending out of their cash reserves - no new money is created.

<comment><USER60> Though they were obtained at the discount window, as they are not circulating they have no impact on the functional money supply until you use them...at which point you still have that $20.

But I am engaging in some hair splitting, I admit.

</comment></comment></comment><comment><USER62> This is a video of Richard Werner (an economist the article refers to) in action:

[https://www.youtube.com/watch?v=EC0G7pY4wRE](https://www.youtube.com/watch?v=EC0G7pY4wRE)

</comment><comment><USER63> Is this the US way of defining assets & liabilities?

In india, all deposits are considered liabilities (since you need to pay the customer interest on it).

All loans are considered assets (since you make money on them)

<comment><USER64> TFA says the same. Rather what's considered assets are the book value of the loan and the cash the bank actually has on hand.

<comment><USER63> Cash at hand is generally also not considered an asset. Because you're paying interest on it.

It's usually raised using deposits. Unless I'm missing something

</comment></comment></comment><comment><USER53> The devil is in details [https://en.wikipedia.org/wiki/Money_supply](https://en.wikipedia.org/wiki/Money_supply)

</comment><comment><USER65> What... An... Awesome... BLOG! We need more of those!!!!!

</comment><comment><USER66> Would the same principle work for non national currency ? I am thinking specifically of Bitcoin.

Say a bank would accept deposit and issue loan in Bitcoin. We apply the same example as in the article. Someone deposit 100BTC. Another person takes a loan of 10BTC and owns the bank 11BTC. (that would be much bigger value than $100, but the principle is the same)

Would the total number of Bitcoin be higher than before those transactions ? That would break the hard limit on the total number of Bitcoin. My understanding was that hard limit was a key feature of Bitcoin.

<comment><USER67> As the article said, deposits are just IOUs. You can definitively have IOUs denominated in BTC.

The number of Bitcoins in the ledger/blockchain would not increase, but if you asked everyone how many Bitcoins they owned and summed it all, it would have increased.

To use the standard terms, the hard limit on the number of BTC in the ledger/blockchain is M1. You can have an increase in M2/M3 without an increase in M1.

</comment></comment><comment><USER68> "There are two ways to conquer and enslave a nation. One is by the sword. The other is by debt."

Debt created by a bank through a loan can never _truly_ be repaid. The debt is just passed on to another place in society, and the society as a whole remains forever indebted to the bank. Sinister in its very essence and a form of true evil.

</comment><comment><USER20> These descriptions are way too complicated.

If I have a check account with $0 balance and you have the same we have no money. If I write a check for $100 and you deposit it suddenly you have money - created from thin air.

</comment><comment><USER69> > These facts support the main argument of this article: that banks do not > have any special powers in relation to money creation.

Nothing in this blog post comes even close to supporting the idea that banks have no special money creating power.

The hidden assumption is that this "iou power" is not regulated or enforced by government control over the money supply.

That you can write a cheque and then not cash it, and that a poker site can commit fraud, do not make banks unspecial.

This is just a libertarian is/aught fallacy dressed up in a lot of words.

<comment><AUTHOR> We could quibble about the definition of "special power" all day. Sure, a bank is in a better position to create money than a poker site. And a poker site is in a better position than an individual person. But these are not fundamental differences, these are differences of degree. Fundamental difference is having a literal money printer, versus not having one (central bank's ability vs regular bank). When you issue IOUs with the backing of a literal money printer (as a central bank), those IOUs are fundamentally different from the IOUs issued by me/poker site/bank.

<comment><USER26> Well, legal barriers aside, Amazon could print their own currency and be in the same position as the Fed.

Though to make it absolutely the same position, Amazon's currency should not be tied to the dollar but freely floating.

Then there can be no run on Amazon's currency, just like there can be no run on the dollar. However, of course, both Amazon's currency and the dollar can lose in value compared to goods and services or other currencies.

<comment><USER51> "legal barriers aside" is insane, legal barriers aside I'm off to rob a bank. There's only really two or three things that could possibly make banks different: the law, de facto capital requirements to enter the market and hidden knowledge, and you can normally buy hidden knowledge so the thing distinguishing banks from anyone else is either the law or money, and it's mostly the law.

<comment><USER26> > "legal barriers aside" is insane, legal barriers aside I'm off to rob a > bank.

Well, that's not just a legal barrier there, but also that the people on the other side of that transaction don't like to be robbed.

People deal in currency blackmarkets all the time, and all participants are willing. Obviously, being able to do business out in the open is much more efficient and productive. And especially eg Amazon as an above board organisation could not engage in blackmarket operations without endangering their legal activities.

</comment></comment></comment></comment></comment><comment><USER70> This article makes no sense? There is a fundamental difference between issuing a random "IOU" (like anyone can do) and an "IOU" which is universally accepted as payment (ie money - which banks do).

I'm sure I could issue a OMGPWNIOU, but difference is, that no one will accept it as payment.

<comment><AUTHOR> It's not black and white like some IOUs are accepted everywhere and some IOUs are accepted nowhere. For example, USD is not accepted as payment in Finland, where I live. In the article I gave a concrete example of non-bank IOUs which were effectively money. If you have an argument why the Full Tilt Poker IOUs should not be considered money, let me hear it.

<comment><USER54> Full Tilt Poker didn't operate like a bank from what you described as they "had slowly siphoned off almost all player funds over the course of multiple years, leaving only a small fraction in reserve".

In this case they were like a _Ponzi Scheme_ and not like a fractional reserve bank as they had _no assets_ to redeem the claims of their depositors with.

Pokerstars (from what you've described) was operating in a manner similar to a fractional reserve bank.

<comment><AUTHOR> Pokerstars was not operating like a fractional reserve bank, because it had segregated player funds to separate bank accounts. As in, it didn't have a "fraction" of reserves for the money players saw in their accounts, it had "full" reserves. It didn't have to go out and sell illiquid assets in order to pay players. It already had the money at hand.

If you want to characterize Full Tilt Poker's operation as a ponzi scheme, I have no problem with that. Full Tilt Poker was operating as a fractional reserve bank, and in addition to this it was siphoning assets of the bank to its owners.

</comment></comment></comment></comment><comment><USER71> >> A bank loan is merely an exchange of 2 IOUs

Wow. This is a flat out lie. Banks operate on a fractional reserve system and they are allowed to loan out more money than they have. It's not just about swapping an IOU between a depositor and a borrower. With the recent COVID-19 regulations, banks don't need any reserves at all anymore. The Fed had been constantly lowering the reserve requirement over the years, effectively causing an infinite but controlled supply of money to enter the economy with financial firms being the biggest beneficiaries.

<comment><AUTHOR> The "money" created by the bank in the process of loaning money _is_ an IOU, so all this stuff that you talked about does not invalidate the description that "taking a loan is an exchange of 2 IOUs". If you disagree with something in the article, please be more specific what you disagree with.</comment></comment>