
Banks create money, but it's less impressive than it sounds - baobabKoodaa
https://www.attejuvonen.fi/money-out-of-thin-air/
======
mehrdadn
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).

~~~
baobabKoodaa
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).

~~~
roenxi
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.

~~~
pjc50
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.

~~~
SilasX
>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)

------
aronpye
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.

~~~
golergka
> 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.

~~~
aronpye
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.

~~~
squiggleblaz
>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.

~~~
alasdair_
> 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.

------
athrun
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)

~~~
anticristi
Thanks for sharing!

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

------
riffraff
> 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)

~~~
kgwgk
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?

~~~
dwd
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)

~~~
kgwgk
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

~~~
dwd
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)

------
H8crilA
> _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.

~~~
baobabKoodaa
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)

~~~
H8crilA
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)

------
dalbasal
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.

------
csomar
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.

------
jonplackett
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.

~~~
rags2riches
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.

~~~
jonplackett
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)

~~~
rags2riches
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.

~~~
jonplackett
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?

~~~
rags2riches
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.

------
x87678r
> 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.

~~~
anticristi
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

~~~
SpicyLemonZest
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.

------
gridlockd
_" 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.

~~~
baobabKoodaa
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.

~~~
gridlockd
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?

~~~
baobabKoodaa
> 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.

~~~
gridlockd
> 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?

~~~
baobabKoodaa
> ...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.

~~~
gridlockd
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.

~~~
baobabKoodaa
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.

------
marcell
> 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.

~~~
mgraczyk
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)

~~~
jkhdigital
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.

~~~
eru
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.)

------
II2II
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?

~~~
dalbasal
>* 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."

~~~
zajio1am
> 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.

~~~
dalbasal
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.

------
justinzollars
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.

~~~
FinanceAnon
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.

~~~
bproven
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.

------
7373737373
'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).

~~~
Zamicol
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.

------
omazurov
_> 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...

~~~
patrickthebold
IOU for what?

~~~
omazurov
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.

~~~
baobabKoodaa
This sounds more like am argument for USD's utility/value. That doesn't make
it an IOU.

------
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.

------
danybittel
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?

~~~
baobabKoodaa
> 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.

------
vmception
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.

~~~
sethjgore
Would love to know more about your unpopular opinions. Too many people think
the same way about money.

~~~
vmception
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.

~~~
pjc50
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.

~~~
vmception
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.

------
nly
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

~~~
jacobush
The UK is like that, banks have their own notes, still.

~~~
pjc50
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)

~~~
phaemon
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)

------
habosa
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.

------
FinanceAnon
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?

~~~
andrewaylett
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.

------
hinkley
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.

~~~
AmericanChopper
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.

~~~
whyhow
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?

~~~
AmericanChopper
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)).

~~~
whyhow
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.

~~~
AmericanChopper
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.

------
MrXOR
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)

------
jkhdigital
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.

------
PeterStuer
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.

------
axilmar
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.

~~~
adwn
No. Money creation through fractional banking is neither directly related to,
nor dependent on, wealth creation.

------
zimablue
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)

~~~
amgreg
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.

~~~
zimablue
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).

------
known
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)

------
nstj
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.

------
known
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)

------
scottmsul
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.

~~~
baobabKoodaa
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.

------
asgard1024
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.

~~~
chii
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.

------
ipython
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)

------
italicbold
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.

------
gumby
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.

~~~
count
When you use your credit card, the bank fronts your spending out of their cash
reserves - no new money is created.

~~~
gumby
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.

------
pan69
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)

------
sandGorgon
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)

~~~
bobthepanda
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.

~~~
sandGorgon
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

------
known
The devil is in details
[https://en.wikipedia.org/wiki/Money_supply](https://en.wikipedia.org/wiki/Money_supply)

------
axegon_
What... An... Awesome... BLOG! We need more of those!!!!!

------
UmbraeImperator
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.

~~~
icebraining
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.

------
daneel_w
"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.

------
x87678r
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.

------
stormbrew
> 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.

~~~
baobabKoodaa
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.

~~~
eru
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.

~~~
zimablue
"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.

~~~
eru
> "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.

------
synnejye
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.

~~~
baobabKoodaa
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.

~~~
nstj
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.

~~~
baobabKoodaa
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.

------
cryptica
>> 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.

~~~
baobabKoodaa
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.

