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Money is Debt

Printing banknotes or coining money is an industrial activity carried over by manufacturers that have been instructed to do so by Governments or Central Banks. But, with the term ‘printing money’, it is usually meant ‘introducing new money in the market’. This obviously includes the physical printing of banknotes but it is not limited to it.

For centuries, this decision to issue new money was linked to the availability of gold (or silver), because money was made of it or was convertible to it. After Bretton Woods Agreement in 1944 and President Nixon decision not to convert US dollars in gold in 1971, money issuance is not linked to the existence of a gold reserve anymore. The reality is that Governments or Central Banks will generate money like this: out of thin air! They are very careful in doing so, though, because it can generate inflation: as for any other good, for the law of supply and demand, the abundance of it decreases its value. So the generation only requires the decision and no other pre-requisite.
More importantly, Governments and Central Banks are not the only ones that can generate money; any bank will do so by lending money: this is what happens, for example, with credit cards. A credit card is actually a  credit line – i.e. a form of debt – but it gives the same service that money gives.
Returning to a more traditional form of lending, in most Western economies, the practice of Fractional Reserve allows a commercial bank to lend much more money than what it holds in its deposits. If I deposit 100$ in my bank account, my bank will keep some of it as a fractional reserve (should I want to withdraw it) – say 10$. It will lend the other 90$ to another customer – let’s call him Peter, who will sign a loan agreement with the bank. When Peter spends the 90$, the recipient – let’s call him John – will see his account credited – let’s assume it’s the same bank – with $90. At this point in time, my bank statement will show a balance of 100$ and John’s will show a balance of 90$. This process can continue: out the 90$ John has in his account, 9$ will be kept by the bank as a reserve and 81$ will be lent again. It can be calculated that, out my initial 100$, the bank will be able to generate an additional 900$! The fractional reserve percentage (10% in the example) determines how much money can be generated through the mechanism: if it is very low (it could be zero!), the amount of money can grow indefinitely!
As of today, commercial and retail bank generate more money than the Governments and Central Banks. For example, in December 2010 in the U.S., out of the $8853.4 billion in broad money supply, only $915.7 billion (about 10%) consisted of physical coins and paper money.
Now, there is an important point not to be missed: in the above example, only $100 are “real” money (being paper money deposited), the rest is somehow “virtual” because it has been generated by debt. This means that at least 90% of the money circulating is debt. If we now imagine Central Banks issuing billions, most of the time this means crediting commercial banks or other financial institutions accounts: just an electronic record!
Moreover, bear in mind that this money is not given: it’s lent; so it’s debt again!
Either through the credit card lens or through the fractional reserve mechanism, it becomes impossible to distinguish money from debt!

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{ 6 comments… add one }
  • Pascal Inard 14-Oct-2013, 11:09

    Interesting perspective on what money really is and how we view debt – some religions prohibit it, politicians in Australia like to sell the idea of “surplus”… Looks like a reality check is needed and not everyone will like it!

  • Moiz Mehmood 15-Oct-2013, 14:25

    The money created through fractional banking goes out of existence when the loans are paid back. What would happen to an economy if everyone stopped borrowing and started paying back all loans? Would there be serious deflation?

    • ArmandoGherardi 15-Oct-2013, 15:39

      If every loan was paid back, there wouldn’t be enough money to run the economy: much worse than some deflation!
      But this is just theoretical because it would require everybody withdrawing the money from their bank accounts (these are loans as well: you’re lending to the bank!) and all the deposits at the Reserve or Central Bank as well (this one only is deadly!). Only paper money and coins would be left….

  • Robert 15-Oct-2013, 20:50

    A good read. Thank’s for sharing! What do you think of bit coins or equivalent, i.e. the emergence of new digital ‘currencies’ ?

    • ArmandoGherardi 16-Oct-2013, 09:47

      Bitcoins and other surrogate currencies are a very interesting phenomenon.
      I’m gathering information and making some research: it deserves me making a post specific to that….