Everybody Should Read This Paper About Where Money Really Comes From

Earlier I wrote about how more and more people are calling for a ban on banking, and how that's not quite as crazy sounding as it seems.

Under their vision, there would still be entities called banks. But they'd have a radically scaled back function. They would primarily serve as places that process payments and hold deposits, but they would be stripped of their most pivotal function, which is creating money.

This is a point that's presumably missed by most of the population. You look at money and you think it's something created by the government. In fact, money is for the most part created by the banking sector.

In March, the Bank of England published an excellent, very clear paper titled Money Creation In The Modern Economy.

It explains how, contrary to what people might think, a bank doesn't make loans, by taking the deposits of a client and then lending those deposits out. Instead, the bank creates money out of thin air. If you want to get a mortgage for a house, and the bank deems you to be credit-worthy, at puts the amount of money you need into an account. That money in your account becomes a liability for the bank. And the mortgage it now owns is an asset of the bank.

These two images from the Bank of England report spell out nicely how it works.

The first shows how money is created from a bank's perspective.

Prior to your taking out the loan, the bank has a certain amount of reserves, and a small amount of currency as assets, and its liabilities are its customer deposits.

After you take out your own, the bank doesn't dip into its assets to give you money. Instead it creates a brand new asset (the loan it gives you) and a new liability, the brand new money you have as a deposit, which the bank just gave you.

Now here's the same transaction from the customer's perspective.

Your assets consist of some deposits and currency prior to the loan. Then after the loan, you have way more deposits than you had more (remember, when you get a loan, it's not like the bank sends you out with a basket of cash. When you get a loan you have more money in your bank account than you had before). That loan is also a liability, since you have to pay it back.

This might seem basic, except this is where money is created these days, not from some other outside force.

Along with their paper, the Bank of England made a nice video explaining this.

And read the full paper here >