Friday, February 4, 2022

Adding Private Banks to the Mechanical Exercise

This is a follow-on for the recent post "A Mechanical Exercise Tracking the Creation and Lifespan of Fiat Money" (METC). In the original exercise, the user made all of the economic decisions. Private banks were money users. In this post, we introduce private banks into the role of decision-making for the process of creating money.

Figure 1. The raw material for money
creation by private banks.
In METC, we needed a virtual storehouse to store real tokens that we could later call "money". Here we introduce a private bank's version of a virtual storehouse which is, of course, real all the time.

In the drawers of this new storehouse (Figure 1), we have existing money sources that the banks can use to ensure that new borrowers have access to existing money. So how is it that new fiat money can be created in this new version of METC? Private banks take systematic advantage of the pool of money on deposit by making a loan without linking loan risk or deferred spending to any one account. The loan is made by creating a deposit account for the borrower. Loan risk is spread to the entire body of depositors, including the lending bank. Deferred spending is transformed into accelerated spending. As a result of the loan, the amount of money on deposit in the banking system is measured as increasing. *

Now to use money belonging to others sounds like a reuse of existing money. You might think of it as being the same as if I made a loan to you, wherein I clearly used money that I owned. Both cases reuse existing money. 

So, what does the bank do that is so different? Because the bank is lending money that it does not own, bank borrowers do not need to first work for the position to which they are assigned in the banking system (All depositors are equally able to spend-out their account balances.). The bank has not only apparently created money, but the bank has also made available equal access into the marketplace. This has serious implications for what money really is, making it appear to be like a valuable ticket rather than being a pure expression of past work or wealth. [The tickets we envision here are like concert tickets that are valuable and tradable until they are finally put to conclusive use. Read "Money is Not an IOU, It's more Like a Ticket." for more on this alternative perception of money.]

If we use the "money is a ticket" analogy, then bank deposit records are the current ownership record of tickets past-issued. The sum of all deposits becomes the money supply.

Knowing how many tickets are currently available is a very useful management tool that can be used to prevent the over-issuance of tickets.

What happens when a currency issuing government borrows from private banks? The process is the same with one exception: A government bond is usually judged by bank regulators as being nearly cash. Therefore, government bonds can be substituted for holding actual cash reserves up to some limit. (Any interest payments on government bonds bought with funds provided by depositors can be a source of income for banks.) Of course, the indicated money supply goes up after each such borrowing event when the borrowed money is spent into the measured economy.

Using METC with private bank decision making ability

To run the actual exercise, we follow the original exercise by replacing the drawers with envelopes and coins. For each exercise transaction, relocate a loan document coin and fiat money coin to the appropriate sector envelopes. When drawers/envelopes containing preexisting coins become empty, you know it is time to relocate money from sector envelopes at least partially back into the common deposit drawers/envelopes (which completes one round of the exercise).


* There should be no question that the money supply owned by the private sector grows.   To see the growth recorded as money supply and total of customer owned bank accounts, follow the links to the FRED sites M2NS and commercial bank deposits.

(c) Roger Sparks 2022


  1. Roger,

    I wrote a reply to you this morning and am afraid I hit the wrong button and have lost it.

    Did you get a post from me where I talk about my shifting understanding of money, and where I make reference to the Wizard of Oz?


    1. I've done that!

      Please try again. From my experiences, the first effort was well thought-thru, the second effort even better thought-thru. GL

  2. Okay, Roger. I'll try to put it back together.

    My understanding of money is shifting again. You used the metaphor "money is a ticket" which has reminded me of all the tickets I've kept as souvenirs of past ship/airplane/train/bus rides, concerts, etc. Once they were used to gain entry onto a means of transportation, or into an event venue, they lost all but sentimental value. Your money-as-ticket metaphor works if the same ticket can be used for multiple entries into similar activities. Okay.

    Also, those tickets only work if those who redeem them believe that they represent value/wealth which they can use themselves. Money, more and more, is sounding like faith, and when I think of faith, I can't help but think of Hebrews 15;1 "Now faith is the substance of things hoped for, the evidence of things not seen." Isn't that what money is? So money's value is predicated on the belief of people using it that it is the substance of things they want which they can't see in the present but hope for in the future.

    What happens if people lose their faith in money in much the same way that they lose their faith in their respective religion? Then the script/scripture is valueless. I feel like I don't want people to realize that money is a token of faith. It's better if they just keep on thinking that it has value in an of itself. Less likely for the system to crash.

    I can see how what a bank does through its creation and assignment of loan monies is give someone an opportunity to participate in the economy and spread the risk of that loan out to the other deposit holders.

    In one of your posts you talked about the risk the bank takes when lending money, saying that the promise of future profit is based on the borrower ordering their lives in consistent productive activities. What happens when the borrower can't order his life in that way because of a chaotic social system, disrupted by criminality, disease, or scores of millions of illegal immigrants undercutting the value of his labor and limiting access to meaningful entry-level work for himself or his children?

    Also, I just watched a video of Allen Greenspan talking about inflation. In it he asserts that there is a one-to-one correlation between the oversupply of money and the appearance of inflation. We're seeing inflation start to kick in now. This correlates to the chart you posted showing the money in bank deposits versus the GDP. The question that arose in my mind while listening to him talk is this: does the law acknowledge and permit bank-created money, or is it just an unintended consequence of the assumption of risk-reward dynamics of the financial industry? Because he made it sound like the only place money could be created was within the federal government.

    Sorry about this post. I know it's a mess, but it's like putting a plate back together with crazy glue after you dropped it on the kitchen floor.


    1. Josh,

      Thanks for the comment.

      For the first question, I think the ability of the borrower to order his life can be disrupted. As in "The best of plans can be upended by unforeseen events." In the event of external disruption, both borrower and lender need to be fair with one-another. There could be a need to rejigger plans.

      Can private banks create money? I would say "Yes, using an implicit license from government." Earlier today, I described it this way in a blog comment:

      "I got to thinking this morning about a child who wants to go to the drug store. Mom always says "NO".

      Finally, Mom says “Yes, you can go.”

      Now what? The child can go but has no entry once there. Only if the child has money can the child do more than walk through the store. This child needs “evidence of permission”.

      Money is “evidence of permission”.

      Banks have the ability to create “evidence of permission”.

      Turning to the destruction of “evidence of permission”, it really can’t be destroyed. It can only be returned to the entity that granted it originally.

      So, if Mom said, “Bring back the evidence of permission.”, it would be very hard for the child to do that. Maybe the child could work and thereby earn evidence that he could return to Mom."

      The comment is a little out of context with your question but may apply. Loans made by the central bank would clearly constitute new money (usually called "reserves" in the U.S.). Reserves don't necessarily directly translate to private bank deposits as can be seen in the two charts referenced in the article.

      The topic of money turns out to be difficult to tie down. I appreciate your thoughts.



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