The way in which banks work is a deep mystery to many people. In this video I aim to demystify it - by explaining just how money is created.
This is the second in series of videos on money related themes. The first is here.
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These new videos are much better, getting over just one point at a time and lasting an attractive three to four minutes, rather than the 10 minutes or more of previous ones.
I am trying…..
I’d like to emphasise just one point, if I may.
It is that whereas the domestic banks can “create money” they can’t create net credits in the Private Domestic Sector. For every created credit (+ve) there has to be an offsetting liability (-ve).
Those net credits have to come from one of the other two sectors which in a net importing country like the UK has to be the government sector.
No, it is the public
The government can do this
It also creates base money….
@ Richard,
I’m not sure whether you are disagreeing. Yes, as you say, the government can do this and they do create base money. That’s why each country, except not in the eurozone, tends to have its own government created currency.
The eurozone also involves base currency
If I borrow my neighbour’s lawn mower i am under a moral obligation to return it. If I break my leg and am unable to do so in person I am under a moral obligation to go to some extra effort – e.g. contacting my son and asking him to return it – to fulfil that moral obligation. I think it is entirely different if I borrow money from a bank.
The bank does not merely lend me money but also expects me to pay interest on the loan at a rate which factors in the possibility of my being unable to repay it. In effect the bank is insuring itself against a bad debt and I am paying the premium. This would seem to imply that if, through no fault of my own, I am unable to repay the loan, I have already fulfilled my moral obligations to the bank. So I am under no moral obligation to go any extra effort – e.g. getting an extra part-time job – to pay off the loan. Of course it is not a good idea to default of a bank loan unless you absolutely have to but it seems to me that, from an ethical point of view, a bank loan is very different to a many other sorts of borrowings.
This post is about banks but it can work for anyone in the same way.
For example, say I owe both Dick and Harry £1000. Harry wants to buy a car from Dick, also for £1000. I simply transfer my debt to Harry. So now I don’t owe Dick anything but I owe Harry £2000. If the car had been priced at £2000 then I could have increased my debt to Harry to £3000 but Harry now owes me £1000.
Of course all this is fine providing Dick and Harry trust me. And I trust them. To test me they might want to take some money in cash and I have to be able to provide that to maintain my own credibility.
You have to be a bank
And be regulated as one
And you are not
So the claim makes little sense
Minsky said the much same thing. ie “Everyone can create money; the problem is to get it accepted”
I do accept that Dick and Harry are more likely to accept Barclay’s bank money than Tom’s money!
Interesting point about the euro earlier. You might want to expand on that further in a separate post. It looks, on closer inspection, to be less of a single currency than is generally supposed. It is more a collection of separate national euros ie German euros, French euros etc which are all held together at rigid parity by the actions of the ECB.
How does the question of legal tender fit into this. If I owe you £20 and place a £20 note in your hand then I have legally paid my debt. However you could presumably simply refuse to accept payment in any other form, which would imply that a bank deposit is not legal tender.
But bank payment is legal tender
The law says so
So are you saying that if I attempt to pay off a debt you cheque or credit/debit card then you can you refuse to accept it but if my bank transfers the money from my account to yours then you can’t? This, of course, assumes you actually have a bank account and have given me enough details for me to instruct my bank to make the payment.
I am saying bank payments are legal tender