P02　Creating money from credit

Bills of exchange/Deposit receipts → Bank deposits/Credit creation

On whose ledger does that balance exist?

Four Steps

Similarities

A third party's record facilitates transactions between strangers.

Differences

Deposit receipts are backed by gold coins; bank deposits are created simultaneously with loans. The type of backing differs.

Applications

A perspective for seeing on whose ledger a "balance" exists.

Limitations

⚠ When lumping ledger records and modern payment systems under the same term "credit." The mechanism of settlement finality must be considered separately.

These are the four steps for going beyond "it's similar." The "limitations" step defines the point beyond which historical analogies should not be drawn.

Read at the Modern Money Stations

Stations from the textbook "Modern Money: Whose Debt Is It?" where this structure appears. The four steps for each station are not displayed on the screen in the textbook. Here, you can read them side by side.

Is 10,000 yen in a wallet the same money as 10,000 yen in an account?

1-01 / Modern Money　Present. Tokyo and London.

Similarities: Whatever the recipient can accept without doubt circulates as money. The marks on silver coins and the face value of bank deposits both serve this function.
Differences: Silver coins carried value in the material itself. A deposit is a liability of the bank, backed by the bank's assets, regulations, and central bank settlement.
Applications: When you see a balance, make it a habit to ask whose liability it is. Do not treat the banknotes in your wallet and the numbers in your account with the single word "money."
Limitations: The figure of three percent is the value for the United Kingdom in 2019 and varies by country and year. The proportion for Japan cannot be stated at this station.

Why do bank loans increase deposits?

2-01 / Banks　2014. London. Bank of England Quarterly Bulletin.

Similarities: The mechanism of creating money from credit is in the same lineage as goldsmiths' receipts and merchants' bills of exchange. A third party's record takes on the burden of doubt in a transaction.
Differences: Deposit receipts were backed by gold coins in a vault. Bank deposits are created simultaneously with loans. The type of backing is different, and the constraints lie on the institutional side: regulations, capital, reserves, and interest rates.
Applications: Consider "loans create deposits" and "what constrains lending" as a single set.
Limitations: This station is based on the British explanation. Details of the Japanese system (e.g., reserve deposit system, capital adequacy regulations) should be verified separately with primary Japanese sources.

What constrains bank lending?

2-02 / Banks　2014. London. Bank of England Quarterly Bulletin.

Similarities: Even the mint could not strike coins indefinitely. There is always some upper limit on the quantity of money.
Differences: The upper limit changed from the output of mines to conditions on the books: capital regulations, central bank money for settlement, borrower behavior, and interest rates.
Applications: When you hear "banks can create money from nothing," identify one by one which of the three constraints is at play.
Limitations: This explanation is based on a 2014 paper and a 2019 commentary from the United Kingdom. The levels of capital regulation and the operation of reserves in Japan should be verified with Japanese sources.

When a loan is repaid, money disappears.

2-03 / Banks　Present. Frankfurt and London.

Similarities: The fact that repaying a debt erases the record of the "loan" is the same as the act of breaking a clay tablet debt record. The erasure of the record becomes the destruction of money.
Differences: Material money like a silver coin does not disappear upon repayment. A deposit is a matched pair on a ledger, so it disappears upon repayment.
Applications: When you see a report that "the amount of money has decreased," suspect who has repaid a debt or what a bank has sold.
Limitations: What disappears upon repayment is commercial bank money. Central bank reserves and cash increase or decrease through different channels.

Central bank money and commercial bank money.

2-04 / Banks　Present. Frankfurt. European Central Bank commentary.

Similarities: The two tiers—money with the state's mark and merchants' bills—are similar to the relationship between bills of exchange and silver coins in the Middle Ages. The upper tier settles the lower tier.
Differences: Medieval bills were backed only by the merchant's credit. Commercial bank money is supported by the bank's assets, regulations, and deposit insurance, and is settled with central bank money.
Applications: When you see the word "money," first distinguish whether it is central bank money or commercial bank money before reading on.
Limitations: Three, eighteen, and seventy-nine are the proportions for the United Kingdom in 2019, and they vary by country and year. The proportions for the Eurozone and Japan cannot be stated at this station.

Reading a Bank's Balance Sheet

2-08 / Banks　2014. London. Figure 1 of the paper.

Similarities: Money changers' ledgers also recorded deposits as liabilities and loans as assets. The concept of double-entry bookkeeping remains the same.
Differences: Modern banks can create liabilities at the moment of lending. For money changers, deposits became liabilities only when they were received.
Applications: Rephrase your account balance in terms of its corresponding item on the bank's balance sheet.
Limitations: Figure 1 is a schematic for the UK explanation; the actual bank accounts and ratios must be checked in each bank's financial statements.

P02 Creating money from credit