Creating money from credit

On whose ledger does that balance exist?

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

How Credit Creates Money in 3 Minutes

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In the past

People wanted to trade, even with strangers.

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In the past

Promissory notes and receipts for deposit bridged the gap between two people.

A record from a third party served as a substitute for trust.

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In the past

A deposit receipt was backed by the gold coins you deposited.

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Today

Today, when a bank makes a loan, a deposit is created at the same time.

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Today

Your 'balance' exists in the bank's books.

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What's different

The backing is different. In the past, it was gold coins; today, it's loans.

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A useful perspective

See whose books the balance is on.

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What to watch out for

Don't lump ledger records and modern payments under the single term 'credit'.

2What would you do?

Your bank app shows your deposit balance. Where do you think that money is?

Pick one

It's kept as banknotes in the bank's vault.

With old deposit receipts, there were gold coins backing them up. Today's bank deposits are created at the same time a bank makes a loan. The type of backing is different.

It exists as a record on the bank's books.

That's right. The balance is a record on the bank's books. Seeing 'whose books it's on' is the key to understanding money.

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Representative Historical Scenarios

Contemporary Financial Scenarios

Situations from the book where this theme appears. We present a comparison with past situations for each case.

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.

How to compare past and present

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.

To go beyond "they are similar," we also describe the differences, what can be applied today, and where past examples should not be applied to the present (limitations).

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