How money is created

For background watch this video: Money as Debt. I am expounding on some ideas raised by it.

Anyone can create money, with the assistance of a bank. The act of signing a loan document creates money. Now the bank has a new asset, the note receivable, and a new liability, the demand deposit. The bank will quickly sell the note for cash but this just changes one asset class into another one. The total amount of money in existence has increased by the amount of the loan. With credit cards, the debtor is literally creating money every time the card is used.

When you write (draw) a check on this newly created money, you are creating an asset to the banks; however, this does not in itself create money (unless there is overdraft protection). The recipient deposits it in his bank. Now his bank has a new asset, the check, and a new liability, the increase in the recipient's bank account. They will "sell" the check to a clearing house. Now the clearing house has the asset, the check, and will credit the recipient's bank account. They will then "sell" the check back to the originating bank. The originating bank then "sells" it back to the drawer by debiting his account. Once a check has cleared, it is no longer an asset.

So once this model is understood some more discussion points emerge.

1. What happens if a check is made out to Cash and circulates as money for a while, say one month, before being deposited. In this situation, you are creating sort of your own private money out of then air. Furthermore, this private money exists in the "shadow" economy, outside the formal banking system. Imagine a club where people do this and write a number of $100 bills all post-dated for one month which they use to trade amongst themselves. And then at the end of the month, the holder of the note then would redeem it, or possibly reissue a new check in perpetuity. Now if people actually tried to do this they would be committing the crime of "check kiting". The banks who run everything hate this type of behavior. Yes there are valid concerns about fraud, but they are probably more worried about the competition. I think this is the main reason why banks are concerned about third-party endorsements - not because they are worried about whether the check will clear but because they don't want people using endorsed checks as private money.

But big corporations do this all the time. It is called "commercial paper" and since it is negotiable, it can be used as cash. In the 1800s, bank would print their own bank notes as money. They can no longer do this since the Federal Reserve has a monopoly, but commercial paper is a form of money. Some banks also issue commercial paper; however, the minimum denomination is usually at least $100,000.

2. Since anyone can create money, why not create an unlimited amount? The only constraint seems to be interest, which is necessary to pay for bank operations. What would happen if there were no banking costs? The Bank of North Dakota is a state-owned bank. Although I'm sure it is self-supporting, what would happen if its operating costs were just paid by the state? Could it create its own "commercial paper" at 0% interest in $100 denominations in whatever amount it wanted which would function literally as cash? I think it could but I'm sure there is some law against doing that.

3. This model of money creation, which our whole economy is based upon, has a fatal flaw. Although money is created out of thin air, no money is created to pay back the interest. It is mathematically impossible for all loans in existence to be paid back with interest. A certain amount of defaults and bankruptcies are necessary for the system to work.

4. Money is destroyed by people when they default on their loans. The process of money destruction is much more painful than the process of money creation. When money is created, the bank doesn't make any money except for the loan origination fee. When the loan defaults, the bank loses the entire amount of the loan - it is a bad debt expense. And since banks are so thinly capitalized, it doesn't take many of these defaults to totally wipe out their capital.

5. Right now we are in the process of money destruction, which is actually very healthy for the economy in the long run. Private money is being destroyed at an enormous rate. The Federal Reserve is creating money, but as long as the private money is being destroyed faster than the Federal Reserve creates new money, then there is no danger of hyperinflation. However, at some point in the next few years, the destruction will slow down, and then there is a huge danger of hyperinflation.

6. The flip side of this is although anyone can create money, it is idiotic to do so. Why would banks ever issue unsecured loans when default is so painful to them? And the borrower literally becomes a debt slave. Having a negative net worth is a lot worse than being poor. And this process of money creation is also destructive to the economy as a whole because it makes it unstable. And the more debt money that is created the more unstable the system becomes because the risk of default increases over time.

Anyways, enough rambling for now.