I've Read UNSCRIPTED
- Feb 8, 2019
What you are asking is more about monetary economics, how money runs in the modern economy.So I'm trying to formulate my idea of how the economy works and would like others to think about this too.
New money is created via debt - yes or no?
Banks lend out money, often in the form of either a business loan or a mortgage.
So let's say that I get a business loan and I hire 20 people. Those 20 people each get mortgages. Their work pays down my business loan over time, and in return I pay them wages or salaries, which they use to pay down their mortgages over time.
This would eventually cancel out my debt and their debt. New value and new wealth was created! ...Right?
Is that true? Can it really work that way across the board, or is more debt always necessary?
I'm trying to figure out how this all fits together intuitively.
Honestly, @JScott ... your expertise would be great for this question.
edit: guys...I know what value is and that it isn’t money. I’m asking people how the government, banks, etc actually function. I’m not asking for people to tell me my own ideology! I am already pro-capitalism and value
Central banks create base money but credit/debt is generated by the private banking sector.
The banks can create far more debt than the money they own, through the double entry book keeping system.
When Jack the business wants to borrow one million dollar loan for business from Bank A. Bank A approved his loan by not taking from its banknote reserve. Bank A just key in digitally 1 million dollar in Jack’s account. Debt in the form of digital money is created. It is an asset for the bank, because Jack now owe 1 million dollar the bank. It is also a liability for the bank, because the digits represent the obligation to provide banknote once the owner choose to withdraw (even though they rarely do so).
So whatever transfer of the money across account is simple a transfer of “promise to pay”.
Because most of the money is in this form rather than base money or money notes, we say when money is created, debt is created.
Jack the business owner wants to make a profit. He targets a 50 percent return on investment for the year through business profit. He spends the one million dollar away buying equipment and hiring staffs. One million credit is spent. For that 50 percent return to be possible there must be at least 1.5 million of credit in the system. It means new money/credit/debt must be issued other than the existing 1 million in circulation.
In short most people want to “make money”, having more credit/money, than yesterday. This means that banks have to constantly “create money” which is issue new debt into the system. Only then it is possible to have more money than yesterday. Only then it is possible for Jack to earn an revenue large enough to pay down its debt plus interest and have a profit. If banks all stop giving out new loans we will have massive bankruptcy and financial collapse.
Ideally banks in aggregate should expand credit proportional to the real economic growth (value creation), to avoid economic stagnation or too much inflation.