Home > Money Series - Part 1 - The Big Mystery: Money

Money Series - Part 1 - The Big Mystery: Money

What is the most fundamental building block in our current financial system?

Published: 06-03-2013 00:00

Money Series - Part 1 - The Big Mystery: Money

If you have to pick one factor influencing everything else in the financial and economic system, what would it be?

GDP growth of industrial and developing countries?
Interest rate?
Rules, regulations and government stimuli?
Macro-economic factors?

What about money?

What is money and how is it created? It is fascinating that most everything in media and society touches on money, yet so little is discussed about what money is and where they come from.

The question of what money is and how money is created is debated mainly outside mainstream media. Strangely enough, different economists have different opinions.

If the supposed economic experts cannot agree on such a fundamental question, how can they then suggest solutions to the economic problems of debt and instability?

Is money creation too uncomplicated for people to grasp?  

In a speech last year, the governor of the Bank of England, Mr. Mervyn King, said

“When banks extend loans to their customers, they create money by crediting their customers account”

A similar opinion has been expressed by Mr. Adair Turner, Chairman of the Financial Services Authority (FSA) in the UK stating

“The banking system can thus create credit and create spending power – a reality not well captured by many apparently common sense descriptions of the functions which banks perform”

The same description of money creation can be found in central bank and institutionalist publications.

No other concrete alternative descriptions are available.

So what implications does this have?

When money is created by banks extending loans to their customers, the money has to be re-paid with interest. The problem is that there is “no” money available for the repayment of the interest. The money necessary to repay the interest must also be created as new loans which are also bound to be paid back with interest.

Fractional reserve banking (FRB) is the name of the current monetary system. FRB means that banks only need to keep a fraction in reserve when banks extend loans to their customers. By repeating this process, banks can effectively loan out multiple times what is deposited.