In this fifth of our series on money basics we will discuss the process of issuing top down bank money. Our discussion will relate to a group bank authority instead of one unitary banking authority, as that is the kind of system that we have today.
Top-Down Fiat Bank Money Issuance
Bank fiat money is the result of an agreement between a private banking system and the State, giving to the private banking system the power to create and manage the money supply for the State and its citizens. The State enforces the system through its laws.
There are two classes of loan issuance in this system. The first involves the members of the bank money creation authority lending the money they borrowed from the user community asset-liability account in the money creation process, back to members of the user community. Money is issued into the user community in this application through loans from money 'creators' to users.
The second class of loan issuance consists of loans made by money managers; individuals and groups that have a surplus of money to loan but cannot create money, lending their surplus to users. A reminder; these two groups make up the top-down money authority community.
So we will need to deal with two kinds of loans; loans issued by money creators and loans issued by money managers. We will discuss both types, noting similarities and differences. First we will discuss how money creators issue money they 'created' into use. We will then describe how money managers issue loans from funds already created.
For the present we will deal only with the principal of the loan. While interest will be noted here, the complications introduced by its introduction will be dealt with in a later post.
Bank Money Creator Money Issuance
For starters let us remember that the top-down authority must 'create' their credit before they can issue the loan. This is done through the money 'creation' process described earlier with a debit in the user community asset-liability account and a credit in the money creator account.
A money creator (in this case a banker) and a money user (borrower) meet through our connections between our money user and money authority communities. We come to an agreement on the terms of a loan. These terms are patterned on the terms of loans currently being made. A borrower is by definition a member of the user community except where financial capitalism is being practiced.
Again let us note that money creators have the power to determine what their money will be used for. Because they create the money supply and manage its quantity as well as who gets it, they have great leverage over the economy.
The loan issuing process is as follows: The bank, as lender, transfers the credit it has given itself to cover the principal of this loan from their personal equity account into the money authority equity account which forwards it to the money users current account, which forwards it to the borrower.
In exchange, the borrower makes a commitment to repay the bank at a later date with interest, again mediated through the user community current account and money authority equity account. This is a strictly money transaction, with no current value traded except if specific collateral is temporarily held by the bank to cover the risk of non-payment. In any event, by law, the bank can take assets of the borrower if we are unable to repay the loan.
Repayments to the bank from the borrower on the principal of loans, are returned from the borrower through the money user current account, then through the money authority equity account and finally back to the user asset/liability account where the functional liability originated.
This zeros out the original loan from the community of users to the money 'creation' authority as well as the loan from the bank money 'creator' to the individual user. In current practice repayment zeros out the fictitious deposit of the bank recognized by Werner in his explanation of our current money creation process.
The banking system has simply become an intervening authority that decides what money will be created for and the conditions of its temporary issuance, charging interest for this service. We will point out here that the sum of outstanding loan balances is the user community money supply.
This is the slight of hand by which top-down authority-based money is created and issued, to be traded by the users in a private bank fiat money system. The income of the money creator in this sequence is the interest on loans. It is in the interest of the banking community to maintain money scarcity in order that the value of its money might be maintained.
Money Manager Loan Issuance
The major difference between a money creator loan and a money manager loan is that the money manager lends existing money that they have accumulated rather than 'creating' the principal. The authority must have a surplus of money numbers in their asset account to cover the principal of the loan.
As above, a money manager first meets a potential borrower through our connections between the user community and the money authority community. We come to agreement on the terms of a loan. These terms are again patterned on the terms of loans currently being made. As borrowers we usually have little wiggle room in setting these terms.
Once the terms of the loan have been agreed on, the loan issuing process works as follows: Again, the lender deposits a credit for the amount of the principal of the loan, from their individual equity account into the money authority equity account which forwards it to the users current account, which forwards it to the borrower, issuing the loan. It must be noted again here that money managers have the power to determine what their money will be used for, determined primarily by potential income.
In exchange, the borrower makes a commitment to repay the lender at a later date with interest, again mediated through the user community current account and the money authority equity account.
Again this is a strictly money transaction, with no tangible value traded except if title to specific collateral is temporarily held by the lender to cover the risk of non-payment. And in any case, as with money creator loans, by law the lender can take assets of the borrower if the borrower is unable to repay the loan.
Repayments on loan principal are returned to the lender as the loan is repaid through the same channels. This zeros out the debit for principal of the borrower to the lender. Repayments on interest are a separate matter, and as noted above, will be discussed later . The lender's income in this sequence again consists of the interest money numbers they receive.
Results of Bank Money Use
Again, the user community money supply consists of the sum of community member's outstanding loan balances from the money creator. Because we can't create money, us users have to depend on money borrowed from the banking community in order to trade between ourselves. In order for there to be a reliable supply of money for us to trade with each other, loans from the top-down authority continually have to be made because money is continually being extinguished in the loan repayment process.
If not enough loans are continually originated, there is insufficient money in the user economy for trade, causing deflation and stagnation. If too many loans are originated, inflation will occur, with more money chasing the same amount of value. In practice, this necessary balance demonstrates why unlimited helicopter money will inevitably produce inflation, and ultimately system breakdown.
It must be understood that the government is in the same position as all of the rest of us users with respect to the banking system. If the government wants to spend more than it has available through taxes, it must borrow it, with interest, from the banks which 'create it out of nothing'.
The reason that inflation has not occurred currently is that almost all of the new money created has accumulated in the top-down money-authority community and is not available as a part of the user-community money supply for use in trade. Our user community, which is the real economy, still operates with a scarcity of money numbers, despite the fact that many new numbers are being created. The lender's income in this sequence again consists of the interest money numbers they receive.
The bottom line is that the community of users loans money to the bank money creation authority, which has borrowed it without acknowledging its source; loans from our user community asset-liability account. In order to get the use of this money we loaned to the money creator, we are required to borrow it back from the bank money creation authorities with interest.
At the same time it has to be understood that there is no net movement of money from the money authority community to the money user community or vice versa due to the lending of principal. All money that is loaned is returned to the money authority and thus to the user community asset/liability account. Thus there is no net movement of money from the user community accounts to the money authority asset account. The addition of interest will change this.
In the sixth in this series on money basics, we will now turn to top-down government money issuance.