We are told all our lives, that money is hard to come by, and we should study hard to earn it. How then, can all this money suddenly come from nowhere? Where does the money come from? Who creates money? Most importantly, what's the true meaning behind money?
Money by definition is an exchangeable piece of value. It is a universal intermediate for the exchange of goods and services. To ensure that this “currency” always has worth, it is usually tied to a physical object, which in this case was gold. However since 1971, this case has changed, and money is no longer tied to a universally valuable object. This means that what keeps money going, is simply that we believe the fact that money holds value. This argument will be of great importance as you will see.
So who creates money? There are multiple answers to that question.
Around 3%-8% of the money is created by the government, by printing notes, which we use for circulation. This forms a large part of how governments fund themselves in essence. But as seen, this is but a fraction of the amount.
The vast majority of the money is created by the Private Banking sector-around 97% as to the question of how one would be surprised to know that the process is as simple as typing numbers into a computer.
Banks invented digital money when they persuaded lawmakers to do so. This model comes with a lot of history, which will be covered in a later post.
The primary function of a bank, to us at least, is to hold money, lend it to the populous if so needed, and provide interest to the customer for having the bank hold their money. However, this is not exactly how it works.
Banks are legally required to hold only about 10% of our actual deposit. The remaining 90% can be invested into extending loans for other people, or businesses, who eventually pay it back with interests-creating a profit. Banks then use this interest to provide us with interest on our deposits. This type of system generates new money in the overall economy and promotes growth. However, gaps are already evident, because as we know, not all investments have returned, and one can lose money.
Whenever an individual or a business borrows money from the bank, we say that the person generates debt. This debt is the borrowed money that is to be paid off by the bank. In the modern economy, debt is as good as actual money itself. This is how banks create money. These “promises” actually flood the system with new “generated” money which is later paid back. Now, the problem happens when the money cant be paid back. This is when things get “too big to fail”.
This system of generating debt by private banks, and using these debts and deposits to invest in businesses, companies and even governments can get quite tricky when either party does not have the actual money to pay it back. This creates defaults.
In the early days of March 2023, a combination of these instances occurred, when the Silicon Valley Bank, a well-known bank for startups and companies in Silicon Valley, had a catastrophic collapse. The bank had made a series of bad investments, combined with low deposits from the customers, coming out of the pandemic which had hit roughly 2 years ago. A series of rather confusing statements caused the people to lose faith in the bank, and remove their existing capital in the bank, and as word spread to wall street, the damage had already been done.
Usually, governments are aware of said problems and to keep the trust of the people will ensure laws to prevent this. For the US, the government ensures all bank accounts which have less than $250,000, unconditionally. Of course, large businesses also have bank accounts, with a lot more money. This is the reason why they start pulling their credit out in the first place- as their deposits are not ensured by the government and they might make a huge loss. However, the governments usually bail these banks out and ensure that the clients still make back their credit. But you might wonder, if the banks are the ones making money, where does this money come from? Also if the banks have the ability to quite literally, generate money, why don’t they bail themselves out?
When it was highlighted in the previous section, private banks generating money was not entirely accurate. While private banks can generate money in the form of debt, they can't do so infinitely. This is the power which lies with the central bank.
We have all learnt from an early age, that central banks print money. While this is true, they have one crucial element above the others, their currency is universal and can print almost infinite amounts of money. By regulation, the central bank cannot generate actual money, but it generates debt almost infinitely, which has to be paid back. This is the factor that sets them apart from the others.
After the 2008 financial crisis, some of the biggest banks around the world failed. The conditions were similar to the situation pointed out before. But with so much at stake, some of these banks become what we call, “too big to fail”, that is, inadvertently hurt the country greatly in such a situation. Thus, to prevent total collapse, the Federal Reserve, the body responsible for the generation of said money, basically generated the money needed to bail these banks out-which is essentially debt which has to be paid back. This is what is called the national debt. Inevitably, the ones who have to pay this money are people. At the current moment, the global debt is estimated to be more than $226 Trillion. After the crisis, the global economy has essentially been on life support- with hyper-low interest rates on extended loans and super-high distortions in the market. Many argue that the true economy died in 2008, with the enormous bailouts. Essentially, we are paying back the money we lost to ourselves.
After this, the whole concept of modern currency might feel like a distortion in itself, which is working because it is, until it crashes. This also creates an ethical dilemma as big banks do not hesitate to make risky investments and lose money, as they know that they are much too big to fail and the government will swoop in to save them. The governments know that they should not extend this credit because the banks will simply repeat the cycle, but In not doing so, they would greatly hurt their own economy. Mitigating this is the dilemma of the modern financial world, with governments simply operating with increasing national debts.
One cannot say when a system like this would inadvertently collapse in on itself, as we must remember, that money is only worth itself as long as people believe so. Truth be told, nobody really knows just how much money is hooked up in this gambling game, however, some estimates show as high as 1 Quadrillion Dollars. The moment we stop trusting it is when our current financial economies fail.
Nicely articulated. Thanks for making it so easy to understand.
Now I am a bit scared to park my money in bank.
Though money is not 'Everything' in life but it is 'Everything' when you need it the most.
Very well