Money and Banking – How a Reserve Bank Creates Money

There is a common misnomer that money is created on a printing press. While it is true that a few notes are printed and used in commerce, the vast majority of money in circulation does not even have the soundness of paper notes. All but a very small percentage, peperocc of money is nothing more than ledger entries on a bank computer.

When a central reserve bank needs to buy a stapler or desk, it writes a check to the supplier and takes receipt of the good. The supplier deposits the check in a commercial bank, and the commercial bank forwards the check to the reserve bank for payment. The reserve bank uses the check to erase the liability created when the check was written and credits the amount of the check to the commercial bank.

Let’s follow the accounting starting with, voteherd clean balance sheets.

When the central reserve bank purchases the stapler (let’s say for 10 units) by writing a check, the reserve bank’s assets increase by one 10-unit stapler, and its liabilities increase by 10 units. The supplier increases both his assets and owner’s equity by 10 units less the cost of the stapler to him.

When the stapler supplier deposits the check with his commercial bank, the commercial bank increases both its assets and liabilities by 10 units. When presented, origaniz to the reserve bank for payment, the reserve bank records the deposit as an increase in assets of 10 units and an accounts payable liability (the commercial bank’s account) of 10 units. Since the check has been paid, it is canceled along with the 10-unit liability it created.

By writing a check presentable only to itself, the reserve bank has just created 10 monetary units out of thin air. With a few keystrokes, the money supply has just been inflated by the 10 units the stapler supplier now has on deposit at his commercial bank. Unfortunately, the inflation doesn’t stop there.

For every unit a commercial bank has on deposit at the central reserve bank, they can loan out .9 units. Since our example commercial bank now has 10 units, afrihand on deposit at the reserve bank, it can make a 9-unit loan simply by writing another check. If that check is deposited at another commercial bank, the second commercial bank will present that check to the reserve bank for payment. The reserve bank will move 9 units from the first commercial bank’s account to the second commercial bank’s account and cancel the check.

Now, the stapler supplier and the recipient of the loan proceeds have total bank deposits of 19 units. Of course, the money inflation doesn’t even stop there. The second commercial bank can now loan 8.1 units to another bank which can then loan 7.2 units to another bank and so on until the total money supply has been increased by 100 units all without ever turning on a single printing press.

Of course, a central bank can only use so many staplers. The most effective method a central reserve bank has of creating money is by purchasing government bonds. Since government borrowing is ubiquitous, a reserve bank can easily purchase these bonds on the open market, highdean The problem with this, though, is that it amounts to a double tax on the people of that country.

The people are taxed once to repay the bond and interest and a second time in the reduced purchasing power of their money. While the costs of this scheme are borne by the people, the benefits are realized solely by politicians and the individuals and corporations who contract with the government. By the time the newly-created money filters through government, government contractors, and banks, the wage-earner derives little increase in his standard of living if not an outright decrease.

The central reserve bank is both the lynch pin and Achilles heel of a fractional reserve banking system. Monetarist economists claim a central bank is required to promote economic stability and growth in the economy; any costs, they maintain, are outweighed by the benefits. Very few monetarists explain, though, that the bearers of the cost and receivers of the benefits are not the same people. By shrouding a reserve bank in an “official” cloak, bankers and economists fool people into believing that a little ink and paper and a lot of digits on a computer screen is just as good as sound money.


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