I’m amazed that nobody commented on this article. Anyway, you’re right that banks create most of our money, but actually it’s not really a big deal. Admittedly it took me many months of research to reach that conclusion, because the idea is so different from what we’re normally lead to believe.
Essentially all of our money is an IOU owed by a bank to the holder of the bank account or the cash. Banks aren’t really doing anything special by writing IOUs – anyone can do it. In fact, if you look at the banking regulations, you’ll see that it’s taking deposits which is the more regulated activity. Don’t worry – banks don’t get rich by writing IOUs to other people.
The idea of a bank is that instead of you trying to pay your local supermarket £50 with your personal IOU (which of course they won’t accept), you go to a bank, write them an IOU for £50, and they write an IOU to you for £50 in the form of new money. You then transfer that to the supermarket, who accept it because the bank has to keep its promise to them even if you default on your IOU to the bank. As long as the bank has enough net worth to cover all the defaults, all users of the money are fine.
Of course, some people do default, which means that the bank’s owners end up losing out. They need some sort of income to cover the defaults (as well as their costs of doing business and any profit), and that means they need to charge fees or interest on loans.
In general, to understand this and other topics in economics, look at how each decision or action affects each person’s net worth – what you own plus what you’re owed minus what you owe – and it all makes sense.
I’m amazed that nobody commented on this article. Anyway, you’re right that banks create most of our money, but actually it’s not really a big deal. Admittedly it took me many months of research to reach that conclusion, because the idea is so different from what we’re normally lead to believe.
Essentially all of our money is an IOU owed by a bank to the holder of the bank account or the cash. Banks aren’t really doing anything special by writing IOUs – anyone can do it. In fact, if you look at the banking regulations, you’ll see that it’s taking deposits which is the more regulated activity. Don’t worry – banks don’t get rich by writing IOUs to other people.
The idea of a bank is that instead of you trying to pay your local supermarket £50 with your personal IOU (which of course they won’t accept), you go to a bank, write them an IOU for £50, and they write an IOU to you for £50 in the form of new money. You then transfer that to the supermarket, who accept it because the bank has to keep its promise to them even if you default on your IOU to the bank. As long as the bank has enough net worth to cover all the defaults, all users of the money are fine.
Of course, some people do default, which means that the bank’s owners end up losing out. They need some sort of income to cover the defaults (as well as their costs of doing business and any profit), and that means they need to charge fees or interest on loans.
It’s explained in my Money and Banking video.
In general, to understand this and other topics in economics, look at how each decision or action affects each person’s net worth – what you own plus what you’re owed minus what you owe – and it all makes sense.