In his pocket, Joe has an old leather wallet. It contains enough banknotes to buy him a brand new wallet of a better model he saw in a magazine. This buying power is exclusive to him, who alone can use those bills to buy something. Likewise, if he transfers them to another person, then instead of him, only this other person will own their buying power.
However, although Joe’s transferring away his banknotes can always transfer along their control, it could never transfer along their whole property, which is not only his. The bills, as possibly distinct from their purchasing power, do not belong to him alone. For example, he has no right to create or destroy them: they are public. What belongs to either him or whoever else controls any such notes is rather their buying power, which hence is privately owned.
Indeed, by always just privately owning his banknotes, Joe could sell them independently of their purchasing power, which they could not represent. However, selling them in this way would prevent him at least temporarily from using the same bills to buy anything. Then, by recognizing their lost purchasing power as a monetary value, for keeping which they must remain its representations, one can conclude:
- All monetary value must be private.
- All its representations must be public, or unsellable.
Still, if not Joe, then who else can sell, buy, create, or destroy his or any equivalent banknotes? This question should be negligible if what he owns is their monetary value rather than the bills themselves. However, since the purchasing power of each bill can change once people sell, buy, create, or destroy other such bills, the same question becomes critical. Indeed, part of its answer is that now commercial banks create most of the money supply by selling it, in a process called fractional-reserve banking.
According to the Federal Reserve Bank of Chicago, this is how fractional-reserve banking originated:
Then, bankers discovered that they could make loans merely by giving their promises to pay, or bank notes, to borrowers. In this way, banks began to create money.
Bankers also needed, however — and still need — to keep, at any given time, enough money to provide for expected withdrawals: “Enough metallic money had to be kept on hand, of course, to redeem whatever volume of notes was presented for payment.”
Hence the name “fractional-reserve banking”: commercial banks must hold a fraction of all deposit money as reserves — which legally (since 1971) need no longer be “metallic money” but only a public debt — to meet withdrawal expectations: “Under current regulations, the reserve requirement against most transaction accounts is 10 percent.”
In a fractional-reserve banking system, on which most of today’s international economy relies, commercial banks create money by loaning it, hence as a private debt.
Transaction deposits are the modern counterpart of bank notes. It was a small step from printing notes to making book entries crediting deposits of borrowers, which the borrowers in turn could “spend” by writing checks, thereby “printing” their own money.
For example, once a commercial bank receives a new deposit of $10,000.00, 10% of this new deposit becomes the bank’s reserves for loaning up to $9,000.00 (the 90% in excess of reserves), with interest yet without withdrawing the loaned money from the source account. Likewise, if that maximum loan of $9,000.00 does occur and the borrower deposits it into another account, whether in the same bank or not, then again 10% of it becomes the latter bank’s reserves for loaning now up to $8,100.00 (the 90% now in excess reserves). As always, the bank charges interest on the loaned money despite not withdrawing it from the source account. This process could proceed indefinitely, adding $90,000.00 to the money supply, valuable only as their borrowers’ resulting debt: after countless loans of recursive 90% fractions from the original deposit of $10,000.00, that same deposit would have eventually become the 10% reserves for itself as a total of $100,000.00.
Thus through stage after stage of expansion, “money” can grow to a total of 10 times the new reserves supplied to the banking system, as the new deposits created by loans at each stage are added to those created at all earlier stages and those supplied by the initial reserve-creating action.
Yet how can credit alone create new money? How can a debt retroactively create its owed money? Something else must be happening here, in addition to mere loans. What is it? What else happens in the whole process of commercial banking? First, there is a deposit. Then, there is a loan of up to a fraction (of 90%) of this deposit, at interest yet which the bank never withdraws from the source account. Finally, the borrower can credit that loan to another account, in the same or any other bank. Suddenly, the trillion-dollar question emerges: are these two accounts sharing the same value?
- Regarding deposit money the answer is yes: the loan can still belong to the balance of the source account, consequently being that same deposit money.
- Regarding account balances the answer is no: the loan can also belong to the balance of the target account, consequently being additional deposit money.
However, if the partial balances of both accounts must represent the same deposit money, then how can they duplicate it?