How money is born -- it's time we had The Talk

by John MacBeath Watkins

It has come to my attention that many people don't know where money comes from, so I think it's time we had The Talk.

You see, gentle reader, when a central bank loves a commercial bank very much, it has tender feelings and follows an instinct millions of years old, and slips a loan in that bank's portfolio.

I believe a bird is somehow involved, something that begins with "P", probably a penguin.

So, that loan is new money. It didn't exist before the bank had it, but it exists now. And when that penguin drops the new-born money into the loving arms of J.P. Morgan, he immediately farms it out to work for someone else. Even at a tender age, money can be found working in textile mills, in mines, in steel mills, and on construction sites. The more risky the work, the greater the profit, and who keeps the profit? J.P. Effin' Morgan.

Now, as it happens, only about 3% of money is created by government. Most of it is created by banks, taking deposits and loaning the money from the deposit to someone else. The theory here is that not everyone will want their money back at once, so you can pay the depositor a small interest, and then loan out their money at a higher interest. The money thus gained is one of the ways banks make profits. But in the process, they make money, in the sense that the depositor and the borrower now have an amount of money equal to the amount deposited and the amount loaned. That's nearly twice as much money, or at least it is until everyone wants their money back at once, which is called a bank run.

The life of money can be long, or it can be short. Many people believe in paying back money, but are unaware that when money is paid back, money is destroyed.

This is why depressions are so depressing. A depression tends to happen when everyone tries to pay back their money at once, thereby destroying the money they pay back. Picture a bunch of blips on a computer screen quietly dying into darkness as dollar after dollar is paid back and goes to its rest, being paid back and not loaned out again because everyone is afraid to take on the responsibility of bringing new money into such a world.

And not everyone can pay back their loans. Loans that are not paid back are called non-performing. If there are enough of them, banks develop loan performance anxiety, and this creates a slump. With loan performance anxiety causing a slump, banks cannot provide borrowers with the liquidity they so ardently desire. As a result, less money is born.

And a country depopulated of money is a poorer one. If only there were someone who could have the confidence to bring new money into the economy existed, you might be able to do something about the situation. But that would have to be someone who could create money even in the worst circumstances, when most lenders have lost their ability to insert loans into new borrowers, because they are afraid. They are anxious that their next loan may fail to perform.

The reader will have noticed that the commercial bank is acting in both male and female roles, like an earthworm. The central bank puts loans into it, and it puts loans into borrowers. So even when the commercial bank's performance anxiety about its loans leaves its new loan portfolio flaccid, it can still act as a recipient of loans.

If a country has its own currency, its central bank never runs out of money, because it can create an infinite amount. The central bank, seeing its commercial bank compatriot unhappy, will try to restore its ability to loan by creating more money with it. Ah, you say, but if the bank creates lots of new money, won't there be that overpopulation of money that we call inflation?

Well, no, because the reason the central bank is trying to make lending more attractive (think mood lighting, soft music) is because it sees all the money being destroyed as it is paid back, and wants to make sure the economy is not devastated for want of money.

It's a bit like when our soldiers came back from World War II, having seen terrible destruction and loss of life, and created more than enough people to replace the ones they had kill in what we now call the baby boom.

Now, usually, when we talk about money, we think of bills and coins. But those are used to signify money. Money itself can exist with other kinds of signifiers, such as an entry on a ledger or a memory in a computer.

I'm glad we had this talk. If you have any more questions, don't be afraid to ask, it's better to do that than to create unwanted money or destroy money. I admit I'm not an expert, you can always try and get hold of Dr.. Yellen, who has brought more money into existence than you or I will ever have.