Money and Currency
Since this topic seems to cause a lot of confusion, I thought this thread was needed to help clarify a few things. I do not claim to know anything, I am only reading material that comes from reliable sources and coming up with my own interpretations. These interpretations often change when new material is discovered. I would encourage everyone to look for yourself and search for your truth.
[greenmachine wrote]
Yes, I think banks lend money that they have
as a result of people who deposit it with them
and/or invest with them plus the corporation's
existing stock of capital.
This seems to be a common misconception that most people believe. Why is that? I'm not sure but it may have something to do with the fact that if citizens do not understand the money system then they certainly can't get ahead within that system. Also, if the truth as I see it ever was accepted by the masses there would be problems within the system.
An example:Imagine there is only one bank in the country and that it has two private depositors, each with $50 in his checking account. Total bank demand deposits would then be $100. Suppose John Jones asked for a $50 loan from the bank, and the bank approved the loan. The bank would then lend the money to Mr. Jones by simply opening a checking account for him and depositing $50 in it. This is
what ordinarily happens when anyone-business or private individual-borrows from a bank. The bank deposits the amount of the loan in the relevant checking account.
In making the loan to Mr. Jones, the bank did not reduce anyone's previous bank balance. It simply credited the Jones account with $50. The total amount held in bank demand deposits now becomes $150, The bank has, therefore, issued $50 in "checkbook money."
This quote is from Money and Banking 6th ed.
It is a bit long but it gives a good explanation...
What is a bank deposit? A simple question, isn't it? Anyone can answer
it. Unfortunately most people will answer it incorrectly or, at best, inexactly.
If, without reading farther, you can accurately define bank deposits, you are
the exception.
There is a persistent confusion respecting deposits.
1. Deposits are our most important money. Yet to the bank, the deposits of
its customers are not money at all.
2. You take a handful of currency to the bank and deposit it. However, under
no circumstances whatever do the bank's deposits consist of currency.
3. Most people suppose that a bank lends the deposits of its customers. In
fact, however, no bank ever lends its deposits.
These apparent contradictions result from the fact that we regularly use
the word deposit in two entirely different, and completely inconsistent, ways.
Ambiguity is inevitable unless we clearly specify which meaning the word is
to have. We cannot possibly, in an analysis of bank operations, follow the
common practice of allowing deposit to mean one thing one moment, something
entirely different a moment later.
Specifically, we must decide whether we are going to consider a deposit
as being the thing that is turned in to the bank-the actual checks on other
banks and pieces of silver and currency-or as being the sums owed to depositors.
These two things are not the same at all, for one is an asset, the other a
liability of the bank.
Logically, perhaps, the term deposit should refer to the physical asset that
one surrenders to the bank. There is no difficulty in understanding what has
taken place if we say someone deposited $50 of currency or made a deposit of
$300. The customer turned in that amount to the bank, and the word is used in
accordance with the first definition.
But then we say, "The customer has a deposit of $300," and we have
swung over to the second definition. The deposit is an asset of the customer.
It cannot possibly be at the same time an asset of the bank. Exactly what is
the customer's deposit asset? Certainly it is not the handful of currency or the
check the customer turned over to the bank teller, for these are now assets of
the bank. The asset the customer received in exchange was a claim on the
bank. From the bank's point of view, this deposit, as such, is a liability. When
the bank increases its assets (currency, checks on other banks, other negotiable
instruments), it increases its liabilities by an equal amount (or sometimes gives other assets in exchange). In this respect it is no different from any other firm.
Two hundred years ago, banks gave their notes in exchange for coin (and
other assets) rather than giving deposit credit for it as they do today. The
increase in the bank's liability, offsetting the increase in its assets, was in the
volume of its notes outstanding. There was no chance for ambiguity, since the
promissory notes that one has given to others are clearly and unmistakably a
liability for the giver. The item "Deposits" did not appear on the bank's balance
sheet at all.
But as present-day banking techniques evolved, especially in the United
States, the banks ceased to issue notes. Instead, when a customer brought in
specie or other forms of money, the bank simply made a record in its books
that it owed that sum to the individual. Probably some word other than "deposits"
would have been less troublesome. If at the outset the banks had
called these "Customer Accounts," perhaps, or "Public Credits," much confusion
might have been avoided. Unfortunately they termed the liabilities
"Deposits" because in a great many instances it was a deposit (asset) that
created the liability.
But the importance of deposits (in the sense of liabilities) lies in the very
fact that they do not necessarily result from deposits (in the asset sense). The
particular asset that customers leave with the bank is not important. So although
we may agree that, logically, deposits should refer to bank assets, we
shall use this term only to refer to the bank's liabilities to its customers. This
choice is not an arbitrary one. Bankers themselves universally agree in drawing
up their balance sheets to list as deposits the sums that they owe. A bank
never lists as deposits its holdings of currency and coin. These holdings of
currency and coin are classified as Vault Cash and appear, quite properly, on
the asset side of the sheet.
A bank's deposits, then, are the amounts that it owes to its customers.
Most individuals whom the bank owes at any particular moment will be individuals
who have brought some sort of money to the bank. These specific
dollars then belong to the bank, which may use them in any way it wishes-as
a basis for lending or for paying current expenses or as a pool of idle funds.
The bank agrees in return to make the same number of dollars (but not the
same pieces of currency) available to the customers at any time they may
wish to have them.
But some individuals to whom the bank is in debt may never have brought
any form of money to the bank. The bank's employees, the telephone company,
the firms from which the bank buys its office supplies, all have claims of
one sort or another on the bank. Periodically, usually the first of the month,
the bank will change the form of most of these miscellaneous liabilities. Many
of these creditors then hold deposits in the bank instead of their bills for
goods and claims for wages. (Creditors who bank elsewhere will instead be
paid by a cashier's check, which is another form of bank liability.)
As a result the bank owes no more and no less. It has simply changed the
form of its liabilities. The process is somewhat akin to that of a corporation
that sells bonds (borrows on long term) and uses the receipts to pay off its
short-term indebtedness, except that the bank, instead of converting shortterm
liabilities to long-term, is converting them to demand liabilities. These
deposits are, of course, completely indistinguishable thereafter from deposits
originating in other ways.
Still a third and extremely important group has claims upon the bank because
its members have borrowed from the bank. There has been an exchange
of liabilities. The bank holds the borrower's promissory note and the borrower
holds a deposit in the bank. It is very important to realize that the
deposits of these borrowers as well as the deposits provided for the ernployees
and business creditors mentioned in the preceding paragraph are not
"borrowed" from the first group of deposits. They are in addition to those
deposit liabilities. And this power to create deposits is the reason banks are so
important to the economy.
CREDIT EXPANSION BY THE INDIVIDUAL BANK
Usually a commercial bank makes a loan by crediting the borrower's account.
There is no need to pass currency back and forth. It is more convenient
for the borrower to spend the proceeds of the loan by drawing checks
against his new deposit. These checks are received by other people, who can
either:
1. cash them, forcing an increase of currency in circulation outside the
banks; or
2. deposit them to their own accounts, possibly in the same bank, more likely
in other banks.
So far as the total money supply is concerned, the interrelations between
an increase in deposits and the resulting drain of currency into circulation are
more significant for the banking system as a whole than for the individual
bank. We shall consider them later in this chapter.
If the loan-created deposit is transferred to other accounts in the same
bank, the bank's total deposits are unaffected by the transfer. The bank owes
less to the person who has written the checks (in this case, the borrower) and
more to those who have received them.
However, as the borrower writes checks against the new deposit, the
bank that lent the money will most likely lose reserves and deposits to other
banks. Total deposits of the banking system are unaffected by the transfer of
deposits from one bank to another, but the shifts are of vital significance to
the individual banks.
This should at least get everyone thinking a little bit
. GAAP which all banks abide by is an accounting practice that uses a double entry bookkeeping system. Which means that for every entry on the credit side of their ledger they need to enter a corresponding debit. This is to keep their books straight and shows how money/credit flows.
Now I ask you this question... When an individual goes to a bank and gets a home loan, did the bank loan him anything?
