Where does money come from?
December 15, 2009
The simple answer is: "from nothing." The more accurate answer is debt.
To explain this one, I will describe the Canadian Monetary system, which the basic principals can be transfered to pretty much every other nation's money system.
In an earlier post I talked about today's bank notes is called "money" only because the Government says it's money. Without the backing of the Government, Bank notes would simply be worthless pretty pieces of paper. But where does "money" come from? The Bank of Canada basically just prints some colorful paper, slaps the words "this is legal tender" on it, and injects it into the banking system. Nowadays, they don't even need to print the money, they just enter a few numbers into a computer and pesto, money is injected into the banking system. The bank offsets this with an accounting entry and records the debt as an asset on their books (kinda like an Accounts Receivable) and later packages all the debts into an investment of some kind, like a Government Bond as an example, and sells the Investment to investors.
Why is this important?
If we watch the amount of money that gets created (either by the BoC or by the Chartered banks,) we can estimate the impact on the purchasing power of our dollar. We can estimate future foreign exchange rates. We can estimate future inflation. We can estimate future interest rates.
If we can begin to predict some of these kind of things, we can make life decisions now that will help us in the future.
To explain this one, I will describe the Canadian Monetary system, which the basic principals can be transfered to pretty much every other nation's money system.
In an earlier post I talked about today's bank notes is called "money" only because the Government says it's money. Without the backing of the Government, Bank notes would simply be worthless pretty pieces of paper. But where does "money" come from? The Bank of Canada basically just prints some colorful paper, slaps the words "this is legal tender" on it, and injects it into the banking system. Nowadays, they don't even need to print the money, they just enter a few numbers into a computer and pesto, money is injected into the banking system. The bank offsets this with an accounting entry and records the debt as an asset on their books (kinda like an Accounts Receivable) and later packages all the debts into an investment of some kind, like a Government Bond as an example, and sells the Investment to investors.
The real magic of money is done at the public bank level though. Much in the same way, Chartered banks in Canada can create money out of nothing. They do it by lending it out to people. Some will ask "don't they lend out money that is kept on deposit from other bank customers?" The answer is no. It used to be kinda that way: prior to Prime Minister Mulroney, the banks used to have to hold at least 8% of deposits in their vaults and they could lend out the other 92%. That in itself is outstanding, because it basically means that the banks could lend out 11.5 times what they had on deposit. But Mulroney changed the fractional reserve rate down to 0%. This basically means that the banks can lend out money even if they have $0.00 in their vaults. There is no limit to the amount they can lend out.
Why is this important?
If we watch the amount of money that gets created (either by the BoC or by the Chartered banks,) we can estimate the impact on the purchasing power of our dollar. We can estimate future foreign exchange rates. We can estimate future inflation. We can estimate future interest rates.
If we can begin to predict some of these kind of things, we can make life decisions now that will help us in the future.
Posted by Dave Robertson.
