Adding Private Banks to the Mechanical Exercise

This is a follow-on for the recent post "A Mechanical Exercise Tracking the Creation and Lifespan of Fiat Money" (METC). In the original exercise, the user made all of the economic decisions. Private banks were money users. In this post, we introduce private banks into the role of decision-making for the process of creating money.

Figure 1. The raw material for money
creation by private banks.

In METC, we needed a virtual storehouse to store real tokens that we could later call "money". Here we introduce a private bank's version of a virtual storehouse which is, of course, real all the time.

In the drawers of this new storehouse (Figure 1), we have existing money sources that the banks can use to ensure that new borrowers have access to existing money. So how is it that new fiat money can be created in this new version of METC? Private banks take systematic advantage of the pool of money on deposit by making a loan without linking loan risk or deferred spending to any one account. The loan is made by creating a deposit account for the borrower. Loan risk is spread to the entire body of depositors, including the lending bank. Deferred spending is transformed into accelerated spending. As a result of the loan, the amount of money on deposit in the banking system is measured as increasing. *

Now to use money belonging to others sounds like a reuse of existing money. You might think of it as being the same as if I made a loan to you, wherein I clearly used money that I owned. Both cases reuse existing money. 

So, what does the bank do that is so different? Because the bank is lending money that it does not own, bank borrowers do not need to first work for the position to which they are assigned in the banking system (All depositors are equally able to spend-out their account balances.). The bank has not only apparently created money, but the bank has also made available equal access into the marketplace. This has serious implications for what money really is, making it appear to be like a valuable ticket rather than being a pure expression of past work or wealth. [The tickets we envision here are like concert tickets that are valuable and tradable until they are finally put to conclusive use. Read "Money is Not an IOU, It's more Like a Ticket." for more on this alternative perception of money.]

If we use the "money is a ticket" analogy, then bank deposit records are the current ownership record of tickets past-issued. The sum of all deposits becomes the money supply.

Knowing how many tickets are currently available is a very useful management tool that can be used to prevent the over-issuance of tickets.

What happens when a currency issuing government borrows from private banks? The process is the same with one exception: A government bond is usually judged by bank regulators as being nearly cash. Therefore, government bonds can be substituted for holding actual cash reserves up to some limit. (Any interest payments on government bonds bought with funds provided by depositors can be a source of income for banks.) Of course, the indicated money supply goes up after each such borrowing event when the borrowed money is spent into the measured economy.

Using METC with private bank decision making ability

To run the actual exercise, we follow the original exercise by replacing the drawers with envelopes and coins. For each exercise transaction, relocate a loan document coin and fiat money coin to the appropriate sector envelopes. When drawers/envelopes containing preexisting coins become empty, you know it is time to relocate money from sector envelopes at least partially back into the common deposit drawers/envelopes (which completes one round of the exercise).

Notes:

* There should be no question that the money supply owned by the private sector grows.   To see the growth recorded as money supply and total of customer owned bank accounts, follow the links to the FRED sites M2NS and commercial bank deposits.

(c) Roger Sparks 2022