Is it money? It depends who's counting
(This is basically me blogging. I have a blog but I haven't posted in a decade, so I figure I might as well write here.)
We live in a weird times when people often question basic premises of economics. Some populists and/or scam artists promote cryptocurrencies, meme stocks, and other unorthodox investments. It's easy to make fun of. Meanwhile there has always been a populist distrust of banks (particularly in US history) and distrust has increased since the 2008 financial crisis.
A lot of populist distrust isn't based on any deep knowledge of how finance works, but rather a deep-seated feeling that someone must be getting away with something. And yes, someone probably is getting away with something, but that doesn't mean you need to believe every crank theory that becomes popular on Reddit.
That being said, I'd like to tell you about my slightly unorthodox way to think about money and banking. It comes to the same thing in the end (banks still work the same way) but it seems like a useful framework.
I'm going to set up a hypothetical example. There is a casino where gamblers use plastic chips to gamble, and there a cashiers' window where they can buy chips to gamble with when they arrive and turn them in for cash when they leave. So here is the question: are these plastic chips money?
From a gambler's point of view, when they want to know how much money they have, they count their chips. These chips behave as essentially as money for them, and I claim that they actually are a kind of money, at least within the casino. Though this is unlikely, you could even imagine a nearby store that accepts chips for purchases and goes later to the casino to cash them in. When the store counts its money, it would be reasonable to include any chips that it didn't turn in yet. You could think of it as "cash" or (in a more orthodox way) as a "cash equivalent" but this is a matter of accounting definitions; the chips serve the same purpose in the system.
When the casino counts its money, it never counts its own chips as cash. If they ask "how much cash does the casino have" then that's just the cash that the teller has behind the window. If they ask about the casino's financial assets more generally, if the chip is held by the cashier, it doesn't get counted at all; it's just worthless. All the chips that they gave out to gamblers are subtracted because the casino will lose cash when the gambler turns in chips before they leave.
So the status of a plastic chip depends on who's asking and how they're counting. The chip hasn't physically changed, but its status depends both on its location and your point of view. Weird, huh?
If someone says "this plastic chip is money," what kind of statement is this? Is it subjective? There are reasons why gamblers might disagree on the value of a chip. Let's say that, while the casino is closed, one gambler trusts that the casino will always honor its debts, but another has come to believe that they're a scam and they're never going to reopen, and your chips are worthless.
You might think of this as a prediction. Saying that "this chip is money" is a prediction that the teller will give you cash when you go to the window and other gamblers will treat it like it's worth money, and maybe the nearby store will too.
Such a prediction can depend on time. For example, maybe the chips could have an expiration date where the teller won't accept chips after that. So, from a gambler's perspective, the chip is money before the expiration date and no longer money after that. Or, more subjectively, a gambler might think that the casino will open tomorrow but be gone by next week.
So we see that statements about money aren't timeless, that they depend on your point of view, that they can be matters of opinion, but they are statements people will eventually be right or wrong about. In this way they are like promises and other predictions about the future. Nobody knows what the future will bring, but there are some promises we trust over others.
Okay, now we can look at bank deposits. What does the number in your account in the bank's computer actually do? For you and almost everyone else, bank deposits are money. (For example, they are officially part of M1.) But to the bank, they are a liability, because you can withdraw money from your account. From a bank's point of view, a deposit in any other bank is money, but the deposits in their own bank are not.
So a key point here is that banks create money, but only for other people. They can never create money for themselves, and they won't create money for other people for free, because they will pay later. How much later? Well, that's a prediction.
For the same reason, the teller in the casino won't just give you a chip, and the casino will have strict security to make sure nobody steals the chips. Sure, the casino owner could take a chip to a nearby store and buy something, but this is a form of buying on credit. This turns a plastic chip that's valueless for them into money for the store owner, but the casino will pay for it later.
Thank you for posting this. What's most interesting about this perspective, to me, is that the concept of money might be thought of as a thing unto itself, but your suggestion is to think of money more as something that exists by virtue of the transactional relationships it participates in. That is, in terms of graphical relationships, put more emphasis on the nodes and edges in the graph, in addition to the information flowing through them. This motivates thinking about not just money and people who have it, but all parties participating in exchange of money and when the exchanges occur across time.
Ehhh... I think you're getting hung up on the definition of "money." It's all assets and liabilities of various levels of liquidity and paper value vs. expected value. A casino's outstanding chips are assets in the hands of the gamblers or any nearby businesses that agree to exchange goods and/or services for those assets. To the casino, they're a liability because there's an expectation that chips can be redeemed for currency. If someone doesn't trust they can redeem the chip for the full value, they're assuming that the asset's real value isn't equivalent to its stated value.
It's not like the chip stops being a money equivalent if you don't trust that it's worth the paper value, you just have two currencies with a shifting exchange rate due to changing trust in the institution backing the currency.
For a bank, they absolutely do create money for themselves. Fractional reserve banking lets them create money out of thin air (or governmental expectations,) and indeed you just saw this happen in China, where the government let banks make billions of dollars appear just by easing the reserve requirements. The money is created "for free", and in some instances is given away as forgivable "loans" or for zero interest, but generally banks charge interest on the loaning of the money to cover their costs and/or make money. It's not a requirement, though.
The teller won't give you chips for free because they're an asset, not because they are or aren't "money," and the chips are as valuable to the casino owner as they are to anyone else, because they're still an asset.
I think my alternate explanation might be helpful for understanding situations like in China.
Using the casino example, suppose the casino makes a loan, and it does this by giving chips to someone. The borrower goes to the window to exchange the chips for cash, and that reduces the casino’s cash. Even though its own chips were involved temporarily, making the loan isn’t free money for the casino because it resulted in a withdrawal. The loan itself might be profitable later, or not, depending on what payments flow the other way.
To see the cash situation from the casino’s point of view, you need to follow the money, not the chips. Money usually flows out when it makes a loan and trickles back in again as it’s repaid. (On the other hand, making a loan in chips to a gambler who loses it to the casino doesn’t reduce cash at all.)
And this shows how making loans can be abused for fraud. If a fraudster controls the casino then they could make it give them a loan. A forgivable “loan” is a way of convincing the teller to hand out cash that looks legitimate, rather than looking like a robbery. The day of reckoning could be delayed by attracting more gamblers who put in their own cash. Eventually this could be bad for some of the gamblers, but as long as money keeps flowing in and gamblers keep losing chips to the casino, the game could keep going for a long time.
This is another way to be wrong about money. The casino (or, well, it’s essentially a bank now) might already be robbed but the employees don’t even know it. It depends on loan payments, which is a prediction that they could be wrong about.
From a real bank’s point of view, the situation is similar, except that its reserves are “real money.” Loans usually result in payments to other banks on the borrower’s behalf, using reserves. Making loans usually causes real money to leave the bank. This is why reducing reserve requirements allows more loans.
(Also: the plastic chips behind the counter are neither an asset nor a liability for the casino’s accountants. The casino can’t make money by manufacturing more chips and keeping them behind the counter. More chips behind the counter isn’t going to help if it’s out of cash, unless it can attract gamblers. You might compare with signing a check and not giving it to anyone.)
That's not true, though. Banks hold reserves, yes, but the money for the loans aren't made using those reserves, they're created at the moment of the loan. Even if a bank exceeds their reserve rate, they may get in trouble with the government, but they're still not paying out their own cash. Right, now, there is functionally zero reserve requirement in the US. The "real money" on hand is in the low tens of millions per bank, if that.
Also, while the chips behind the counter at a casino aren't a liability in terms of potential payout obligations, they would be an asset, as making those fancy chips is expensive and they're a physical asset for the business.
I'm really not sure of your point, though. You're making a lot of claims about money and chips and casinos and banks, and most of the specific points really don't match my experience working with and understanding money. Is there a larger philosophical point you're trying to make?
I think you might be misinterpreting the zero reserve requirement? It doesn’t mean banks don’t need to make payments when they make loans.
When you buy something with a credit card, the merchant needs to be paid even if they don’t have an account with your bank. Settlement needs to happen behind the scenes to make a number go up in the merchant’s bank. Banks don’t make numbers go up for free, so your bank needs to compensate their bank. This is why I’m saying that making a loan usually isn’t free for the bank. The money supply increases, but not in a way that makes it possible for the bank making the loan to make payments by “creating money.”
If you prefer you could read the Bank of England’s explanation which is the best I’ve seen from an authoritative source. I’m trying to explain things in a simpler way than they did, using an analogy that works for me and hopefully for others, but maybe it didn’t work for you?
I am quite clear that banks hand out money when they make loans, and that wasn't what I said. What the zero reserve requirement means is that they don't have to have the money in order to make the borrower's bank balance go up. It doesn't make the the bank's cash balance drop. It just appears, at that moment. This is a special power that banks have, provided to them by the government. Your link specifically supports my point, which is that the moment the loan is created by the bank, the money is also created.
Also, credit cards are regulated quite differently than banks, and don't have at all the same abilities and constraints as banks. You shouldn't conflate their respective abilities to make loans that look the similar on the consumer's end, and while the examples of how money flows between a purchaser, a seller, and a credit card company are similar to what happens in many loan situations, the way a bank and a credit card company fund their loans aren't really analogous. Credit card companies need to have the cash before they can hand it out, and banks don't.
I'm glad you're trying to provide a simple narrative for how money works, but it's important to simplify without adding in extra stuff that's flat out incorrect.
Yes, when a bank makes a loan by increasing a borrower’s bank balance, that’s just changing a number. Then, usually, the borrower spends the money, and their bank balance goes down again. So this locally created money (from the borrower’s perspective) is just a blip. In my casino analogy, giving out a loan as plastic chips usually results in a withdrawal soon after, so the plastic chips end up going back to the teller.
This is because the goal of a borrower usually is to buy something. If it’s a car loan then the car dealer’s balance needs to go up, at another bank.
So I’m not arguing that the borrower’s balance didn’t go up, but that it’s focusing on the wrong thing. Paying for stuff is what matters. A bank that makes a loan usually needs to be prepared to make payments for the borrower, or have cash available for withdrawal.
Also, as far as I know a credit card issuer is always a bank or credit union. (Sometimes it’s hidden. Discover and American Express own their issuing banks.) So a credit card loan is a kind of bank loan. I used that as an example to skip over the blip but I think the fundamentals apply to any bank loan.