1. The Current Monetary System and the Need for Change
John N. Howell
1. What is money?
2. Who creates money?
3. How is money created? (How do banks create money?)
4. Banks, money, the economy: what is the big picture?
5. How are banks different from other lending institutions?
6. What is the role of the central bank (the Fed) in money creation by commercial banks?
7. How would all this be different under a sovereign money system?

2. Account money – numbers in computers
1. What is money?
$$$$$$$$$$$$$$$$$$$$$$$$$$$$
$$$$$$$$$$$$$$$$
Account money – numbers in computers
Currency (cash)
Cash now represents about 3–15% of the stock of money (M1), depending on the country, and a continued declining share in the long run.
When referring to broad money aggregates (M2/3/4 which include, for example, deposit savings and money market fund shares) cash amounts to only 2–10%.
Joseph Huber, Real-world Economics Review, issue no. 80

3. Money (account money) is being created all the time – over ¾ of a trillion dollars within the last year.

4. 2. Who creates this new money, $750 billion a year?
Question: Who creates the bulk of new money?
The government – perhaps through the Treasury Department?
The Federal Reserve?
Banks?
I don’t have a clue.

5. Assets
What the bank owns
What is owed to the bank
Liabilities
What the bank owes
A bank balance sheet
1. Cash, central reserves, bonds (liquid assets)
2. Loans to customers
(illiquid assets)
1. Customer deposits
2. Stockholder equity
Example of a bank loan: Jack takes out a $10,000 loan. Here is the new information that is entered on the bank balance sheet.
Assets
Liabilities
$10,000
$10,000 – Jack’s account

6. Jack now writes a check to Sam for $10,000.
Jack buys a car
Jack now writes a check to Sam for $10,000.
Sam happens to have an account at the same bank.
The bank balance sheet changes.
Assets
Liabilities
$10,000
$0 – Jack’s account
$10,000 – Sam’s account

7. What if Sam banks at a different bank?
Federal Reserve bank transfers $10,000
from the reserves of Jack’s bank
to the reserves of Sam’s bank.
The reserve bank would now have a liability of $10,000 to Sam’s bank instead of to Jack’s bank.
The banking system acts like one big bank.
(The clearing house function of the Federal Reserve Banks)

8. From M. McLeay, et al. Money Creation in the Modern Economy, Quarterly Bulletin (Bank of England), 2014, Q1, pp

9. As bank lending proceeds, the money supply increases, and total bank assets increase.
The money supply doubles, but the banks haven’t lost any liquid assets. They can continue to lend. Note that the banks could only provide money to half its depositors, if all the depositors wanted to withdraw their money at the same time in cash, as in a bank run. Bank runs are a thing of the past since all accounts are now insured by the federal government. Regulations require banks to retain a certain fraction of the assets as liquid reserves, typically 10% in this country, to make sure the banks will be able to provide cash if it is demanded.
With 4 loans, the money supply (deposits) have doubled. Liquid assets of banks have NOT decreased, although they are now a smaller percentage of their total assets.

10. 4. What is the big picture?
Assets
Liabilities
$10,000
$0 – Jack’s account
$10,000 – Sam’s account
Jack takes from the economy to repay the loan
Sam spends into the economy.
The Economy
Loans stay ahead of repayment and keep the system in “money.” Loans keep the system afloat. This looks sustainable.

11. Problem #1
Assets
Liabilities
$10,000
$0 – Jack’s account
$10,000 – Sam’s account
Repayments
Loans
The Economy
When loan-making slows down as repayments continue, the money supply shrinks and we have recession or depression.

12. Problem #2 The bank created the principal, but not the interest.
Interest payments
Assets
Liabilities
$10,000
$0 – Jack’s account
$10,000 – Sam’s account
Jack takes from the economy to repay the loan plus interest
Sam spends into the economy.
The Economy
The bank created the principal, but not the interest.
Where does the borrower get the money to pay the interest? Where does the economy get the money to pay the interest?

14. But wait! Where do those interest payments go?
Assets
Liabilities
$10,000
$0 – Jack’s account
$10,000 – Sam’s account
Repayments
Loans
The Economy
Don’t interest payments also get fed back into the economy?

15. Some interest does filter back into the economy,
Interest payments
Financial sector grows.
Bank assets
Bank liabilities
$10,000
$0 – Jack’s account
$10,000 – Sam’s account
Jack takes from the economy to repay the loan
Sam spends into the economy.
The Economy shrinks or fails to grow.
but much of it stays in the financial sector as investments. (Note the current record levels of the stock market and the record level of inequality of wealth distribution.)

16. In a debt money system, to keep a constant money supply in the economy,
the total money supply rises exponentially as money is filtered off into the financial sector.
The steepness of the exponential rise is primarily a function of interest rates.

17. Money creation by banks is a process by which wealth is systematically transferred from the many, the borrowers, to the few, the lenders, through interest payments.

18. Interest flows from the bottom 80% of the population to the top 20%.
Lietaer, B., et al., Money and Sustainability: the Missing Link (2012)

19. Progressive fiscal policies ( ) have slowed this wealth transfer, but have not been able to bring it to a halt.

20. 5. How are banks different from other lending institutions?
Only banks (depository institutions) create money when they make loans.

21. Lenders, including banks, do face constraints to lending.
Assets Liabilities
Assets Liabilities
“cash” or “reserves”
loans
deposits
deposits
“cash” E E
As loans increase, “cash” decreases.

22. As “cash” approaches zero lending has to stop.
Assets Liabilities
Assets Liabilities
“cash” or “reserves”
loans
deposits
deposits
“cash” E E

23. But any lender can borrow more money to be able to continue to lend.
Assets Liabilities
Borrowed money
This new “cash” can be lent out.
“cash”
Assets Liabilities
“cash” or “reserves”
loans
deposits
deposits
“cash” E E

24. Is there a limit to the borrowing?
Assets Liabilities
“cash”
This new “cash” can be lent out.
Yes, for nonbanks, it’s the market.
Can the lender find another lender willing to loan at rates that will permit further profitable lending?
loans
deposits
“cash” E
For banks, the situation is different, because, at least in principle, they can turn to the lender of last resort, the central bank.

25. When commercial banks need money, the central banks provide it.
6. What is the role of the central bank in money creation by commercial banks?
Central bank
Commercial bank
Assets Liabilities
“cash”
loans
deposits
“cash” E
When commercial banks need money, the central banks provide it.
Central banks create new money, called reserves, for banks.
Those new reserves provide the liquid assets necessary for continued lending by banks.

26. 5. How are banks different from other lenders?
Two distinctions:
1. As banks, they can go to the central bank for loans provided at very low interest rates.
2. As depository institutions they have customer deposits to use as the basis for lending.

27. Money supply is unchanged.
7. How would all this be different in a sovereign money system, as proposed in the NEED Act?
Sovereign Money System
CD – customer deposits CD A L
Loans decrease liquid assets of the bank, as money is transferred from bank A to a checking account in Bank B.
Total bank assets remain unchanged.
Money supply is unchanged.
Bank A $
Bank B
The money supply is the sum of liquid assets of banks plus customer deposits.

28. Conclusions
The current monetary system is unstable and unfair.
The current monetary system is unsustainable in that it lies at the root of the increasing concentration of wealth into fewer and fewer hands, an unstable social condition.
Monetary reform offers a fair system of money creation, a more stable economy, with the possibility of funding infrastructure repair, education, and health care without cutting other programs, without raising taxes, without increasing federal debt.
A consideration of monetary reform, as proposed in the NEED Act, should be part of the national conversation about how to make the future just and sustainable.