Money, Money, Money

Money, money, money
Must be funny
In the rich man’s world
Money, money, money
Always sunny
In the rich man’s world
A-ha, ah
All the things I could do
If I had a little money
It’s a rich man’s world

(Abba)

Money today is simply a claim on a bank. In the case of cash, it is a claim on the Federal Reserve Bank (Fed). Otherwise it is a liquid deposit in a commercial bank, S&L, credit union or similar institution which can be converted to cash. By law, any debt, public or private, can be settled with cash.

Banks do not lend depositors’ money. Or anyone else’s money. Nor do they lend their reserves (money banks deposit in the Fed). They create the money that they lend. The proceeds of a loan transaction are deposited in the borrower’s bank account. The money is not transferred from anywhere. The loan is added the asset side of the bank’s balance sheet and a  deposit is added to the liability side. This deposit becomes money because it now meets the definition of money (see above). This is also exactly what the Fed does when it monetizes Federal debt. It buys Treasuries (loans to the government) from a bank or other approved institution, which become Fed assets, and credits the purchase price to the seller’s Fed account. Which, by definition, is money.

If the loan is not fully repaid, eventually the loan is “written off”. In this case, the unpaid amount – loss – is charged to the bank’s equity capital.

Edit: Note that bank reserves are not included in M1, which is not affected by the Fed’s Treasury purchases from banks. Bank reserves are included in the broad money supply, the monetary base (MB).