Home > Macro/Monetary Theory > Misconception #1: Money is Debt

Misconception #1: Money is Debt

I was going to write a long post about how nobody understands monetary economics, but I’m not moving very fast tonight so instead I will do it as a series.  This way it will keep you coming back for more.  Besides, this is probably the biggest thing that people don’t get, and don’t get that they don’t get.  So take the time to mull it over and the next time you read something about hyperinflation, ask yourself whether you think the author understands the difference explained below.  So without further ado, the first thing that people don’t understand about money.

Misconception #1: Money is debt

Money is not debt.  It is, in fact, the opposite of debt.  There was a time when you could deposit precious metals in a bank and they would give you a bank-note which was a promise to pay you precious metals in return for the note.  At that time money (bank notes) was debt.  Now money is created differently.  The Federal Reserve creates money by “printing” it and buying government debt with it.  The debt must be repaid with the same type of money.  In other words, if you have a dollar, you are not holding a promise by someone else to pay you something, you are holding the right to repay $1 worth of loans.  Money is anti-debt.

The same thing is true if your dollar was created by a lesser bank.  These banks don’t print money, they create bank credit.  They do this through fractional reserve banking.  In other words, they can loan more money than they have on hand.  So if they have 100 Federal Reserve dollars in the vault and the reserve requirement is 10%, then they can support $1000 worth of loans.  So if you want a loan, you go to the bank and say “I want a loan.”  If they say yes, then they assign you an account with, let’s say, $200.  You now have an account worth $200 and you owe the bank $200.  The $200 in your account is capable of extinguishing the debt you owe.  But it can also extinguish other debts.  Because of this you can use it to buy a boat and the boat-maker can use it to pay off his loans.  Of course, then you have to get another $200 from someone else later to pay off your debts.  More on that later.

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