What Is Money And How Is It Created?


That “intellectual strategy” is actually a mistake, which is why mainstream economists miss the importance of banks in creating money. It isn’t just the Federal Reserve that can create money—as many people that Krugman labels monetary cranks believe—nor can the Federal Reserve control bank lending, as mainstream economists like Krugman believe.

Banks create money by issuing a loan to a borrower; they record the loan as an asset, and the money they deposit in the borrower’s account as a liability. This, in one way, is no different to the way the Federal Reserve creates money, which Rosenberg rails against as fraud. In reality it is simply the nature of a monetary economy: money is simply a third party’s promise to pay which we accept as full payment in exchange for goods. The two main third parties whose promises we accept are the government and the banks.

That’s simply the nature of money: it is not backed by anything physical, and instead relies on trust. Of course that trust can be abused—and frankly that’s done more often by the banks than by the government. But thanks to the anti-government attitude of monetary cranks like Rosenberg, and the dominance of economics by “barter cranks” like Krugman—who ignore banks completely and yet pretend to understand the economy—we continue to ignore the main game: what the banks do (for good and for ill) that really drives the economy.

Reddit discussion: http://www.reddit.com/r/Bitcoin/comments/2xgwpz/any_monetary_payment_must_therefore_be_a/