Money does not move

In response to one of the commentators on yesterday’s post on the political economy of money, I mentioned one of the most difficult ideas that there is when it comes to truly understanding the nature of money. That idea is simply stated. It is that money never moves. That needs explanation.

I offer it by suggesting what I think most people believe, and then by suggesting why that is wrong.

Most people seem to believe that when they deposit money in a bank that somehow, and in a way that defies imagination, something moves tangibly from them to that bank, meaning that they then have, as is commonly said, “money in the bank‘.

In fact, no such thing happens. Instead, when a person deposits money in a bank, what they actually do is accept a promise from that bank that they will be repaid in due course. They promise, in exchange, to comply with whatever conditions the bank imposes on the management of that account. And that is it. Nothing moves. Instead, promises are exchanged.

There is nothing physical about this, or tangible, and the only manifestation of the existence of the deposit is the contract between the bank and the depositor, and the balance printed on the depositor’s bank statement, which reflects the accounts of the bank itself.

That is the sum total of what happens when “money is paid into a bank”. The bank’s ledger changes, and if the depositor also kept a ledger, then theirs would too, in an equal and opposite way.

There are, therefore, some computer entries to represent what happened. But, very importantly, there is no “money in the bank”.

Unfortunately, even if this can be comprehended, there remains another common and fundamental mistake that most people still make. This is the belief that because the bank is now in possession of some imagined asset that has a mysterious, tangible, and yet wholly unseen quality, that bank can then use the money deposited with them by a person and lend it to someone else. On the basis of this completely erroneous assumption, the whole model of banks as financial intermediaries is built, and it is total nonsense.

In practice, the bank has no legal right to assign the debt that they owe to the depositor to someone else. Their contract is to repay that sum to the depositor. To reflect that fact, the depositor’s account balance with the bank must be left unchanged until repayment takes place.  The bank cannot move that balance. They cannot assign it. They must simply maintain it. As a result, it is impossible for it to be used as the basis of a loan to another person who is completely unknown to the person who originally deposited the sum in the bank.

Instead, of course, what happens is that when the bank lends money it promises to make a payment to whosoever the borrower instructs and, in exchange, the borrower promises to repay the bank in accordance with the contract between them, including interest. It is that exchange of promises that makes new money. What is clear is that this new ending relationship is discrete and utterly distinct from any relationship between the bank and the depositor who thought that they put “money in the bank”.

This is not to say that, in aggregate, the depositor with a bank is not at risk as a consequence of the lending decisions that the bank makes. If that bank is reckless and makes loans to people who are unable to repay them then the bank might become insolvent. If so, it will not be able to fulfil the promise to the depositor and repay the “money they have in the bank”, not least because there never was any. That, however, is not a consequence of any direct relationship between the loan made and the deposit. It is because of the failure of the bank to manage its business properly.

It is precisely because we know the banks do not manage their businesses properly that the bank savings of most people in the UK are covered by guarantees of repayment issued not by the bank itself, but by the government.

The truth is that, deep down, we know that banks are not always good for their promises to pay. That is why we rely on bank guarantees instead when deciding to use a bank. But, despite that far too many people persist with the belief that they really did give the bank something that they can use to lend to someone else when they did not. They just exchanged promises, and that was it. And because those promises were not assignable not only do they not fund anything, but they also never move. Even when repaid, the record that they existed still remains. And in that case, the idea that money flows is simply not true: there is little that is more static in the world.

Money either exists, or it does not. What it does not do is flow. Instead, it is destroyed and recreated. But it’s then something different from the money that existed beforehand, because new promises will be involved. Understanding that is fundamental.