Money is created when it is spent into existence by the sovereign. Money is also created when it is loaned into existence by bankers. Most money is created by bankers. Money circulates in payments between subject (non-sovereign) parties in exchange for goods and services. Money is destroyed when it is paid to the sovereign for taxes and fees. Money is also destroyed when loan principal is repaid to the owner of the loan. Finally, money is destroyed when bankers write down bad debt.
Money is created when it is spent into existence by the sovereign.
To maintain a theatrical facade of old-fashioned, finite,
commodity-oriented money, which serves well the cause of austerity,
modern sovereigns typically pretend that tax and fee revenues,
combined with borrowings, are the source of funds
that are spent by the sovereign.
This is a charade.
Indeed, without the sovereign spending to create the money,
there would be no basis for paying taxes
other than loan creation by private banks.
to require a sovereign to
the shortfall between revenues and spending
is mainly an indirect subsidy to the richest segment of society,
via the associated interest payments,
since those sovereign bonds are the only debt instrument
that is free of the risk of involuntary default.
The excess of sovereign spending over revenue,
typically referred to as the deficit on an annual basis,
or as the national debt in aggregate,
is the only pool of financial assets in the economy
which are free of the risk of involuntary default.
These are the safest of financial assets and are prized as such,
especially in times where fear is outweighing greed
in other financial markets.
We might as well refer to them as the national wealth.
Money is also created when it is loaned into existence by bankers. A loan origination results in four balance sheet entries. On the bank's balance sheet, the loan creates an asset, which is the borrower's promise to repay. The loan also creates a bank liability, which is the deposit available for the borrower to use. For the borrower, the loan creates an asset which is the deposit at the lending bank. The borrower's liability is the promise to repay the lender. All four of these entries have been created from nothing except the agreement to enter into the loan! The money created is embodied in the deposit, which is the bank's liability and the borrower's asset.
Money is destroyed when loan principal is repaid to the owner of the loan; both the loan asset and the corresponding borrower liability are reduced by the amount of principal repaid. The owner of the loan keeps the interest repaid as revenue; that money has to come from elsewhere in the economy. Default on the loan by the borrower impairs the asset, possibly forcing the bank into insolvency. When the sovereign creates money, the liability is the acceptibility of the money for payment of taxes and fees to the sovereign. The sovereign can never be forced into default although any subject may be forced into involuntary default for failure to make timely payments.
Between the creation of the money by bank lending or sovereign spending, and the destruction of the money by loan repayment or taxation, the money can circulate amongst subjects, facilitating transfers of resources in society.
As the then-governor of the Bank of England Mervyn King once explained, it is the private commercial banking system thatprints95 percent of broad money (money in any form including bank or other deposits as well as notes and coins) while the central bank issues only about 5 percent or less. In a lightly regulated system, it is private commercial banks that hold the power to dispense or withhold finance from those active in the economy. (p. 3; bold added)
From Well and Truly Buried, a review of Pettifor's valuable book:
The creation of money via bank lending requires the participation of a borrower who is willing to undertake the burden of repayment with interest and to risk whatever collateral the lender will require. Although Pettifor considers thisin a sense democratic(p. 106) that seems quite a stretch to this reader in that qualifications for borrowing do not seem to correlate very strongly with those for citizenship. Nonetheless, there is valuable insight in recognizing the importance of demand in money creation. In times of exuberance, tolerance for risk will be high, and borrowers will be lining up for loans. Money creation explodes and inflationary pressures rise as more money chases limited assets and services. When asset prices rise accordingly, bigger loans are authorized against more valuable collateral, creating a self-reinforcing cycle that, unchecked, inflates a speculative bubble.
Conversely, as greed gives over to fear, risk tolerance plummets and borrowers flee so bank money creation too plunges, further contributing to deflationary pressures. As fear intensifies and demand falls, investments are cancelled or postponed and employees are discharged. As asset prices fall, loans go bad when the underlying collateral is devalued, reinforcing the deflationary tendency. These feedback mechanisms in enthusiasm and revulsion for lending are at the heart of perhaps the most useful theory of the business cycle, the financial instability hypothesis due to Hyman Minsky. Where once bank failures and fraud prosecutions put a consequence to reckless lending, today lenders can be confident of the backing of the central bank no matter how irresponsibly they deploy capital.