So, here's the first "monster thread" on #money . In this one I will explain, how money is/should be created and why all credit (money) created by the #CentralBanks corrupts our monetary system. A brief history of central banking to start with. 1/24 mtmalinen.substack.com/p/money-163

How is #money created in the modern #economy ? Most money is created by commercial banks through standard loan issuance (bank deposits). Here's an excellent study explaining and empirically showing the process by @Richard Werner . 2/ sciencedirect.com/science/articl…

In short: When a person or a company takes a loan, a bank creates a double entry to its balance sheet. One adds the loan to the asset side of the borrower and the other credits the deposits of the borrower's account. 3/

When the loan is paid back, the money is "destroyed", and the double-entry in the bookkeeping disappears. (There's an inclusion; more later.) If a bank gives out too many risky loans, loan defaults can lead to substantial losses and to insolvency bankrupting the bank. 4/

Simple accounting rules and rules of the market economy tend to hold the money creation at bay, but it's also restricted by regulation from the government and reserve requirements issued by the central bank. 5/

So, banks need to obey the budgetary limit, which is partly set by the economic agents, and partly by the central bank through interest rate decisions and reserve requirements. Moreover, if the projects of households and corporations, funded by loans from a bank... 6/

... turn unprofitable, so will the bank. The share of so called non-performing loans, in the overall loan portfolio of a bank increases, hurting it profits. This means that money creation by commercial banks is inherently also bound... 7/

... not just to the riskiness of their loan portfolio, but also to the overall health of the economy. The credit created by banks accounts for approx. 80% of all new money entering circulation. Rest comes from central banks and/or the government. 8/ bankofengland.co.uk/knowledgebank/…

The figure below shows the trends in global money (credit) creation by commercial banks. It quite straight-forwardly implies that something in the global banking system broke in 2020 (like during 2008 and 2011/2012), and the situation has not improved. 9/

It's possible, even likely, that we have been in "hidden" global banking crisis since 2020. However, the reason we are in this very fragile financial environment has less to do with banks than with #CentralBanks . 10/ mtmalinen.substack.com/p/global-liqui…

Central bank is the monetary authority in most countries of the world nowadays. This means that it controls the issuance of currency notes, or cash, it monitors and supervises the banks, and it it's also the 'lender of last resort' for banks during crises. 11/

In a simplified balance sheet of a central bank, money, the government's bank account (domestic liabilities) and the reserves of commercial banks and net worth are on the liabilities-side. 12/

Asset-side of the central bank's balance sheet include securities, foreign-exchange reserves (net foreign assets) and loans to commercial banks. Thus, when a central bank buys assets, like government bonds, it simply either creates money directly (the old way) or... 13/

... debits the reserves of commercial banks to maintain balance between assets and liabilities (the modern way). In the programs of quantitative easing (QE), or asset buying programs, central banks have been using the latter option. 14/ mtmalinen.substack.com/p/quantitative…

And now, the 'beef'. This accounting rule twisting ability means that central banks need not to obey the fundamental economic principle of scarcity, which dictates the distribution of scarce resources. To simplify, they do not have any budgetary limit in a normal sense... 15/

... and they can, theoretically at least, cover any losses by printing more money and earning seigniorage revenue (the difference between nominal value and "printing" cost of currency). Alas, the money central bank creates has no foundation, no basis in the real economy. 16/

It has not arisen from a transaction that has required labor or capital inputs and/or risk taking. More precisely, there's no risk-reward relationship dictating the money creation of a central bank. The central bank just conjures the money (currency). 17/

Why is this important? Because money was created to facilitate exchange of goods and services. When banks lend money (with a risk), to finance an investment, it facilitates a business exchange, following its original purpose or 'nature'. 18/ mtmalinen.substack.com/p/money

More precisely, when a commercial bank creates money (credit), it takes a risk. It's a business transaction for the bank and for the borrower. That is, #money created has a business counterpart and business role in the economy. It enters the economy in a correct form. 19/

However, when a central bank creates money, there's, e.g., practically no risk. Moreover, it is not created as an effort to enter into a business transaction with anyone, but to manipulate the economy, i.e., to manipulate the prices of capital and money (interest rates). 20/

Alas, the money central banks create, is corrupted and we can even argue that it makes the economy "sick". Because of the large flow of #money created by #CentralBanks , prices in our economy are not prices set by businesses, but they are artificial, set by central bankers. 21/

It's almost certain that our economies would be in a better share, if there would not be money created by central banks making a mess of things. For example, before the creation of central banks, periods of hyperinflation, where the purchasing power of money collapses... 22/

... were practically unheard of. There were periods of rapid #inflation , due to e.g., debasement of metallic coins. They just underline the fact that the destruction of the value of money usually requires some (massive) government meddling or manipulation. 23/

What the #CentralBanks are now trying to create with their digital currencies (#CBDCs ) is something even more horrible, but that's a topic of another thread. /End #FederalReserve #ECB