Some people think that because banks create fiat money out of thin air it is not real money, and so they might call it funny money, but what is money?
Money is work done or the promise to do work, i.e, you can buy a product that someone made (work done), or get someone to do work for you.
So, do banks create money out of thin air? What they do is get you to sign a contract that you will promise to do the work necessary to pay money back, in other words, the borrower creates the money by doing work, often over many months, or years. So we could say the borrower gives the fiat money value as he works to pay the loan off.
So you get a loan for $10,000 and the bank credits your account by putting in the number 10,000 and it appears that the money came out of thin air, as libertarians believe. But let's say now that the borrower does two hours overtime a night to pay off the loan and it takes him two years to do it, and as he pays his loan off the amount be owes goes down and the 10,000 figure slowly gets reduced to zero.
So you can see that the borrower created the money by doing work. The fiat system - where the money is created up front - is a brilliant system for facilitating this money equals work process where people can do the work after they have got the fiat money as a loan (where this loan is the promise to do work that will be done in the future), and as they work to pay off the loan the money is given its real value. The work they do is the money.
Fiat money smooths everything out so you don't have to make what it is you need yourself - so you can work in accounting instead, or whatever. Fiat money makes it easy for us do work for each other. By getting the fiat money upfront as a loan, we then have to do the work to pay off the loan. So, money = the work we do.
So you can see that fiat money is real money.
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Kevin,
I think you are underplaying the role of the Banker, and society in this. The banker relies upon the fact that he knows you, and that you are good for fulfilling your word. On the other side, the banker is accepted by the society for being good on his word. So all three, you, the banker and the society at large are what gives money (the banker's paper note) its value.
Government fiat money is slightly different than the banker's fiat money, and the government relies upon its power to extract work from you, and the rest of society in return for its promise to accept the note in return for cancelling a tax liability, and other fees due to the government.
Future income is only one of the metrics that banks use in assessing credit.
The second and usually more important one is collateral. Collateral can be viewed as past work that is embedded the collateral as "real savings."
Credit not only draws income forward but credit also liquifies collateral making the collateral "work" without relinquishing ownership.
Yes Unknown, the whole system is built on trust. Trust is not physical, but an idea, a thought.
Government fiat money is slightly different, but many libertarians believe that real money has to be tied to gold, and that even private bank fiat money is not tell money unless it is pegged to commodities.
This doesn't mean that banks don't abuse the system and create too much money driving asset prices up, and then getting everyone into enormous debt just to buy a home.
So you can see that fiat money is real money. KV
What you are calling fiat money is bank credit - mere liabilities for fiat, not fiat itself.
Except for physical fiat, aka "cash", only the banks, credit unions, etc. may use a Nation's fiat*, not the citizens themselves. Instead, the citizens must use the liabilities for fiat, including the ones the banks themselves create, of what is, in essence, a heavily privileged usury cartel.
The essential difference is that fiat is meant to serve the general welfare while bank credit serves the private interests of the banks themselves and the most so-called credit-worthy of what is, in essence due to government privileges, the public's credit but for private gain.
*Fiat exists in two forms:
1) Risky, unhygienic, totally inadequate for modern commerce physical fiat, aka cash which the public may still use to some extent
AND
2) Convenient, inherently risk-free account form at the Central Bank which the public MAY NOT use.
Another thing to keep in mind is that fiat, whose purpose is the general welfare, must compete with bank credit, created for private interests, for real resources.
Thus, for a given amount of politically allowable price inflation, the more credit banks, etc. can "safely" create for private interests, the less the monetary sovereign may create for the general welfare.
I wanted to comment here, but I accidentally posted my comments to a different post...
https://mikenormaneconomics.blogspot.com/2018/07/the-next-system-money-matters-why.html
You're right, Andrew. What I was really addressing was the libertarian belief that the only real money is that what is linked to gold.
What I was really addressing was the libertarian belief that the only real money is that what is linked to gold. KV
Speaking of which, years ago, when just learning about banking, I wrote a spreadsheet simulation of a bank complete with balance sheet. Its notes were common stock redeemable in gold, iirc. Anyway, to my amazement, the more gold redemptions the more profit the bank made!
And the reason for that is that gold is a dead asset and the bank's notes that were redeemed for it could be invested in productive assets instead.
Andrew, I agree with your point that “…more credit banks, etc. can "safely" create for private interests, the less the monetary sovereign may create for the general welfare.” However, I think that point can be put better, as follows.
“When a private bank creates money and lends it, spending that money raises demand, which means (assuming the economy is already at capacity) that government and central bank have to impose some sort of deflationary measure, like raising taxes, and robbing the private sector of part of its stock of base money.” I.e. the private sector in general subsidises private banks’ money creating activities.
I.e. the effect is not a hundred miles from the effect of a traditional backstreet counterfeiter: for every fake $100 bill he puts into circulation, government and central bank have to withdraw one real $100 from the private sector.
The French Nobel Laureate economist, Maurice Allais, made that “counterfeit” accusation: see the opening sentences of Ronnie Phillip’s paper, “Credit Markets and Narrow Banking”. So did David Hume, writing almost 300 years ago.
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