I often talk about the misconceptions of money being a physical thing. Austrians tend to tell us that money is something like a physical commodity while many Keynesians tell us that the ultimate form of money is paper or cash. There’s a smaller group of (mostly economists) who believe that the ultimate form of money is currency (bank reserves, cash and coins). I think they’re all wrong. Money is no longer dominated by a physical thing (though it can be) or by what the central bank or government creates (cash, coins and reserves). Today’s money is created almost entirely by private banks and tracked electronically for record keeping within a payments system that they control and the rest of us have to be members of.
Of course, our textbooks also tell us that government money matters most. They tell us that the central bank creates some amount of money and the banking system “leverages” or “multiplies” this money, but that’s not really true. Banks create loans first and obtain reserves second if necessary. The money multiplier is a myth. And that puts the private banks squarely at the center of the money creation business. When a bank makes a loan it results in the creation of a deposit. And those deposits are what we are all chasing in a system that is dominated by electronic bank money.
The mainstream media is nearly as oblivious to this reality as the economic textbooks. In the mainstream, the belief is that the government “prints money” as if it’s just running a printing press running up government debt all day long to pay for things. But the reality is that the government is a massive redistributor of bank money. That is, when the government taxes you they’re just taking bank deposits from person A to pay person B with bank deposits. When the government runs a budget deficit they’re selling a bond to Person A and giving person A’s bank deposit to Person B. There’s no “money printing”. There’s only redistribution of bank deposits. And because these bank deposits dominate the US payments system as the means of settling payments in the process of transacting business, we are all seeking out these deposits so we can interact within that payments system.
The reality of banks “ruling the monetary roost” has only become that much more apparent as technology has developed in recent decades. In fact, I would argue that we’re becoming increasingly bank dependent as technology begins to reduce the importance of cash and other forms of government money in the economy. Canada, for instance, has no reserve requirement as technology has made their interbank payments system extremely efficient. The cash market for transactions is also taking a back seat to other transactions around the world. In the USA, cash transactions account for just 27% of all transactions. That’s down from 80% just 50 years ago. Credit and debit cards account for over 60% of transactions. Cash is still the most frequently used form of payment (because cash transactions tend to be in small denominations), but in total dollar volume it is becoming less and less significant. If we include wire transfers in the volume of payments data the electronic market already dwarfs the cash market (via the Cleveland Fed):
And although the US has been ahead of the trend in many regards here, other developed nations like Sweden and Canada are already on the fast track towards a cashless economy. For instance, in Sweden, less than 3% of all transactions occur in cash.
This doesn’t mean cash as a form of money is going away entirely. But it is becoming increasingly less significant. And that’s precisely due to the way our money system has been designed. Banks have been placed in charge of managing and driving the payments system around the world. So their money dominates that system. That’s not going to change any time soon. In fact, we’re becoming increasingly dependent on bank money as technology makes other forms of money less and less competitive/necessary with a highly efficient electronic (bank controlled) system.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.