Chapter 3: How Money Works Today: A Summary.


This chapter summarises how money works today. For convenience’s sake, there will be some repetition of material covered elsewhere.

Founded on debt rented out at interest, the money system is difficult for most human minds (mine, for instance) to grasp. It is counter-intuitive, so much so that a leading banking historian (Lloyd Mints) described it as work of the devil. In his own words:

‘It would seem that an evil designer of human affairs had the remarkable prevision to arrange matters so that funds repayable on demand could be made the basis of profitable operations by the depository institutions. It is wholly fortuitous that an income can be earned from the use of such funds, but this being so has resulted in the creation of institutions which have largely taken over control of the stock of money, an essential government function.’[1]

Authoritative sources describe our system of money and finance much as it is described in this chapter. Journalists, teachers and writers of textbooks, however, tend to describe an entirely different (mythical) system in which ‘savings’, rather than newly-created money, form the basis of capitalism.[2]

What is ‘Money’?

We all know what money is. It’s something we can own which can be swapped for other things that are up for sale. It is a kind of abstract property: mine is mine, and yours is yours.

For people who like their truths to be stated with a bit more gravitas, here is an economist saying the same thing:

‘So long as, in any community, there is an article which all producers take freely and as a matter of course, in exchange for what they have to sell, instead of looking about, at the time, for the particular things they themselves wish to consume, that article is money, be it white, yellow, or black, hard or soft, animal, vegetable or mineral. There is no other test of money than this. That which does the money-work is the money-thing.’[3]

Money began as physical objects which in a particular society could conveniently ‘do the money work’. It has been many different things: shells, salt, gold, tobacco, stones, cows, even bullets.

The most interesting example of money as pure, abstract property is the stone money of the Pacific island of Yap. Stones with holes in them were used in everyday transactions, as money. Some large stones sank in the sea generations ago, while being carried from one island to another; but they were still acknowledged as money. It was irrelevant that they were at the bottom of the sea; everyone knew who owned them. The stones were used in exchange for other property – even though they sat on the seabed.[4]

The Special Characteristics of Money Today.

Today, as we know, a certain amount of money is notes and coins, but most of it is numbers in bank accounts. We own those numbers: they are OUR property and if someone steals them, we hope they will be in trouble. So, what are those numbers? What kind of ‘property’ are they?

In our modern world, property, protected in law, comes in many different forms. Intellectual property and mineral rights are two examples. Bank-money is another special case: it is ownership of debt from a bank. The numbers in our bank accounts signify how much the bank owes us. In the words of the Bank of England, numbers in bank accounts are ‘simply a record of how much the bank itself owes its customers.’[5] The bank’s debt is our property because the law says it is so.

When we make a payment, what happens? Some of what the bank owes us becomes owed to another person: it is as simple as that. This is how bank-currency works: it is debt from a bank, that passes between people as payment.

How Money is Created Today.

The way commercial banks create money today is quite simple. When a bank lends, it writes down two identical numbers on opposite sides of its balance sheet, signifying two equal-and-opposite debts. It creates an IOU from itself, which becomes money, and another IOU from the borrower to itself. Again, the Bank of England: ‘Money is a special kind of IOU that is universally trusted.’[6] The borrower’s debt to the bank is real enough: interest must be paid on it, and it must eventually be paid back. The debt from the bank, as already explained, is a fake. Interest is charged on it and it pays nothing but itself – because the law says it is money. A bank will naturally charge a borrower as much as it can get away with, for the loan of what it owes. In more honest days, as I have already noted, this was called the ‘magic trick of banking.[7]

The peculiar status of banks is that they are licensed or ‘chartered’ to create valuable promises-to-pay of the type recognised as ‘money’ by government, businesses and citizens. Banks are regulated by government agencies to prevent them creating too much money and bringing the system down. Regulators face a hard task, because the system is intrinsically self-destructive (see Chapter 7).

Just as money is created when a bank makes a loan, so money also disappears when a loan is repaid.[8]

We tend to assume that money is permanent, or at least long-lasting like stone or metal. The malevolent genius of modern money – the quality that makes it an ideal tool for robbery – is twofold. First, it is created and cancelled continuously for some people to get hold of other people’s possessions and exploit them; and second, it is rented out at interest.

As a result, the money supply grows and shrinks in line with the overall need of banks, either to lend more, or to call in loans. This ‘perverse elasticity’ of bank-created money exacerbates booms and busts.[9]

Making Money Out of Money.

When money is created as debt from a bank, an equal amount of debt is created from a borrower to the bank.

This amount of debt is only extinguished when the customer’s debt is repaid, when money is also extinguished. This means that for every penny of money in existence, there is also a penny of genuine debt from someone to a bank. This debt is also changing hands. That is the very process by which borrowers will make money; they will end up with money, and the debt will pass to others.

This brings in one of the most important qualities of money and debt: so-called ‘fungibility’. If, say, we deposit a gold necklace at the bank, when we return for it we expect to get the same necklace back. However, when we deposit money at the bank, when we return for it we don’t want the same money, we want the same amount of money. This is known as ‘fungibility’.

The trick of making money by borrowing involves the borrower ending up with money and passing the debt on to others – without necessarily noticing how it has happened, even though it must have happened, because the quantity of debt will remain constant until the borrower repays the loan, by which time the borrower will be wealthier and others in debt (or the enterprise has been a failure).

The simplest example must be: a loan merchant borrows at 1% and lends to others at 21%. After 5 years, the loan merchant has received enough to pay the bank back, while all those paying 21% are still in debt (at a very high rate of interest). A more complex example: the borrower buys a business and makes it more efficient by reducing pay or throwing people out of work; to survive, those people borrow and get into debt.

The ‘fungible’ nature of money and debt means that borrowers may not even notice where the debt has gone.

The Structure of the Money Supply Today.

Today, all money – whether its cash or numbers in a bank account – is debt from a bank, either commercial or central. This suggests a question: What does a bank owe us? Or more realistically, does a bank owe us anything at all?

A bank used to owe its customers gold. Nowadays it owes us ‘reserve’, a different set of digits created by the central bank (which is usually an organ of government). This reserve is also fake debt, owed by the central bank; it is one way – though not the biggest way – in which governments as well as banks profit from the monetary system.

Central banks create ‘reserve’ digits simply by writing them down; then they lend or sell them to commercial banks. They also supply the bank with notes and coins on the same basis. The bank, in turn, will supply these to its customers on demand in exchange for numbers in deposit accounts.

‘Reserve’ digits have many functions. One is that they are interchangeable with ‘cash’ – that is, with notes and coins. Fundamentally, ‘reserve’ is a substitute for the gold that banks used to owe their customers. Just as in the old days a bank would owe more gold than it had in its vaults, so today a bank always owes a great deal more ‘reserve’ than it possesses. Economist Henry C. Simons described banking as “a fantastic collection of enterprises for money-bootlegging, whose sanctimonious respectability and marble solidity conceal a mass of current obligations and a shoestring of equity that would be scandalous in any other type of business.”[10]

All these digits have value because the law, and the regulatory system, support them as ‘money’. They are a form of property, created and rented out at interest by banks and central banks, then cancelled again when they have done their work of taking from people. In England for example, 97% of money is debt from commercial banks to customers; the other 3% – including notes and coins – is part of ‘reserve’, which is debt from the Bank of England to commercial banks. ‘Reserves are an IOU from the central bank to commercial banks’ says the Bank of England and ‘there are three main types of money: currency, bank deposits and central bank reserves. Each represents an IOU from one sector of the economy to another. Most money in the modern economy is in the form of bank deposits, which are created by commercial banks themselves.’[11]

It is, in truth, a system of villainy made legal.


The system depends upon a ‘two-tier’ structure, which evolved from the ancient system of gold-supported credit-money. Central-bank-credit has replaced gold.

‘Reserve’ digits are supplied by the government via the central bank, and sold or rented to commercial banks. When banks want notes and coins to supply to their customers, they use some of these ‘reserve’ digits to buy cash from the central bank.

Bank-money – debt from a bank – consists of claims on these ‘reserves’. These claims are the debt that is created and rented out by the bank, when it lends.

‘Reserves’ substitute for gold in more ways than one. Just as a bank’s customers used to turn up at their bank and ask for gold when it suited them, so a customer today turns up and asks for ‘cash’ when it suits them. And just as in the old days, gold would come out of the bank’s gold reserve, so today handing over ‘cash’ depletes a bank’s ‘reserve’ of government numbers.

‘Reserve’ plays yet another part in the system, again identical to a role that gold used to play. As already stated, a bank hopes never to pay out anything to its customers except cash when asked. But debts between banks are different. When a bank’s customer makes a payment to someone at another bank, the other bank will claim some of the first bank’s ‘reserve’. A bank needs to keep a certain quantity of ‘reserve’ handy, because if it runs out and cannot afford to buy more from the government or central bank, then it is broke.[12] That is also why banks are prepared to pay interest on money which stays in the bank for a good long time. If a customer’s money stays in the bank, reserve stays with it.

The situation today has become a little more complex, with the widespread use of ‘quantitative easing’ which supplies reserve to banks at no cost.

‘Quantitative Easing’.

Most accounts of quantitative easing announce that governments ‘create money’ to buy assets. This account is disingenuous and confusing, because the ‘money’ they are creating in QE is actually reserve. The government (or central bank) is buying back national debt with newly created reserve, which goes straight into the reserve of the bank with whom the asset-seller banks. Once again, the main beneficiaries will be government and finance.

The reserve supplied in QE becomes a straightforward addition to the ‘reserves’ of the banking system. The idea behind QE – its public justification – is that because banks need a certain proportion of ‘reserve’ in order to continue creating credit, supplying them with more reserve will enable them to lend more without going bust, thereby increasing the money supply.

With these huge increases in their reserves, banks do indeed lend more. But when the economy is not booming, where can look to lend and make a profit? Productive businesses are not looking to expand, their profit margins are shrinking. The solution for banks is to lend to speculators in assets such as housing, which will automatically increase in value as money to buy them increases via bank lending.

So, the value of these assets shoots through the roof and inequality increases. The simplicity of this was recognised from the start, but the process has been continued just to keep the system of afloat and functioning. QE is an outrageous and criminal act, robbing poor and productive people on behalf of established powers.

This and other developments like deposit guarantee schemes are a measure of how far our existing powers will go to prop up and even extend the system, enabling it to cause ever greater inequality and harm.

To sum up: the system is two-tier – bank-credit and reserve – and both sets of digits are merely numbers typed into ledgers. Money, which buys the produce and human labour across the world, is created out of nothing. This could be an excellent idea if it were done fairly and equitably, in a way that benefits everybody (as outlined in Chapter Nine on Reform). But it is not.

The government’s stake in the system is many-fold. First, money (conjured out of nothing) can be borrowed from banks for governments to borrow and spend: negotiations take place in private, and are not accountable to citizens. Second, the same laws that justify bank-money make it easy for governments to borrow because lenders get equal value (‘government bonds’) in return. Third, governments get a share in the profits of money-creation, by providing reserve and cash. Other advantages, mostly concerning increases in power, are listed in the introduction to this book.

It is entirely historical that this system exists and that we put up with it. Whatever justification it may once have had, enabling wars, conquest and robbery, it is now a danger to humanity. The world is a different place today, and our objectives are – officially, at least – not robbery, but peace and justice. But we are still lumbered with this antiquated system.

To finish off this chapter, it is important to remember that bank-money is just one variety of ‘negotiable debt’. New varieties are continually being invented, and each invention sets off a fresh round of robbery, supported by law. Derivatives, CDO’s, CDS’s, repos and ‘shadow’ banking are some examples. With the introduction of computers and sophisticated mathematics, ‘finance’ – the creation and destruction of value – has become faster, ever more inventive, and ever more destructive. The system advantages powerful people and disadvantages those who are least likely to understand the process by which they are being ‘cheated and pauperized’.[13]

Many who profit from the system prefer not to understand how it works. Obvious dangers in the private creation of wealth – that it must increase injustice and inequality – are strangely easy to lose sight of, especially for those who suspect they may be on the winning side. In addition, the detailed workings of the system are complex and horribly difficult to understand. It is important to remember that this complexity arises entirely from the add-ons to its existence as money: its nature as negotiable debt, the regulations necessary to keep the system from self-destructing, and the attempts of the banks to evade those regulations.

The system is not good for any part of society. To quote banking historian William M. Gouge (1833), “artificial inequality of wealth adds nothing to the substantial happiness of the rich and detracts much from the happiness of the rest of the community… its tendency is to corrupt one portion of society and debase another.”[14]



[1] Monetary Policy for a Competitive Society (1950) p. 5.

[2] The Bank of England acknowledges this on their website: “Rather than banks lending out deposits that are placed with them, the act of lending creates deposits – the reverse of the sequence typically described in textbooks.” From ‘Money Creation In The Modern Economy’, Bank of England Quarterly Bulletin, 2014 Q1.

[3] Frances Walker, Political Economy (1887) Ch.3.

[4] Wikipedia brings the story up to date (2018): ‘Although today the United States dollar is the currency used for everyday transactions in Yap, the stone disks are still used for more traditional or ceremonial exchange. The stone disks may change ownership during marriages, transfers of land title, or as compensation for damages suffered by an aggrieved party.’

[5] ‘Money Creation In The Modern Economy’, Bank of England Quarterly Bulletin, 2014 Q1.

[6] ‘Money Creation In The Modern Economy’, Bank of England Quarterly Bulletin, 2014 Q1.

[7] ‘The banker’s tricks of the trade are, when they are explained, hardly worthy of even a third-rate magician.’ W.J. Thorne, ‘Banking’ (1948), p. 27.

[8] ‘repaying bank loans destroys money just as making loans creates it.’ – Bank of England Quarterly Bulletin 2014 Q1. See

[9] Lester, Richard A. Monetary Experiments (1939, 1970) p. 291; and on p.292, ‘If the monetary system is to moderate rather than magnify the business cycle, money must be segregated from banking.’

[10] Economic Policy for a Free Society (1948) p. 198. This important book is now available on Internet Archive.

[11] Bank of England Quarterly Bulletins 2014 Q1 and 2010 Q4, available online.

[12] C.A. Phillips, misunderstood and little-read nowadays, provides the best explanation (Bank Credit, 1931).

[13] Bray Hammond’s phrase, The Journal of Economic History, May 9 1947 No. I.

[14] A Short History Of Money And Banking (1833, 1968) part I, p.139

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