While there is a lot of talk about “printing money” as though money is created by government printing presses, money is primarily created by bookkeeping entries. About 10% of the money circulating in the US economy is paper currency or coins. The rest is essentially a host of bookkeeping entries in a vast infrastructure of banks or other financial institutions.
The simplest way that money is created is by a bank extending credit to someone. It may take the form of a loan, but the recipient’s account is credited with money which can be spent so that it circulates through the economy. If the loan is repaid, the money is removed from circulation and ceases to exist. The traditional explanation of this is that the money being lent comes from deposits of other customers which are being “temporarily” used for the loan, but the other customers’ accounts are not debited, and all the deposits are still counted as part of the supply of money available in the economy. The fact that a “bank run” can cause a bank to fail is an anomaly arising from the persistence of an outdated concept of money. [ see Banks ]
Obviously a government that guarantees that a certain form of money will be accepted as legal tender is in a unique position to control the creation and distribution of money. [ see Deficit Spending ] Creation of money denominated in a particular national currency is often done via a central bank. The role of a central bank has evolved along with the idea of money. It serves not only as a clearing house for other banks’ transactions, but also as a means of controlling the amount of money circulating in the national economy. In the United States the Federal Reserve functions as the central bank. Like the U.S. Post Office it is theoretically an independent institution indirectly controlled by the government and answerable to it. The separation of the Federal Reserve from the U.S. Treasury produces some convoluted processes in the creation of money. [ see Federal Reserve ] Nonetheless the net result is that dollars can be created by direct payment from the government or by the extension of credit by the Federal Reserve as well as by credit extended by other banks.
Another way that money can be created with credit is with a multi-lateral commercial credit clearing exchange or local exchange trading system (LETS). Merchants agree to accept payment in the form of credit which can be used to purchase anything from any of the participating merchants. The credit is denominated in a unique form of money and may not be exchangeable for other currencies. [see Alternatives ]
In the past elaborate engraving techniques were used in printing currency in order to prevent counterfeiting, but now most money distributed by the government is in the form checks or electronic transfers with other security measures. Concern about the security of government or bank transfers of money is one of the factors that led to the creation of cybercurrencies. [ see Cryptocurrency ]
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