Spending money created by borrowing

Money may be created by transferring it from a loan account to a savings account, which also creates a debt in the loan account.


While the money in the saving account in this example may be as real as any money in any other savings account, you may expect that the bank will really need to get some money from somewhere when you actually spend the money in your savings account. This is true if you withdraw the money as true cash (bank notes and coins), but you probably won't; when you spend the money you will probably transfer it into someone else's account using EFTPOS, BPAY, direct deposit, cheque, or some other means of transfer.


Imagine that you spend the money in the savings account with someone who sells you something, who has a savings account at the same bank that holds your loan and savings accounts.


When you buy something from the seller and pay for it with some type of transfer, goods or services are transferred from the seller to you, and money is transferred from your account to the seller's account. The transaction and the two saving accounts can be represented like this:



Now you have obtained real goods and the balance of your savings account has reduced by the value of those goods, while the balance of the seller's account has increased by the value of those goods.


The money that was in your savings account, which was created when you transferred it from your loan account, has now been spread across two accounts: yours and the seller's. Notice that, again, no money has actually left or come into the bank so the total amount of money that the bank holds still hasn't changed; only the numbers in the accounts have changed. The credit in the seller's savings account has increased by the same amount that the credit in your savings account has decreased, so they cancel each other out. 


Even though you have spent money to obtain real goods, the bank has not had to get money from anywhere else: the transaction has been achieved with the money created from nothing but your debt in your loan account.


This page is referenced from:

Creating money by borrowing it

inter-bank loans and the banking system


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