Thursday, April 30, 2009

Monetization of debt

whenever commercial banks exchange their debt (demand deposits) for a private or governmental debt, they are creating money. It does not matter whether an individual or business firm is securing anew loan from a bank, or whether the bank is buying an outstanding U.S. government security; the result is the same ; debt has been monetized. The bank secure an earning asset, whereas the increase in their liabilities ( demand deposits)means that someone else now has money that he did not have before.
Commercial banks once had the privilege of printing bank notes, which were used as money in hand-to-hand circulation, but the bank note privilege is now restricted to the Treasury and the federal Reserve System. Nevertheless, the great growth in recent years in the use of checks for payment of goods, services, financial assets, and so on has meant that the banking system has kept its importance as the immediate source of most new money. the bank can still create money, but they do it by making changes in their balance sheets rather than by resorting to a printing press. However, before we examine the mechanics of bank deposit creation, let us first consider the major kinds of bank assets and liabilities, inasmuch as we use the balance sheet approach in our explanation of bank deposit creation.

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