When you say, “… creating money decreases the bank’s RNW, because doing this increases its liabilities without changing anything else”, you are visualising <money> creation as a one-arrow transaction.
I agree that a bank’s main profit-earning business is creating new <bank liability> IOUs which customers can use as <money>, but it (almost) always does it in *response* to the creation of a new <debit item> in its asset account, caused by a customer’s deposit of <something valuable>, like a <£200,000 promissory note> [or a £20 note].
Your one-arrow idea represents only two items from a four-item accounting record involving two different balance sheets. An arrow pointed in one direction could represent EITHER the customer depositing its IOU at the bank, for example, OR (in the other direction) the bank responding with its <credit> IOU obligation to the customer. Without a second arrow, you have either the “unfinished business” of the customer’s IOU deposit, or an “unrealistic image” of a bank wantonly giving away its <credit> IOU for no reason, both of which I call “one hand trying to clap”.
Creating <money> does increase the bank’s liability each time - by the amount of the new <credit> it creates – as you say. But it does that in response to a matching increase in its assets – usually by the amount of the <debit> the customer’s deposit creates. It’s not a one-sided increase (in liability), it’s two-sided - as you’d expect in a *double-entry* accounting system - and it has *two* participants with *opposite* (balance sheet) perspectives.
What you draw from Frances Coppola’s coffee machine story is tainted, as explained in a previous comment. It seems she has misled you to your one-arrow description of <money> creation by a bank. Let her go and focus on evidence; thought experiments and “models” are wide open to “undetected” errors.
I’m sorry to be the bearer of bad news (again), but your ‘simplified’ model goes off the rails at (new) step “1” and never recovers. No <money> is created in any of the cases where you claim it is.
I’m NOT saying <money> CAN’T be created when and how you say it is INSIDE your model! You are the supreme authority in that world. When you say, “Jump!”, Eve can only ask, “How high?” and WILL rise 200 feet in the air when you COMMAND her to. If you don’t COMMAND her to come down, she can even stay up there indefinitely.
Reality doesn’t work that way, and any reputable accounting website would have revealed the following accounting facts: bank shareholder dividends, bank employee wages/salaries and external suppliers to a bank are ALL paid out of a bank’s “existing funds”, as follows:
(i) Shareholder dividends: typically drawn from profits;
(ii) Employee salaries/wages: typically drawn from operating income; and
(iii) External supplier costs: typically drawn from cash reserves or operating income. [Source: Microsoft Copilot.]
I think I can see why you're continually disagreeing. You appear to be thinking of equity as an asset - a stock of money from which payments can be made. But that's not what it is. Let's look at an example. Please read it extremely carefully and let me know whether you disagree with any of the balance sheets.
Imagine Alice starts with $10K cash and Eve starts with $1.5M cash. Eve creates a bank, transferring $1M cash to it in exchange for 1,000 shares of $1,000 each. Here's the bank's balance sheet:
[A] $1M (cash)
[E] $1M (paid-up share capital)
Now it lends $40K to Alice, who over the next year pays the $40K principal in full. She also pays $2K cash for the interest.
Retained profits aren't an asset which the firm can spend. The assets are all in cash. There's still exactly the same amount of money as existed at the beginning. But now Eve's bank pays Eve a $1K dividend.
Now clearly the retained profits have fallen, so informally you can say that some of the profits were "transferred" to Eve. But that wasn't a transfer of money. Eve now has a $1K balance in her account at the bank, and this is *in addition* to the original $1,510,000 cash in existence ($1,002,000 at the bank, $500K held by Eve, and $8K held by Alice). If you can accept that the balance in Eve's account is money (after all, she can buy things with it using a cheque or debit card; it's exactly the same thing as banks create when they lend), then you have to accept that the quantity of money in the economy increased by $1K when the bank paid Eve her dividend.
Equity is just a recognition that the difference between the firm's assets and liabilities is owed to the shareholders. You can think of equity as a debt to shareholders which changes constantly:
YOU SAY: “If you can accept that [1] the balance in Eve's [private? or bank owner?] account is <money> … then you have to accept that [2] the quantity of [?money?] in the economy increased by $1K when the bank paid Eve her dividend.”
I accept [1] as detailed below, but can’t accept [2], whether you mean $money$ or <money>.
You specified a total of $1.51M in $money$ initially.
For simplicity, I assume ALL of that CASH was either deposited or invested in E’s bank, creating matching <debits> and <credits> all over the place. The bank therefore starts out holding ALL $1.51M of $money$ as its asset and incurs $1.51M of matching <liabilities> in various accounts e.g. A, E (personal), E (bank owner), etc.
The “economy” has all $1.51M of <money> to play with and the original $1.51M of cash $money$ is sterilized (isolated in the bank vault the whole time). Do you call that doubling the “money supply” or not?
Assuming A’s “loan” was in <money> rather than $money$, then it does increase the $1.51M <money> supply to $1.55M temporarily and her principal repayment puts it back to $1.51M, so no net increase in <money> there.
Her $2k interest payment to the Bank transfers existing <money> within the bank from A to E (bank owner) [no increase].
The bank transfers half of that $2k <money> from E (bank owner) to E (private) [again, within the existing set of accounts, so, no increase]. Cash has not moved.
The only cash which makes it to the bank is what I explicitly mentioned:
1. Eve pays in $1M cash to capitalise it.
2. Alice pays it $2K for the interest on the loan.
Eve and Alice keep all the rest under their mattresses.
I don't know what you mean by a "bank owner account". I've never seen anything labelled that. Just assume Eve has a personal current account with the bank, and that's the one whose balance is increased when the bank pays the dividend.
So there's:
$8K cash under Alice's mattress,
$500K cash under Eve's mattress,
$1,002,000 cash in the bank's vault,
$1,000 "deposit" in Eve's current account.
I've shown the whole balance sheet of the bank at each stage. Given what I've said in this comment, can you say whether you disagree with any of them, and if so, what you would write instead? I think it's vital to show balance sheets because they are precise and unambiguous.
By the way, do look up Frances Coppola's article on J P Morgan's coffee machine.
The decrease in retained earnings doesn't mean *cash* has disappeared. The same amount of cash is still there in the assets: $1,002,000. You have to understand that equity is telling you how much of the firm's assets are owed to the shareholders.
In the "before" balance sheet, the equity says that all $1,002,000 of the assets ($1M + $2K) is owed to the shareholders.
In the "after" balance sheet, the equity says that $1,001,000 of the assets ($1M + $1K) is owed to the shareholders.
Why is less owed to the shareholders now? Because the firm has written a $1K IOU to Eve (by increasing her current account balance), which means that $1K of the assets is no longer left for the shareholders.
Thanks for that comment. I named “profits”, “operating income” and “cash reserves”, as the usual sources for payment of dividends, wages, purchases, etc., by a bank, and stand by that statement (with minor clarification, below).
Saying Eve has acquired a <right to receive $1,000 cash> instead of cash makes a big difference and I agree with your comments. My inference (that she was paid cash) wasn’t unreasonable, as the bank’s only asset was “[A] $1,002,000 (cash)” and you did say Eve’s bank “pays Eve a $1K dividend”, not “declares a dividend of $1/share”.
On “declaration of the dividend”, the bank credits “Dividend Payable” [L] and debits “Retained Earnings” [E], but on “payment of the dividend”, the bank debits “Dividend Payable” [L] and credits “cash” [A]. There are differences between “declaring” and “paying” a dividend, not unlike the differences between <money> and $money$, and they are important. Similarly, “wages” may be “recorded” as an expense in the income statement, which affects the “Retained Earnings” account [E] but they’ll be “paid” out of “cash” [A]. So:
Credit: [L] $1K Dividend Payable (Eve), requires
Debit: [E] $1k Retained Earnings, until the dividend is paid.
But when the dividend is paid,
Debit: [L] $1K Dividend Payable (Eve), and
Credit: [A] $1k Cash.
Eve’s <credit balance> is a “bank promise (or obligation) to pay”, not yet a “payment”. It may “act like” and “seem like” a “payment”, but … there is a difference and it’s important.
Details are important in forensic investigation. Do you think I'm simply nit-picking?
RE: Coppola's coffee machine article. In the second paragraph beginning, “Imagine …”, Coppola says, "JP Morgan ... pays for [the coffee machine] by electronic funds transfer ...".
Do you agree that an EFT can’t originate “ex nihilo”, from nowhere, or from “thin air, and that it’s a vector, with two ends (an arrowhead and a tail, perhaps)?
Coppola initially specifies no source for that EFT and it’s definitely not a “loan”.
Only after looking at the first pair of "balance sheets" does she say, “In effect, JP Morgan has paid for the coffee machine from its own EQUITY.” [capitals in original]
Coppola probably still hasn’t realised that she lied by saying, "... this money is newly created in the course of the transaction".
When she involves Citibank and looks at three “balance sheets”, she concludes that “[Citibank’s] equity buffer is now smaller as a proportion of total assets”, so again it’s not “money creation” by Citibank either, it’s transferring funds out of Citibank’s equity.
As she might say, “In effect, Citibank has paid for the coffee machine from its own EQUITY and been reimbursed by JP Morgan from its reserves.”
Good question about whether depositing cash at a bank doubles the money stock.
The answer is no. MB (cash plus reserve balances at the central bank) isn't affected. And M1 (and higher numbers) includes current (checking) account balances, as well as cash held by non-banks, but not cash held by banks. Depositing cash at a bank increases account balances but decreases cash held by non-banks, so the effects on M1 cancel each other out.
You've convinced me I should write an article on monetary aggregates 🙂
I don’t “have to accept that the quantity of money in the economy increased by $1K when the bank paid Eve her dividend”, because I’ve found your mistake.
You don’t distinguish $money$ from <credit>.
Indeed total $cash$ remains unchanged at $1,510,000, but total <credit> in the bank consists of *[L] + [E]*, which also remains unchanged at $1,002,000, balanced by the bank’s unchanged $1,002,000 [A], as it should be.
With my added symbols [$ $ and <credit>], your comment says it, thus:
... The assets are all in $cash$. There's still exactly the same amount of $money$ as existed at the beginning. But now Eve's bank pays Eve a $1K dividend.
I accept that I made one mistake, but it's not the one you think. I'd forgotten that M1 doesn't include cash held by banks. So when Eve first capitalised the bank, M1 decreased by $1M, since it was transferred from Eve to the bank's vault. However, my main claim that paying a dividend increases M1 is correct.
Let's go through it again, with correct values for MB (all cash plus banks' "reserve" balances at the central bank) and M1 at each stage:
At the start:
MB = $1,510,000
M1 = $1,510,000
After Eve capitalises the bank with $1M of cash:
MB = $1,510,000
M1 = $510,000
After Alice borrows $40K from the bank, repays it, and pays $2K interest in cash:
MB = $1,510,000
M1 = $508,000
After the bank pays Eve a $1K dividend:
MB = $1,510,000
M1 = $509,000
Notice that the payment of the dividend increased the broad money stock (M1) by $1K from $508K to $509K.
As to your claim of other mistakes:
1. I clearly distinguish cash (central bank-created money) from retail bank-created money ("deposits", as banks call them) in the balance sheets. Cash is shown as "cash", and deposits are shown as "deposits".
2. Money has to be a means of exchange. Equity isn't such a thing: how would you spend it? It's very different from a balance in a current account, where it's very clear how it can be spent.
3. You misinterpreted me when you put "$$" around "money": "There's still exactly the same amount of $money$ as existed at the beginning". I was talking about M1, not MB. But as I point out above, I did make a mistake in that cash taken out of circulation does decrease the M1 stock. However, the payment of the $1,000 dividend *does* increase M1 by $1,000.
When you say, “… creating money decreases the bank’s RNW, because doing this increases its liabilities without changing anything else”, you are visualising <money> creation as a one-arrow transaction.
I agree that a bank’s main profit-earning business is creating new <bank liability> IOUs which customers can use as <money>, but it (almost) always does it in *response* to the creation of a new <debit item> in its asset account, caused by a customer’s deposit of <something valuable>, like a <£200,000 promissory note> [or a £20 note].
Your one-arrow idea represents only two items from a four-item accounting record involving two different balance sheets. An arrow pointed in one direction could represent EITHER the customer depositing its IOU at the bank, for example, OR (in the other direction) the bank responding with its <credit> IOU obligation to the customer. Without a second arrow, you have either the “unfinished business” of the customer’s IOU deposit, or an “unrealistic image” of a bank wantonly giving away its <credit> IOU for no reason, both of which I call “one hand trying to clap”.
Creating <money> does increase the bank’s liability each time - by the amount of the new <credit> it creates – as you say. But it does that in response to a matching increase in its assets – usually by the amount of the <debit> the customer’s deposit creates. It’s not a one-sided increase (in liability), it’s two-sided - as you’d expect in a *double-entry* accounting system - and it has *two* participants with *opposite* (balance sheet) perspectives.
What you draw from Frances Coppola’s coffee machine story is tainted, as explained in a previous comment. It seems she has misled you to your one-arrow description of <money> creation by a bank. Let her go and focus on evidence; thought experiments and “models” are wide open to “undetected” errors.
I’m sorry to be the bearer of bad news (again), but your ‘simplified’ model goes off the rails at (new) step “1” and never recovers. No <money> is created in any of the cases where you claim it is.
I’m NOT saying <money> CAN’T be created when and how you say it is INSIDE your model! You are the supreme authority in that world. When you say, “Jump!”, Eve can only ask, “How high?” and WILL rise 200 feet in the air when you COMMAND her to. If you don’t COMMAND her to come down, she can even stay up there indefinitely.
Reality doesn’t work that way, and any reputable accounting website would have revealed the following accounting facts: bank shareholder dividends, bank employee wages/salaries and external suppliers to a bank are ALL paid out of a bank’s “existing funds”, as follows:
(i) Shareholder dividends: typically drawn from profits;
(ii) Employee salaries/wages: typically drawn from operating income; and
(iii) External supplier costs: typically drawn from cash reserves or operating income. [Source: Microsoft Copilot.]
I think I can see why you're continually disagreeing. You appear to be thinking of equity as an asset - a stock of money from which payments can be made. But that's not what it is. Let's look at an example. Please read it extremely carefully and let me know whether you disagree with any of the balance sheets.
Imagine Alice starts with $10K cash and Eve starts with $1.5M cash. Eve creates a bank, transferring $1M cash to it in exchange for 1,000 shares of $1,000 each. Here's the bank's balance sheet:
[A] $1M (cash)
[E] $1M (paid-up share capital)
Now it lends $40K to Alice, who over the next year pays the $40K principal in full. She also pays $2K cash for the interest.
Now the bank's balance sheet looks like this:
[A] $1,002,000 (cash)
[E] $1M (paid-up share capital); $2K (retained profits)
Retained profits aren't an asset which the firm can spend. The assets are all in cash. There's still exactly the same amount of money as existed at the beginning. But now Eve's bank pays Eve a $1K dividend.
[A] $1,002,000 (cash)
[L] $1K (deposit, Eve)
[E] $1M (paid-up share capital); $1K (retained profits)
Now clearly the retained profits have fallen, so informally you can say that some of the profits were "transferred" to Eve. But that wasn't a transfer of money. Eve now has a $1K balance in her account at the bank, and this is *in addition* to the original $1,510,000 cash in existence ($1,002,000 at the bank, $500K held by Eve, and $8K held by Alice). If you can accept that the balance in Eve's account is money (after all, she can buy things with it using a cheque or debit card; it's exactly the same thing as banks create when they lend), then you have to accept that the quantity of money in the economy increased by $1K when the bank paid Eve her dividend.
Equity is just a recognition that the difference between the firm's assets and liabilities is owed to the shareholders. You can think of equity as a debt to shareholders which changes constantly:
E↑ when A↑ or L↓
E↓ when A↓ or L↑
YOU SAY: “If you can accept that [1] the balance in Eve's [private? or bank owner?] account is <money> … then you have to accept that [2] the quantity of [?money?] in the economy increased by $1K when the bank paid Eve her dividend.”
I accept [1] as detailed below, but can’t accept [2], whether you mean $money$ or <money>.
You specified a total of $1.51M in $money$ initially.
For simplicity, I assume ALL of that CASH was either deposited or invested in E’s bank, creating matching <debits> and <credits> all over the place. The bank therefore starts out holding ALL $1.51M of $money$ as its asset and incurs $1.51M of matching <liabilities> in various accounts e.g. A, E (personal), E (bank owner), etc.
The “economy” has all $1.51M of <money> to play with and the original $1.51M of cash $money$ is sterilized (isolated in the bank vault the whole time). Do you call that doubling the “money supply” or not?
Assuming A’s “loan” was in <money> rather than $money$, then it does increase the $1.51M <money> supply to $1.55M temporarily and her principal repayment puts it back to $1.51M, so no net increase in <money> there.
Her $2k interest payment to the Bank transfers existing <money> within the bank from A to E (bank owner) [no increase].
The bank transfers half of that $2k <money> from E (bank owner) to E (private) [again, within the existing set of accounts, so, no increase]. Cash has not moved.
The only cash which makes it to the bank is what I explicitly mentioned:
1. Eve pays in $1M cash to capitalise it.
2. Alice pays it $2K for the interest on the loan.
Eve and Alice keep all the rest under their mattresses.
I don't know what you mean by a "bank owner account". I've never seen anything labelled that. Just assume Eve has a personal current account with the bank, and that's the one whose balance is increased when the bank pays the dividend.
So there's:
$8K cash under Alice's mattress,
$500K cash under Eve's mattress,
$1,002,000 cash in the bank's vault,
$1,000 "deposit" in Eve's current account.
I've shown the whole balance sheet of the bank at each stage. Given what I've said in this comment, can you say whether you disagree with any of them, and if so, what you would write instead? I think it's vital to show balance sheets because they are precise and unambiguous.
By the way, do look up Frances Coppola's article on J P Morgan's coffee machine.
Sorry about imposing my imagination on your model.
On your terms, $1,000 of CASH $money$ has disappeared from retained earnings.
Apparently, it's been transformed into a $1,000 “deposit” of <money> for E.
So, no net increase in “money supply” = {$money$ + <money>}
You didn’t specify HOW the CASH was “transformed” from CASH to CREDIT.
Magic? Or did Eve steal $1,000 CASH and replace it with a $1,000 book entry?
RE: Coppola's article. The second paragraph begins, “Imagine …”. I stopped reading there.
I might plough through it later but without much enthusiasm.
"On your terms, $1,000 of CASH $money$ has disappeared from retained earnings."
Thanks for the correction ("retained earnings", not "retained profits")!
OK, so that seems to confirm my impression that you're seeing equity as money. I hope this reply will help.
Let's just look again at the bank's balance sheet before and after paying the dividend.
Before:
[A] $1,002,000 (cash)
[E] $1M (paid-up share capital); $2K (retained earnings)
After:
[A] $1,002,000 (cash)
[L] $1K (deposit, Eve)
[E] $1M (paid-up share capital); $1K (retained earnings)
The decrease in retained earnings doesn't mean *cash* has disappeared. The same amount of cash is still there in the assets: $1,002,000. You have to understand that equity is telling you how much of the firm's assets are owed to the shareholders.
In the "before" balance sheet, the equity says that all $1,002,000 of the assets ($1M + $2K) is owed to the shareholders.
In the "after" balance sheet, the equity says that $1,001,000 of the assets ($1M + $1K) is owed to the shareholders.
Why is less owed to the shareholders now? Because the firm has written a $1K IOU to Eve (by increasing her current account balance), which means that $1K of the assets is no longer left for the shareholders.
Does that make more sense now?
Thanks for that comment. I named “profits”, “operating income” and “cash reserves”, as the usual sources for payment of dividends, wages, purchases, etc., by a bank, and stand by that statement (with minor clarification, below).
Saying Eve has acquired a <right to receive $1,000 cash> instead of cash makes a big difference and I agree with your comments. My inference (that she was paid cash) wasn’t unreasonable, as the bank’s only asset was “[A] $1,002,000 (cash)” and you did say Eve’s bank “pays Eve a $1K dividend”, not “declares a dividend of $1/share”.
On “declaration of the dividend”, the bank credits “Dividend Payable” [L] and debits “Retained Earnings” [E], but on “payment of the dividend”, the bank debits “Dividend Payable” [L] and credits “cash” [A]. There are differences between “declaring” and “paying” a dividend, not unlike the differences between <money> and $money$, and they are important. Similarly, “wages” may be “recorded” as an expense in the income statement, which affects the “Retained Earnings” account [E] but they’ll be “paid” out of “cash” [A]. So:
Credit: [L] $1K Dividend Payable (Eve), requires
Debit: [E] $1k Retained Earnings, until the dividend is paid.
But when the dividend is paid,
Debit: [L] $1K Dividend Payable (Eve), and
Credit: [A] $1k Cash.
Eve’s <credit balance> is a “bank promise (or obligation) to pay”, not yet a “payment”. It may “act like” and “seem like” a “payment”, but … there is a difference and it’s important.
Details are important in forensic investigation. Do you think I'm simply nit-picking?
Yes, it does. I'll give you a long reply later.
RE: Coppola's coffee machine article. In the second paragraph beginning, “Imagine …”, Coppola says, "JP Morgan ... pays for [the coffee machine] by electronic funds transfer ...".
Do you agree that an EFT can’t originate “ex nihilo”, from nowhere, or from “thin air, and that it’s a vector, with two ends (an arrowhead and a tail, perhaps)?
Coppola initially specifies no source for that EFT and it’s definitely not a “loan”.
Only after looking at the first pair of "balance sheets" does she say, “In effect, JP Morgan has paid for the coffee machine from its own EQUITY.” [capitals in original]
Coppola probably still hasn’t realised that she lied by saying, "... this money is newly created in the course of the transaction".
When she involves Citibank and looks at three “balance sheets”, she concludes that “[Citibank’s] equity buffer is now smaller as a proportion of total assets”, so again it’s not “money creation” by Citibank either, it’s transferring funds out of Citibank’s equity.
As she might say, “In effect, Citibank has paid for the coffee machine from its own EQUITY and been reimbursed by JP Morgan from its reserves.”
Good question about whether depositing cash at a bank doubles the money stock.
The answer is no. MB (cash plus reserve balances at the central bank) isn't affected. And M1 (and higher numbers) includes current (checking) account balances, as well as cash held by non-banks, but not cash held by banks. Depositing cash at a bank increases account balances but decreases cash held by non-banks, so the effects on M1 cancel each other out.
You've convinced me I should write an article on monetary aggregates 🙂
I don’t “have to accept that the quantity of money in the economy increased by $1K when the bank paid Eve her dividend”, because I’ve found your mistake.
You don’t distinguish $money$ from <credit>.
Indeed total $cash$ remains unchanged at $1,510,000, but total <credit> in the bank consists of *[L] + [E]*, which also remains unchanged at $1,002,000, balanced by the bank’s unchanged $1,002,000 [A], as it should be.
With my added symbols [$ $ and <credit>], your comment says it, thus:
“Now the bank's balance sheet looks like this:
[A] $1,002,000 ($cash$)
[E] $1,000,000 (paid-up share capital); $2K (retained profits) *[<credit>]*
... The assets are all in $cash$. There's still exactly the same amount of $money$ as existed at the beginning. But now Eve's bank pays Eve a $1K dividend.
[A] $1,002,000 ($cash$)
[L] $1K (deposit, Eve) *[<credit>]*
[+]
[E] $1M (paid-up share capital); $1K (retained profits) *[<credit>]*"
I accept that I made one mistake, but it's not the one you think. I'd forgotten that M1 doesn't include cash held by banks. So when Eve first capitalised the bank, M1 decreased by $1M, since it was transferred from Eve to the bank's vault. However, my main claim that paying a dividend increases M1 is correct.
Let's go through it again, with correct values for MB (all cash plus banks' "reserve" balances at the central bank) and M1 at each stage:
At the start:
MB = $1,510,000
M1 = $1,510,000
After Eve capitalises the bank with $1M of cash:
MB = $1,510,000
M1 = $510,000
After Alice borrows $40K from the bank, repays it, and pays $2K interest in cash:
MB = $1,510,000
M1 = $508,000
After the bank pays Eve a $1K dividend:
MB = $1,510,000
M1 = $509,000
Notice that the payment of the dividend increased the broad money stock (M1) by $1K from $508K to $509K.
As to your claim of other mistakes:
1. I clearly distinguish cash (central bank-created money) from retail bank-created money ("deposits", as banks call them) in the balance sheets. Cash is shown as "cash", and deposits are shown as "deposits".
2. Money has to be a means of exchange. Equity isn't such a thing: how would you spend it? It's very different from a balance in a current account, where it's very clear how it can be spent.
3. You misinterpreted me when you put "$$" around "money": "There's still exactly the same amount of $money$ as existed at the beginning". I was talking about M1, not MB. But as I point out above, I did make a mistake in that cash taken out of circulation does decrease the M1 stock. However, the payment of the $1,000 dividend *does* increase M1 by $1,000.