Money has no "Expiry Date"

Boxing Day, 2010

Most people - including most monetary reformers - think that new money created by a bank in the form of a loan is extinguished (i.e., destroyed) when either the loan is repaid to the bank that created it, or the borrower is unable to repay the loan. Even I used to believe this until a relatively short while ago.

This, however, now seems rather clearly to me to be an error, as I have been able to discover recently, due to the evasive answers given to me by people to whom I asked the question, "What evidence is there that banks ever destroy money?" No one could produce any factual evidence, from actual and verifiable bank records, that banks destroy money: all they could point me to were economics text books, which over the years I have learned to distrust.

(In this connection, I am reminded of what John Kenneth Galbraith, the famous former professor of economics at Harvard, once said: "The study of money, above all other fields in economics, is the one in which complexity is used to disguise truth or to evade truth, not to reveal it.")

But after thinking about it, I believe I know why the notion that banks "extinguish" money when loans are repaid is so common. I believe the reason is that people confuse bank money with an IOU. When, for example, I give an IOU to a bartender who is willing to accept it, promising to pay my tab at the end of the month, after I pay the bartender at the end of the month the IOU is not valid any more: it is "extinguished". All IOUs have what one might call an "expiry date": if the money is not repaid before the expiry date, the lender resorts to strenuous measures (to put it mildly) to get his money back! This happens even if there is no interest attached.

It is true that between myself and the bartender, the IOU does function like money - it enables me to buy drinks even when I don't have any money - but, be it noted, the IOU is not, itself, money. It has an expiry date, which money doesn't have! (If an IOU did not have an expiry date, its issuer could, without penalty, never repay it, which would make it worthless.)

This is a crucial point. IOUs, which have expiry dates, do get extinguished, but money, which has no expiry date, doesn't get extinguished.

Now most people think that if a bank were to act as a middle-man between me and the bartender, there would be no difference. The bank could take my IOU, give me money in return, and I could use that money to pay the bartender.  That money, as everyone who knows anything about banks knows, the bank creates ex nihilo.

(In this connection, I again quote John Kenneth Galbraith: "The process by which banks create money is so simple that the mind is repelled…. When a bank makes a loan, it simply adds to the borrower's deposit account in the bank by the amount of the loan. The money is not taken from anyone else's deposit; it was not previously paid in to the bank by anyone. It's new money, created by the bank for the use of the borrower.")

However, people forget that once created, money does not have an expiry date. Yes, an IOU does have an expiry date, but money doesn't. There is no requirement that money be extinguished at or before any given date. The only requirement is that any IOU be extinguished at or before its expiry date!

One might argue at this juncture that if the issuer of the money is to be fair to all concerned, the money created as a result of an IOU ought to be extinguished once the IOU on whose strength is it created is extinguished. The operative words here, however, are "fair" and "ought". There is no guarantee that the money so created will be extinguished, since there is no guarantee that banks - or rather their ultimate owners, whose aim is clearly world domination - are fair! Just the opposite, in fact.

It should also be realised that before a loan is repaid - or, alternatively, if the borrower defaults - the money which the bank has lent to the borrower has been spread far and wide into other bank accounts, where the resulting deposits are indistinguishable from any of the others. Besides, those deposits belong to the depositors, not to the banks. It follows that a bank cannot destroy a deposit belonging to a depositor without paying the depositor back - and in this case it will either be transferred to another bank as a deposit, or be withdrawn in cash.

And when the loan is repaid, which normally is done over a specified period of time and often from a multitude of possible sources, there is no reason for the bank's owners to write the repayments off, rather than using them to spend on anything the bank's owners want to spend them on (such as - you guessed it! - world-domination.)

Even in the case of a borrower's failure to repay, the money has already been spent, and is now in someone else’s account, probably somewhere else entirely from where it was created: perhaps even in a different country. Once new money has been created and spent, it belongs to someone else, not to either the bank or the borrower; and it has changed from being a loan from a bank to being private property, either held as cash or on deposit by some third party, perhaps one with no connections whatsoever with the issuing bank.

And when any part of the money which is created as a loan is paid back to the bank in repayment thereof, it goes into the bank's own account - the account from which the bank pays its employees, suppliers, shareholders and (most importantly) its real owners, who, in the case of banks, are clearly not the shareholders. (The real owners clearly don't want to share anything, since they are intent on taking over the world!)

It should be remembered that bank money is not physical, and so cannot rest or remain stationary in space, as notes or coins can: for instance by being kept physically under a mattress, or even in a vault. Bank money is ephemeral, and thus can only be used, as money, to make payments. Bank money can only exist in the form of figures representing bank deposits. However, these figures are as good as paper money or coins for making payments; they are effectively legal tender because they can be converted into cash at the stroke of a pen or a plastic card, at least as long as the bank remains solvent. Even the tax man will accept bank money in payment of taxes!

Here is a chart (taken from <>) of the growth of the money supply in the UK from 1963 to 2007. In the UK there are only two definitions of money: M0 meaning cash, and M4 called the "money supply". The chart below shows the growth of M4.

M4 Chart from

It should be noted, in addition, that M4 does not include sterling deposits held in banks' overseas branches or "off the balance sheet" in subsidiary companies. The magnitude of this is, of course, not known, but is probably very large indeed. These overseas balances may well be increasing even faster than M4.

The above chart, as well as the other considerations mentioned in the paragraph below the chart, suggest strongly that loan money is not extinguished when it is repaid. If it were, it does not seem possible that the money supply could be growing as fast as the chart shows, and the paragraph below the chart strongly suggests. The chart, if you notice, shows the money supply increasing at around 10% between 2006 and 2007; and the same thing happened the year before, and the year before, and the year before. And the paragraph below the chart indicates that it may have grown as much as 20% or 25% in each year, if not even more.

This much more money injected into the economy and flowing to the average UK citizen would result in massive rises in prices, but the price rise figures (in particular the figures of the Consumer Price Index or CPI, which measures the prices of food, clothing, shelter and fuel mostly) for the UK in the 2000s show that the rise in prices has only been around 3% per annum. Over the last 20 years, M4 has risen 450% whilst the Retail Prices Index or RPIX (an alternative measure of price rise in the UK) has risen just 90%. All of which suggests strongly that the bulk of the money is going not to the average Jack and Jill but to the ultra-rich, who do not spend much on the items the CPI or RPIX measure.

If a bank becomes insolvent, its deposits are indeed destroyed, and then there is panic among the depositors. But this does not happen regularly, and this destruction of bank money is certainly not the sense in which most people think that bank money is "extinguished".

Of course you will always find people who tell you that the rules of accounting compel the banks to extinguish money which they are repaid. Yeah, right - as if people whose goal is world domination can be compelled to do anything they don't want to do by "rules of accounting"!

Oh well. Cheers all the same.

ADDENDUM (January 27, 2011)

The clincher is this. Loans and mortgages are a bank's assets, and can, as a result be sold - and often are. Suppose that on Day 1, Bank A has issued a 5-year-term loan to Mr Jones at an annual interest rate of 7% in the amount of $10,000. The principal, namely $10,000, for this loan was, of course, created by Bank A ex nihilo. At the interest rate of 7%, Bank A expects to earn $1,880.60 in interest on it over the 5-year period (the figure of $1,880.60 is arrived at using a loan calculator). On Day 2, Bank A bundles this loan together with a number of others, also for 5 year terms at an interest rate of 7%, in total amounting to $10 million in principal loaned out, and sells this bundle to Bank B for $9 million. (The bundled loans are sold at a discount, of course, because it is not certain whether they will all be paid back; some may default, but that's a risk Bank B is willing to take.) Bank B has now paid - not created - $9 million to buy the bundle of loans from Bank A, the principal of which amounts to $10 million in total, and the expected interest on which is $1,880,600. Bank A, of course, is hardly going to extinguish the $9 million paid to it by Bank B on Day 2: if it were to do so, what would be the point of selling the loans to Bank B in the first place, since both principal and interest on the loans is now going to be pid to Bank B? Nor is Bank B going to extinguish the $9 million it paid to Bank A when the loans are paid back over 5 years, since if they were to do so, they would gain a mere $1,880,600 in interest, plus $1 million in principal, amounting to $2,880,600 - while losing the $9 million they paid to Bank A! That would mean Bank B would end up with a loss of $6,119,400 - and why would Bank B enter into a transaction which leaves them with a loss?

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