Healthy Money Healthy Planet - library.uniteddiversity.coop

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the money spent by the borrower will show up somewhere else in the banking system
as a new deposit. That bank will use it to create new money to lend to another
borrower – say, someone who is building a house. That borrower then pays the builder,
who puts it in his or her bank, which in turn can now create more money. And so the
process continues. This process of depositing and lending is called ‘asset sheet
expansion’.
The reverse happens when the capital of a loan is repaid. The amount the
borrower owes the bank decreases and so does the money supply – money is
effectively destroyed. When the interest on the loan is repaid, it is added to the bank’s
equity, or ‘shareholders’ funds’.
Since the banks’ accounts always balance, the total value of deposits held always
balances the total value of money lent out. This is how banks attempt to justify the
claim that they ‘lend out depositors’ money’. But this isn’t really true, as in fact they
create new money when they lend it. There is no contradiction here, because the banks
create the deposit at the same time as they create the loan. It is such a clever scheme
that British economist John Kenneth Galbraith commented, ‘The process by which
banks create money is so simple that the mind is repelled. Where something so
important is involved, a deeper mystery seems only decent.’ 3
The Two Intertwined Actions
When banks create money there are two closely related actions being performed and
we should think of them separately.
First, for banks to lend money out at interest and not provide the money to repay
that interest puts them at an unfair advantage. The borrowers as a group cannot repay
the principal and the interest without someone being forced to go back to the lenders
for more money. This is the debt spiral. Don’t worry if you don’t understand this yet;
we will look at it in more detail below.