Part 1 on this topic seemed to generate a lot of discussion both on the comments section here and here
The consensus being that I was wrong ! So, what’s the correct view?
Let’s make it all as simple as possible. Let’s consider the example of someone walking into the Royal Bank of Scotland to borrow one of their £10 notes. The RBS are one of those banks ‘north of the border’ who are allowed to print their own banknotes. They are essentially their IOUs . So these notes are the type of credit money we have been talking about. They tend to be well accepted in Scotland but less so in England.
So they borrow £10 and spend it on whatever! When the time comes to repay the RBS the borrower could , leaving aside the complications of fees and interest payments, give them a Bank of England £10 note, the BoE being the Central bank of the UK, and the debt is cleared. The credit money is still in circulation. It isn’t destroyed.
Alternatively, they could repay with a RBS £10 note in which case the credit money is destroyed.
I probably should have said “not necessarily” rather than “they don’t” but I think that’s all there is to the argument.
Modern Monetary Theory: Real Economics 
You are still wrong. The bank will only erase the loan (your debt) when it can cancel its debt to you (deposit). Do the accounting. There is no other way.
“The credit money is still in circulation. It isn’t destroyed.”
If you go in with a £10 note into any bank to pay it in, you purchase a deposit.
So the assets of the bank go up by £10, and a £10 credit money deposit liability is created.
*That* deposit is then matched against your loan and both the loan and the new deposit are destroyed.
The net effect is a change in the asset composition of the banks.
And it doesn’t matter if that £10 is a Scottish note or a Bank of England note. The process is the same.
A £10 RBS Scottish note is just a receipt for a liability at the RBS – a liability that is matched one-for-one with a Bank of England asset (Hypothecated Bank reserves!). When you draw a Scottish note, your credit money is destroyed the same as it would be if you drew a Bank of England note, and you are given a receipt for a different bank liability in the form of a bank note (reducing cash on hand).
Essentially you keep skipping a step and going straight to the net position and that makes it look like something is happening that isn’t.
Isn’t it the case that the BoE is a laudry for Scottish notes.As the regulator, it allows banks like RBS to print Scottish notes which are then credited to the people as IOU’s and when those people repay on IOU’s those are returned as BoE notes and used to buy Gold reserves.I think the Germans done something similar in the 1930’s with the Deutchmark,and Switzerland as the cleaners, I believe it carried a name like MILO or something like that.
I really don’t believe that when a debt or IOU is repaid tto the bank, that the monies then simply burnt?How else does the bank of England buy all that Gold.
No it isn’t. The BoE has no need for Gold, and they are an anachronism from an earlier time. Much like Gilts – which are so named because they are ‘Gilt Edged’ – i.e. as good as Gold.
Scottish notes are reserve backed in the same way the Gibraltar notes are reserve backed. Because there is a hard peg in place between the issuing institutions.
Neil,
I’ll have to think about this a bit more! If you think I’m wrong you’ve got me worried!
In the meantime I’d just ask if I’d chosen something like the ‘Bristol Pound’ for my example would that have made any difference to the argument?
See http://bristolpound.org/
If I borrowed one of those and repaid with a real pound?
Reducing/restricting the debate to notes and coinage merely serves to obfuscate the issue. It does not change the fact that when a commercial bank creates a loan account it creates money and when that loan is paid back the money disappears. If it is repaid with real BOE money that real money goes out of circulation until it is re-issued by the bank at which point it replaces credit in the account – i.e. the equivalent amount of credit in the account disappears. It shouldn’t be difficult to understand and introducing the question of Scottish notes just creates further confusion!
So why not just issue BoE notes per sae? Central banks and governments own the currency, other banks within the nation exsist because the central banks allows them, while it regulates what they print and issue, in the end it all ends up back in the central bank and the government. but lets not be as naive to believe that the central issuer is whiter than white?
Neil, http://www.bankofengland.co.uk/education/Pages/museum/exhibitions/goldandthebank.aspx there saying in the first paragraph that the BoE has the second largest gold reserve in the world? now, why would the BoE collect so much shiny Gold? although you make a very good point about gilt and bonds and the ability to Q.E. because we control our own financial situation unlike many European nations.The point on Scottish notes does have a correlation with the laundering scene as the BoE is the lender of last resort and the central issuer where all roads eventually lead back to the BoE but given the bullion and our position to print money the case for austerity is blow out the water, there simply isn’t a need for austerity because some hedge fund people are playing fast and loose with pensions and loans just to keep austerity high on the table so a few can make massive gains.
I don’t think there isn’t a good reason to suggest why Scotland couldn’t have it’s own central bank and currency, it does seem rather ood that a small nation of just over 5 million souls could cause countrys like Germany and the USA to suggest that an Independent Scotland could cause a world wide recession? unless there is a bigger underlying reason why England and the rest of the world want to keep Britain together?
Peter, very hard question, it took me a while but i give it a try :
I think there is a problem with the words you choose and that makes this story so confusing. Another thing is you go to quick by not doing all the intermediary balance sheet operations.
It’s all in this sentence : ” The vendor still has £10k of BANK CREATED MONEY in his account.”
You should replace it with : ” The vendor still has £10k of DEPOSITS in his account.”
With “bank created money” you implicitly assume it is created by a loan.
But a deposit (D) can be created by a loan (L) or also by a government payment (R). So you can, simply put, say that in some way a D is backed by either a L or R.
In first instance you are right : the vendor has “bank created money” in his account = backed by a L. But when you pay off the loan with cash (R) you change the backing of the vendors DEPOSIT to R’s.
To pay off with cash from another bank you had to withdraw a D and R somewhere from a balance sheet and put it BACK on your banks sheet. To make things easier you could also directly pay with “cash” from your own bank. It’s exactly the same but you can’t miss the intermediary operations.
Simply put : the bank has 2 D’s, one (D1) backed by R’s and one (D2/vendor) backed by a L.
The moment you pay off your L with D1 they both disappear and D2 (vendor) gets backed by R’s.
So when you pay off a loan with a DEPOSIT (created by a loan OR reserves) the deposit also is always destroyed.
It’s not relevant to make a distinction if a deposit is created by a loan or reserves, it’s even mixed up on the balance sheet. You may call it bank created money but don’t assume it’s only from a loan.
So what is the problem?
Why on earth do even MMT economists stoop to calling distributed holdings of denomination units a deficit or debt?
“You’re going nowhere until you create a glossary of new terms allowing coherent discussion to proceed. You can’t prepare coherent operations when there is such high margin of error in interpreting statements.”
http://mikenormaneconomics.blogspot.be/2014/10/semantics-or-sophistry-in-policy.html
That’s a fair point. On the question of public debts and deficits we can look to find other words. Or we can try to explain that there is such a thing as a good debt and a good deficit. In other words governments have to be in debt , ie have liabilities, so that the rest of us can have assets.
Both are valid approaches.
Maybe we can try the abbreviations approach :
Money = Double Entry Bookkeeping Transaction 😉