Money creation in the modern economy (2014) [pdf]
Yes, learning how banks create money for me was a huge turning point in realising most of what people think they know (and what I thought) about money, debt and economics is actually wrong. That the money supply grows when banks lend and contracts when people pay the debt down is a big point to get your head around.<p>The other big one is the national accounts and sectoral balances - see [1] for a much more detailed run-down.<p>To summarise, take the definition of GDP:<p>(1) GDP ≡ C + I + G + (X – M)<p>where C is household final consumption, I is private investment including inventory, G is Government spending, and (X-M) are net exports.<p>Add net external income flows (FNI) to (1) and you get GNP:<p>(2) GNP = C + I + G + (X – M) + FNI<p>Subtract total transfers and taxes from each side:<p>(3) GNP – T = C + I + G + (X – M) + FNI – T<p>Collect terms by sector (private, Government and External)<p>(4) (GNP – C – T) – I = (G – T) + (X – M + FNI)<p>Then we can simplify - (GNP - consumption - taxes) is equilivalent to private saving (we’ll call that S), and (X - M - FNI) is called the Current Account Balance (CAD):<p>(5)  (S – I) – (G – T) – CAD = 0<p>or (6) (S – I) = (G – T) + CAD<p>What this means is that by definition, if your external sector is balanced, a Government budget surplus <i>must</i> reduce the net assets of the private sector by exactly the same amount as it is in surplus. With a trade deficit and a Government surplus, the private sector’s net assets are reduced by the sum of those.<p>This is quite clear graphically too [2].<p>So the end result is that you can only have economic growth when the Government is running a surplus and the private sector is in balance or deficit through money creation from banks. Is relies on people borrowing more and more money - but because equal amounts of debt are also created (no higher net wealth), eventually the sector in aggregate can’t borrow any more, and the system falls apart (the second derivative of credit growth dropped a little while before the GFC, which is how some non-mainstream economists predicted that it was coming).<p>But at the end of the day, this means a balanced or surplus Government budget is actually <i>bad for the economy</i> by definition unless you have a big trade surplus (like Germany for instance), because it’s sapping the private sector of wealth.<p>Do you have to start taking a more nuanced view of Government debt, when Government debt actually represents the net actual savings of the private sector!<p>1. <a href="http:&#x2F;&#x2F;bilbo.economicoutlook.net&#x2F;blog&#x2F;?p=32396" rel="nofollow">http:&#x2F;&#x2F;bilbo.economicoutlook.net&#x2F;blog&#x2F;?p=32396</a><p>2. <a href="https:&#x2F;&#x2F;skeltonphd.files.wordpress.com&#x2F;2013&#x2F;06&#x2F;slide1.jpg" rel="nofollow">https:&#x2F;&#x2F;skeltonphd.files.wordpress.com&#x2F;2013&#x2F;06&#x2F;slide1.jpg</a>