How Money Gets Destroyed [Banking 101 Part 6]

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Remember how new money is created when a bank makes a loan? Well, when someone repays the loan, the opposite process happens, and money is actually destroyed. It effectively disappears from the economy entirely. This video explains how.

Proof & Further Reading:

Bank of England - Money Creation in the Modern Economy

Money is destroyed when loans are repaid:

From the Bank of England’s 2014 Q1 Quarterly Bulletin:

“Just as taking out a new loan creates money, the repayment of bank loans destroys money. For example, suppose a consumer has spent money in the supermarket throughout the month by using a credit card. Each purchase made using the credit card will have increased the outstanding loans on the consumer’s balance sheet and the deposits on the supermarket’s balance sheet. … If the consumer were then to pay their credit card bill in full at the end of the month, its bank would reduce the amount of deposits in the consumer’s account by the value of the credit card bill, thus destroying all of the newly created money.

“Banks making loans and consumers repaying them are the most significant ways in which bank deposits are created and destroyed in the modern economy.” (McLeay, Thomas, & Radia, Money creation in the modern economy, page 3)


This is vitally important

This is vitally important because it means that if we, the public, start reducing our debts by collectively borrowing less and repaying more, then the amount of money in the economy will actually start to shrink.

If we all collectively reduced our debts by £1billion, then the money supply of the economy will actually fall by £1billion. There will be £1billion less money changing hands in the economy.

If we significantly reduce the debt then the shrinkage in the money supply could actually cause the economy to slow down or grind to a halt. Just think of the problems caused when banks refused to lend during the credit crunch.

So although we all think it’s a good idea to get out of debt, and most of us are trying to get out of debt, as long as we keep the current system it will be impossible to reduce our collective debt without slowing down and potentially destroying the economy.

So let’s see exactly how money is destroyed when a loan is repaid

Let’s start with Robert, who still owes £10,000 to Barclays but has spent the money, leaving his bank balance at zero.

(left side): Assets
(What the borrowers owe to bank + bank’s money)

(right side): Liabilities
(What the bank owes to the depositors + bank’s net worth)

(left side): Loan to Robert: +£10,000
(right side): Robert’s account: £0

After a few months, Robert decides to pay down £1000 of the loan. He transfers the money from a bank account with another bank, to his bank account at Barclays.

We won’t show the central bank reserves on this process because, as we saw with the clearing process, any change in the reserves would probably be cancelled out by payments going in the opposite direction, and won’t change things in any significant way.

Now Robert still owes £10,000 to Barclays, but also has an account with Barclays that now has a balance of £1000.

As a result, Barclays has a liability to Robert of £1000 – that’s the numbers in Robert’s bank balance – and Robert has a liability to Barclays of £10,000.

When Robert called Barclays and says that he wants to pay off £1,000 of the loan, all Barclays does is reduce Robert’s bank balance to zero, and reduce the outstanding loan by £1,000.

In effect, both the asset and the liability are cancelled out against each other.
(What the borrowers owe to bank + bank’s money)
(What the bank owes to the depositors + bank’s net worth)
Loan to Robert: +£10,000

Robert’s account: £1000

Repaying loans reduces the amount of money in the economy

Because the money supply in the hands of the public is made up of bank-created numbers in people’s bank accounts, repaying loans in this way actually reduces the amount of money in the economy. Money – the type of money that the public use – has been destroyed in the act of repaying the loan.

Of course, now that Robert’s loan has been partly repaid, Barclays might go hunting for another lending opportunity, and make a new loan to replace this, in which case new money will be created and the money supply will grow again. But if banks are scared to lending, for example following a major financial crisis, and the public are trying to reduce their debts, then the money supply of the economy will shrink.

Here it is in the simplest form:

If we want more money in the economy, we need to go into more debt.

And if we want less debt in the economy, we have to have less money.

[WpProQuiz 6]



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  • MakesMeWantNader

    Suggested improvements:

    1. You could mention the LIBOR rate when speaking of Inter-Bank lending.

    2. The freezing of Inter-Bank lending was a consequence of the financial crisis, not the cause. A cause was mentioned – “reckless lending” but this cause and effect was not clarified and could be misconstrued.

    3. It might be worth adding that the bank balance sheets can grow in a “booming economy” but also in a “bubble economy” where bank asset prices rise due to reckless lending and historic low interest rates.

    For more details:

  • confused about banking

    How does the issue of securitisation work in this model? If a bank securitises the loan then this counts as a further asset to the bank (increase in the digits on the asset side).

    The confusion for me is when in the case of a bank lending money to a borrower then the balance sheet should show a liability from the borrower to the bank? The example in these excellent videos show a deposit account scenario.

    So how would the balance sheet reflect using securitisation?

    • Graham Hodgson

      With securitisation, the bank sets up a separate non-operating company and assigns to that company its right to receive payments of principal and interest from the loans to be securitised. That company issues and sells bonds to investors and gives the sales proceeds to the bank in payment for the assigned rights. The result is that the loans are no longer assets of the bank, since it won’t get any further payments from them, but instead it has either fewer deposits, if the investors who bought the bonds were its customers, or more reserves, if the investors were customers of other banks.

      After the financial crisis struck, investors who had bought the bonds lost faith in the ability of the non-operating companies that issued them to keep paying the interest and principal promised, so the banks that set them up on the one hand were forced to take responsibility for paying out on the bonds, which became liabilities of the banks, and on the other hand took back the rights the had assigned under the loans, which returned as bank assets.

  • Pekka

    I have many times tried to get the media in Finland to bring up the question, where does money come from and even what is money, but without any success at all. Any suggestions? The journalists seems to be totally uninterested in this important matter.

    • James A.

      Try alternative media? Scandinavians on Youtube have stated that mainstream press in some Nordic countries is not always open to some topics.

  • Krzysztof Madejski

    I have few concerns about statement shown in 0:50:
    1) Has the privite debt really fallen down to minus! 20% of GDP? What means below zero – suddenly everybody moved savings from their socks to collapsing banks? Or did you mean it has fallen from 210 to 176& of GDP? Or I don’t get something?

    2) What’s wrong with paying up all the debts? If someone needs money it will borrow it. Total will never go down to zero. The problem was that banks didn’t want to give loans [because they had no trust in borrowers], not because of no money circulating in the market. Shortage of money circulating was the effect, not the cause. That’s way I don’t buy graph showing credit crunch as argument to ‘we cannot repay debts’.

    • Krzysztof Madejski
      • brad

        or lets see it this way. lets start every poor person off with a house. the cost to build a house is far cheaper than what the banks want. my Dad is a construction worker for 23 years. like he told me it much simpler to make the products we need. any person needs to start off with a place of their own to live. before 1935 the banks and the government did not have all these credit score and income job history requirements. after the Civil war 1870-1935 American’s barley used the barter system. the 1st generation of home owner ship began with log cabin houses. from 1935-1975 paper money and the banks and government laws and regulations became more prevalent when it came to home owner ship and education. also racism and sexism is part of this. before 1950 no female could purchase property. only white males could but property or work in the banks or the government. 1964 civil rights act was passed. over time to 1985 the economy picked up more. banks did not always use computers. 1992 is when banks started to use computers more and more same with the government and many corporation’s. we have 50 states I have noticed 7 states have large black people population. in those cities where blacks are 20-50% of the population in black neighborhood’s their property values are super low and their rent is very low. in white neighbor that are closer to black people towns the prices of house goes up. states where the black population is under 10% of that states population all houses are more affordable. in other words the banks and the real estate companies sell/give the black people crappy places for low rent payments as a way of keeping them trapped in bad towns. then the public schools located in black towns are horrible they do not teach the black kids that much. over all blacks are 15% of the American population. both parties are keeping the blacks glue trapped in their towns. segregation and racism is not public today but it is private. just because something is private can t be seen in public does not mean it does not exist. in order to get a decent job you need to have an interview with a boss or manager well buying a house or renting an apartment is the same way. black people you failed the interview.

  • Jeff Eder

    What happens when a loan is paid back in cash? Is money destroyed? I don’t think so.

    I will use the following example to illustrate my point. A man borrows $1000.00 at 10% interest from a bank, he then pays back the loan including interest for a total of $1100.00 in cash. The reason that I specify cash as the repayment method is that it is more difficult to create the illusion of money destruction. I am quite certain that banks do not burn cash if I repay a loan with it.

    Keeping in mind that this is a double entry bookkeeping
    system, meaning that for every entry on the asset side of the balance sheet
    there can be an equal and opposite entry on the liability side of the balance
    sheet, albeit not always.

    When the bank receives the repayment of $1100.00 it separates the principle($1000.00) from the interest($100.00). The interest is entered as interest income which is separate from the balance sheet. The principle is removed from personal loans on the asset side of the balance sheet, while simultaneously removing $1100.00 from personal deposits on the liability side of the balance sheet. If you are just viewing these portions of the balance sheet it gives the illusion of money destruction.

    However in conjunction with the above deletions from the balance sheet the cash is moved to “Cash and Deposits with Banks” on the asset side of the balance sheet where the bank can use the money any way it wishes. If this transaction was all in digital money the result would be the same only instead of cash the amount would be entered as a deposit with a bank.

    In summary, the bank was allowed to create $1000.00 of new money for the purpose of lending to a borrower. When the borrower repays his loan the bank gets to keep the principle plus the additional interest. Money is effectively removed from public hands out of the economy and into the banks’ coffers.

    • Jeff Eder

      Disregard this argument as information I received from an investor relations officer at a major commercial bank in Canada was inaccurate. With regard to the cash, the bank gets to keep the cash because they have already paid for it with an exchange for reserves at the central bank for example. For me the easiest way to visualize this is to imagine there is only one commercial bank, one central bank, one population, and one government all tied together in one closed loop system. It makes money destruction easier to visualize. Again thanks Graham for responding to my inquiry’s.

  • Davide

    This video made a big mistake: you forgot to write that when Robert will send £ 1.000, from another bank of him, to his bank to repay his loan the bank must write on the right side £1.000 in the Robert’s bank account but on the left side the bank must increase his cash assetts (as you will explain in the right way here so in fact its not true that the money disappear. Please answer me I’m very curious to read your answer.
    Thanks and regards.

    • bankster01

      The main thing is that money disappears from the economy when old loans are paid down faster than new loans are created, the total money supply will reduce.

  • Stanley Mulaik

    In the United States when Congress authorizes more spending than the Treasury has collected in tax revenues, the portion of the spending not backed by tax revenues is called ‘deficit spending’, and the amount ‘the deficit’.
    When Treasury has a deficit, it has to borrow money from banks to get the money.

    That was not always necessary. Beginning during the Civil War between the North and the Southern States, the United States (then the North) went first to banks to see what they interest they would charge to lend the Federal government for fighting the war. They wanted 25% and 36% interest. And Lincoln effectively decided, “No thanks, we’ll print our own”. At this point Treasury was directed to create and issue dollars needed to cover deficits, effectively out of thin air. This took the banks out of the picture, and they did not like it. So between 1862 and 1917 the Treasury was able to issue what were called “greenbacks” or US Treasury notes. This was debt-free money (apart from the obligation to accept the money in payment of taxes, fines and fees to the government. No bank was owed for it.

    But banks did not like this situation, and they continued to lobby Congress to pass laws requiring the Treasury to borrow money from US banks to cover deficits. In 1917, as the United States was on the verge of entering World War I, the banks were able to convince Congress to pass their desired legislation. Banks argued that Congress could not be trusted to be always prudent in spending, and should not be allowed unlimited spending. In fact, a ceiling on debt was also passed (although there are arguments, non yet proven in court, that Congress does not have the power to limit an unconditional power to borrow or pay debt granted Congress in the Constitution).

    Now, when Treasury has to borrow from banks to cover deficits, it issues US Treasury securities for certain quantities and intervals to maturity. And the banks buy these at discount at public auction. The difference between the principal paid and the face value of the securities is the interest paid at maturity.

    But Treasury has a way of avoiding ever paying back the principal, and the banks don’t mind: when a security matures, the Treasury just issues a new security with a new future maturity date and swaps it for the now mature security held by the bank, and adds additional interest.

    Where does the Treasury get the money for the interest? It just borrows from the banks interest money, perhaps in large amounts in anticipation of interest payments. It will do the same swapping of new securities for mature ones on the interest securities. Banks love the guaranteed stream of debt-free new money which will go on in perpetuity coming to them, eventually exceeding the principal in accumulated value. So, everyone (among Treasury and banks) is happy.

    So, basically, Treasury just handles the ‘debt’ on deficit spending by rolling over the securities in swaps of new securities for old, and adding in interest it also borrows in the same manner.

    Because banks create loans out of thin air (a fiat money system does not need to use gold-backed dollars of other depositors of the banks to make its loan money legitimate), but the principal is never paid off, the Treasury still has new debt-free money to spend. This is crucial to the American monetary system, because it means the central government in Congress and the Executive can spend money on projects
    in the states that do not have to be paid back by taxpayers. In fact, if taxpayers were required to pay back the deficit money with taxes, it would reduce the money supply and worsen the condition of the economy.

    But there is another player in the American system, the Federal Reserve Bank, the US central bank. It serves similar functions of the central bank in England, but it also conducts ‘open market operations’ to modulate the money supply. During deflations, it will buy US Treasury securities from banks and individuals at public auction. The money used by the Fed (as it is called) to buy these securities is created out of thin air by the Fed. It is debt-free money. It buys these securities from the banks by depositing newly created money in the banks’ reserves. It must be recognized that this does not increase the reserves of the banks because it cancels bank loans to the Treasury. That makes the money for deficit spending behind these securities completely debt-free, although it may in some circumstances be inflationary.

    In other words, the money used to pay the banks for their deficit-spending securities does not come from money already in circulation, so the money in circulation is not reduced nor augmented beyond what already has been augmented by the banks creating and lending to the Treasury for deficit spending. The Fed’s money just vanishes as it is absorbed by the banks’ in repayment of the loan.

    The Fed will later swap these securities it has bought with the Treasury. It will then sell the new securities to banks and individuals during inflations to drain money into time deposits associated with the securities. But these time-deposits will not be used to fund deficit spending. They will be paid back or rolled over with the banks and individuals holding them.

    But the Fed intervenes when it does Quantitative Easing. The Fed can go directly to the banks and demand to see its ‘toxic assets’, and, in the process of buying them, buy also the deficit spending securities held by the banks. That means that the Fed is paying back the national debt on deficit spending by Quantitative Easing. It is doing it by outright buying up of these securities, canceling the debt of the government to the banks. When the Fed swaps these securities it purchases with the Treasury, the Treasury then extinguishes these mature securities used for deficit spending. That means the deficit spending money is also new and debt free money added to the money supply. So, is the interest paid the banks and individuals.

    So, the Treasury and the Fed, each in their own way manage the national debt of the United States: the Treasury rolls over the debt in perpetuity on deficit spending. So, the deficit debt is not a real debt, because it will never be paid back but rolled over forever. It adds new money created by banks into the economy in deficit spending and it adds newly created and debt-free interest money into the economy.

    The Fed completely cancels the government’s debt to the banks. It does not claim the value of the securities it holds, except for a 6% of the interest as a transaction fee for funding its operations free of appropriations from Congress. It just acts as a custodian of them. And it will use new securities swapped from the Treasury to fight inflations by selling them to banks and individuals to drain money out of circulation.

    There is another component of the United States ‘national debt’. About 85% of the debt in marketable securities is held not by banks but private and foreign individuals and state and local governments of the United States. Their securities do not fund government operations, but their money is kept as time deposits like with Certificates of Deposit. The money is always there to return the principal on these individuals’ investments. And interest can be created out of thin air by the banks or the Fed, as the case applies.

    Much confusion exists in the United States because these facts are not well explained or understood by politicians and even economists, who tend to reason about federal money as if it is like household, business, or state and local government finance. But none of these has the power to create money out of thin air and spend it, but have to get their money from what is already in circulation. So, this reasoning from a wrong analogy leads often to bad monetary policy.

  • Mike

    I think your all over complicating this.

    Banks don’t make money.

    • bankster01

      Elaborate, who does then ?

  • Thone Siharath

    The problem is not money creation, the problem is people using money. UK and the world are run by Satanic organisation who think the world is over populated, so they run policies to reduce the world population. How deep the policies goes? Everything you do is part of it.

    Example: wasting time and energy on sport, intoxication, wars, engineered food for Eugenics, air pollution with chem-trail and industries, excessive material wealth to a few instead of wealth as what is good to many, money are used for speculation, not for real physical good creation or multiplication using what is free such as air, sun heat and freshwater.

    Here is the solution:
    – Collect freshwater from typhoons and distribute around the world
    – Let it evaporate everywhere
    – Create more freshwater from seawater.
    – Build vertical Mag-Lev to outer space
    – That will allow to install plenty of megastructures to increase more freshwater and energy
    – Explore more minerals and energies outside of Earth
    – Build space colonies to explore more minerals from our solar system and beyond (freshwater included)

    More details:

  • crowbar

    The problem with the economists is that they are using the language of accounting to analyze economics which sometimes complicates the analysis which might be easier to understand if it was done in a more simple language. Accounting is a tool of a bookkeeper, not the tool for the analysis in economics.
    Here are some points I learned about creation and destroying money.
    1. Central bank does not keep money. All the income that it makes, it returns to the Treasury after deducting its own expenses and paying dividends to the banks that hold certain amount of Central Bank shares (not tradeable).
    2. Central bank does not need to keep money, it is the only institution that can create money both in physical format and in “digital”.
    3. Central bank creates money when it buys securities because it takes the money out of a thin air to pay for them.
    4. I am not sure what happens when it sells securities, i.e. whether it throws the money out into where it took it from – in the thin air or gives it to the Treasury (bad habit). I think I saw that the first is true but I am currently in the search of that place where I saw it. If the first is true, i.e. the money is destroyed, then no new money remain in the economy from the operations with securities.
    5. The bad occurs when the securities that are in possession of Central bank mature. Then the money that government pays to the Central bank is returned back to the Treasury, i.e. to the Government which is a lot of new money that are coming back to the government enticing it to borrow more because it does not need to pay it back in the case when securities are in the possession of Central bank at maturity. It is called monetizing the debt.
    6. So one question needs confirmation: whether Central bank destroys money it gets for selling the securities.

    7. Commercial banks do create money, in both formats, physical and digital, when they make loans to borrowers. When it needs physical banknotes, it buys them from the Central bank. However, they remember this fact of lending the nonexistent money, and when it comes back it is essentially destroyed. They build their accounting accordingly. The only thing that remains with the bank is the interest, which is in effect has to be fed from some new money injected into the economy from some sources (money created by the Central bank, positive foreign trade balance, US foreign debt, some others)

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