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Deficit Owls @DeficitOwls
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Since money used to primarily take the form of coins stamped by the government, people just assumed that gov controlled the total amount of money. Seems logical, right? And that assumption has continued.

But it's wrong. Nobody controls the money supply. It's on auto-pilot. (1/n)
First, let's see where most money comes from. While the coins and notes in your pocket did come from the gov (you can tell because they're signed by the Treasury Secretary), most money is actually "bank money," that has no physical form, but only exists on your bank's ledger (2/)
How does bank money get created? There are several ways, but the main one is when banks make loans. For instance, if you draw on a line of credit at your bank, the bank will add dollars to your account, created from thin air. This also happens when you use a credit card. (3/)
When the loans are reversed, when you pay down your LOC or your credit card bill, the money is destroyed, as the bank decreases your account balance.

Economists have known that part for a long time, but they used to also think that the gov could control this process. (4/)
You see, banks use government money to pay each other. They used to use physical cash, but today they use accounts that banks keep at a government-run bank, the Central Bank (the Federal Reserve in the US). These are called "reserve accounts," or "settlement balances." (5/)
There is also a rule that banks have to hold government money in proportion to the amount of bank money they create. This is called a "reserve requirement." Since people naturally assumed that gov was controlling the amount of gov money, then they logically reasoned that (6/)
reserve requirements would limit the amount of bank money that can get created: if a bank creates too much bank money, then it doesn't have the reserves to back it, so it's violating the rule. Simple enough.

But the gov ISN'T controlling the amount of gov money. It can't. (7/)
First, let's talk about physical cash. Physical cash also comes from banks: when you withdraw cash from an ATM, the bank got that cash by buying it from the gov (using reserve balances).

Can the gov limit the amount of physical cash? No. What would happen if you went to (8/)
the bank to take out cash and they said "sorry, we don't have any"? You'd probably immediately try to pull all of your money out of that bank, and so would everybody else, leading to bank runs! For the last century, govs have taken it on themselves to prevent bank runs, so (9/)
they must ensure that there's enough cash when people come to withdraw their accounts. That means that the gov doesn't determine the amount of physical cash, YOU do - when you decide how much money to hold in cash vs put in the bank. (10/)
How about reserves? Can the gov limit the amount of reserves, and thereby limit the amount of bank money, through the reserve requirement?

No. The reason is, the bank can't even control the quantity of bank money it creates. The bank can't control when you use or pay your (11/)
line of credit or credit card. You control how much you borrow. All the bank can do is respond after the fact. If you borrow more than the bank expects, then the bank will need more reserves, and it will have to get them from somewhere. (12/)
In most countries, banks do this in an inter-bank market, where they borrow reserves from each other. And the Central Bank sees to it that this market is stable. Why? Because banks use reserves to pay each other - what would happen if you tried to make a payment but your (13/)
bank told you they couldn't do it? Again, probably bank runs and mass panic, or even *pricing* of bank money (what if checks from people who bank at Wells Fargo cleared at only 80 cents on the dollar?). The Central Bank is charged with preventing all that (14/)
So the Central Bank sees to it that the inter-bank market is kept stable, by providing all the reserves banks need, when they need them, in some fashion or another (typically by converting gov bonds, the national debt, into reserves).

What's the takeaway here? (15/)
YOU - all of us - determine the money supply, not the government. Through our decisions to borrow and repay, and our choice about how to hold our savings (gov bonds vs. cash vs. bank money), the quantity of money is determined in a decentralized process. (Fine)
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