Revised February 2013
Go to Motion Graphic Gallery version

Inquiry into The Nature of Money:
How is it created? How is it destroyed?

Money is an artifact of accounting. Anyone who has done online banking or paid bills via the internet can appreciate this. In these transactions no cash is handled by anyone. Money payment is made merely by the adjusting of accounts. So to understand the nature of money it is necessary to examine this accounting procedure. Here we do it conceptually, using motion graphics to reveal the essential structure visually.

A Balance Sheet

At the left is an elemental balance sheet. The fictional Archibald Mises, 45 years of age, his wife Aribella and their two children constitute an economic unit.2 On Thursday, September 1, 2005, the balance sheet for this family might look like the figure. What they HAVE is listed in the two ASSET columns on the left; one (green) above the other (brown). What they OWE is listed in the LIABILITIES column (red). And what they, therefore, OWN is the blue column, called NET WORTH. The difference between what they have and what they owe defines what it is that they own. Thus the meaning of the words describing these columns is contained in the equation

HAVE minus OWE equals OWN
or put formally
ASSETS minus LIABILITIES equal NET WORTH

We arrange for the height of each column to portray the values within them. Then the equation says that the combined height of the two head-to-tail asset columns on the left must always equal the combined height of the pair of head-to-tail columns on the right. The net worth of the economic unit - the blue column height - is deduced precisely from this 'equal height' condition.

Assets are of two kinds: liquid and non-liquid (here called viscous). Examples of viscous assets are titles to buildings, titles to land, furniture, bonds, shares in companies, IOUs, ... Assets whose value is determined only in a transaction (when they are sold) are viscous assets. The price of a viscous asset must be negotiated so it doesn't have an invariable exchange value. (The terms viscous and value are explored leisurely in the gallery format version of this exposition.) The quintessential liquid asset is money6. Cash, check, payments by debit card.., anything that is generally acceptable in return for a purchase is a liquid asset.

A Purchase

The figure shows the dynamics of a sale transaction explored from the point of view of the purchaser's balance sheet. Clicking on the yellow go button in the figure initiates the transaction. The item purchased might be a new washing machine, or 100 shares of IBM stock - any viscous asset. Acquiring it results in an increase in the (brown) viscous assets column. After the transaction the purchaser has more viscous assets than before.

In a cash transaction the amount paid for the item results in a decrease in the purchaser's liquid assets (green). That the height of the combined assets column doesn't change means that the value assigned to the newly acquired viscous asset is just the amount of cash paid for it.

Asset value is a subject that demands clarification. It is one of the issues explored in the expanded motion diagram gallery format version of this exposition.

Because the purchaser's liabilities are not affected by the transaction the red column does not change. Nor is the net worth (blue) affected because neither the total assets nor the liabilities have changed.

What is apparent from the demonstration is that we may examine transactions visually via changes in the balance sheets of the parties concerned. Next we examine simultaneously the balance sheets of both of the parties to a transaction.

A Bank Deposit Creates Money

The figure portrays the simple act of depositing some cash into a bank account. Remarkably the same figure makes it visually apparent that when money is deposited in a bank the world ends up with more liquid assets (green) in it than it had before! Generally more green in one place means less in another. For example, in a simple purchase, the cash that leaves the buyer's hand ends up in the seller's hand. The amount of green is conserved: the amount of liquid assets in the world does not change. But making a bank deposit increases the world's supply of liquid assets.

The motion graphic of the figure was constructed from the simple facts involved in the process. By means of an example, I lay out below the logic of the display.

Mr. Mises sells his motorcycle for \$1,000. He has decided to give up motor biking - permanently. Having no pressing need to spend the money immediately what is he to do with it? Rather than carry it around in his pocket, he deposits it in the bank. Knowing he can reclaim it from the bank, as needed, at any time, he puts the money there as a matter of convenience.

'In the bank' is as good as 'in the pocket'.

His liquid assets are not any less because they reside in a bank! He still has \$1,000 liquid whether it is in the bank or in his pocket. His viscous assets are not affected by making a bank deposit, nor are his liabilities - and nor are his liquid assets. Nothing on his balance sheet is changed by making the bank deposit. He has merely exchanged his cash for the privilege of writing checks. And that is what is shown in the animation. Press the go/reset button to see it. In accounting terminology the \$1,000 is listed as cash equivalent among his liquid assets.

But this transaction does change the bank's balance sheet. In accepting the cash, the bank acquires more liquid assets than it had before - by just the amount of the deposit, \$1,000. Simultaneously it acquires a liability of \$1,000. The liability is the obligation to pay, upon demand, whatever Mr. Mises says it should pay - up to \$1,000. The checkbook that Mises gets from the bank represents this liability. The bank deposit doesn't affect any viscous assets the bank possesses. Nor does it change the net worth of the bank. And this state of affairs is exactly what is depicted in the figure. Both the bank's liabilities and its liquid assets rise by \$1,000 and nothing else changes.

The incontravertible conclusion is that, as long as Mr. Mises doesn't draw down his account, the world contains \$1,000 more in liquid assets than before. It is clearly visible in the figure. Just tally up the green before and after. The total amount of green increases. How are we to understand this?

The figure offers the answer: the increase in the bank's liquid assets matches the increase in its liabilities. In effect, the bank's increased liability is being treated as money. The bank's promise to pay (its liability) is perceived as being as good as the money itself. The deposit is what generates this 'promise to pay' so depositing money ends up creating it. And, of course, closing the account annihilates \$1,000 of the world's liquid assets.

The key issue in this story is the matter of trust. Mises 'trusts' the bank, else he wouldn't put his money there. And he patronizes the bank only because others in the community will accept his checks drawn on this bank. They too trust the bank. The trust in the honesty and integrity of the bank is buttressed by the FDIC gaurentee that the U.S. Government will see to it that Mises gets his money back. It's 'enforceable trust' on which Mr. Mises relies.

Mises may draw on his account by writing checks. He may also draw on it via his DEBIT CARD. A debit card is an electronic checkbook. When the check Mises writes gets back to Mises' bank, his account is debited, i.e. depleted, by the amount of the check. The bank pays the payee and debits Mises' deposit account. The debit card is a substitute for writing checks. It allows an immediate debiting of Mises' account. It eliminates the time it takes for the payee to get the check back to Mises' bank and thus to collect his money.

Moral: The manufacture of liquid assets comes from trust in institutions. And that trust requires a stable and peaceful society.

An expanded exposition where the concepts behind the words are explored in detail, is given here in motion diagram gallery format. In this format the animated image stays put as you scroll the text until you call forth another image commensurate with the new text you are reading.