I’ve just lent my wife £10k. I know, I don’t have that sort of money because I am just an honest world famous tax expert. I just magicked it out of thin air.
It amazes me that most people think that money is printed. It isn’t. Only 3% of all money in the UK is created by the Bank of England. The rest is created by anybody who fancies it at the time.
How do I create money? The honest answer is out of thin air. It happens whenever I lend someone money.
Most people think when they ask me for a loan, money paid in by one person is paid on to them. That’s not true. Not true at all, in fact.
Instead what I does is a conjuring trick. Look, I’ll lend you £10k now.*
I agree to give you a loan. I do it by writing two pieces of paper with IOUs written on them. One is the amount I will give you. The other is the loan you owe me. If you borrow £10k I mark your current account as having £10k in it. You’re now free to spend that however you like.
I also mark your loan account as having £10k in it. You now owe that to me.
Add the two together and they add up to nothing. One you apparently own and one you apparently owe to me. But if you decided to cancel the deal you could straight away repay the loan using your IOU and there would be nothing left. Which is why I mean they add up to nothing.
Note there’s no cash involved in this process at all. It’s just an accounting trick. Nothing more.
And now I charge you interest for the benefit of having created that money. Even though there is no money as such, even though you think there is, because you take the IOU to the shops as if it were money and run up a £10k tab which I have to pay on your behalf.
And of course I can’t repeat this lending trick forever because if I did people would think that I’ve no idea what I’m doing and realise that there’s no substance behind the promise I made to you when you agreed to pay me back that loan.
That promise is that the money on my IOU can be used to pay other people – a promise that is only as good as the bank on which the cheque is written on. Which is why we need promises of money from a bank we can rely on… like the Bank of England…
… I better call my wife to see why the shopping is taking her so long….
I just remembered her telling me she has a £10k credit card limit as she left the house!
*I’m not going to lend you £10k. I don’t have that sort of cash to just give away.