Who Makes Money?
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When we think about who makes money, our first impulse is probably to think about the mint where coins and bills are printed and formed. The Royal Canadian Mint has a production facility right here in Manitoba, the only one outside of Ottawa. But the coins and bills that are produced at the mint are merely the tangible form of our money. Only a fraction of our money ever occurs as bills and coins - most money is a simple record of exchange, some debt, and some credit. New records of debt and credit create more money. To understand this process we need to look back at the first banking systems. It's a bit of a ride but this is how it works:

The first bankers were Mediaeval goldsmiths. Since goldsmiths had safe and secure storage for their stock in trade - gold - early merchants, rather than building their own strong rooms and hiring their own guards, stored their gold with the goldsmiths, and no doubt paid a fee for the service. The goldsmiths gave them a note of receipt for their gold, promising that the merchants could come and get their gold at any time. These "promissory notes" were in fact records of a debt and credit - the owners of the gold having "loaned" their gold to the goldsmith for safekeeping, "crediting" him (we're assuming that all Middle Ages goldsmiths were male) with a belief in his basic honesty - and he having the obligation or debt to return it on demand.

But the merchants very seldom did demand their gold back. It was safest to leave it in storage, and about ninety percent of them did that. Instead of the gold, they started to make payments by passing back and forth the receipts for the gold. These "banker's notes" gave any holder the right to get the gold without ever having to actually take the gold out of safe storage. The notes - the record of the indebtedness of the goldsmith banker to the owner of the gold - transferred the right to get the gold to the owner of the receipt for the gold, and were just as good as the gold itself for making all kinds of payments.

When the goldsmith bankers found that the people who owned the gold very rarely came to get it they decided that they might as well use the gold themselves for a while - for "sure thing" business deals for example - and return it after use. As long as they had the owner's permission, there was no crime involved. And that permission could be easily bought with a "rental" fee paid for the use of the gold. As long as the goldsmith bankers didn't use all the gold at once, but held back enough gold to pay up with whenever someone who had a receipt for it asked for it, there was no problem. Actually, the bankers never took the gold out of safe storage either. They just issued additional receipt notes giving other people a temporary right to the gold they were "renting".

So, say there are ten merchants with 100 pounds of gold each on deposit with the local goldsmith, and they are passing around the thousand pounds worth of receipts for that gold as though it were the gold itself. Meanwhile the goldsmith is doing short term business deals using brand new notes entitling several new people to about nine hundred pounds of the same gold, which he can safely do since only one merchant in ten ever asks for his gold back. Suddenly, instead of a value of a thousand pounds of gold circulating, there is the value of nearly double that - one thousand and nine hundred pounds of gold.

This kind of thing went on for a whole lot of years and very rarely got anyone in trouble. The modern money system was created. Money "as good as gold" based on or "derived from" an actual store of gold, began circulating in values much greater than the gold in storage - money that was created out of nothing by transactions of credit and debt. But that is not the end of the story.

The paper notes, "as good as gold," could themselves be stored and further notes of receipt could be written promising to pay to the bearer of the new receipt, banker's notes instead of gold. Following the same one-in-ten rule, we see that the bankers could spin off from the original 1000 pounds of gold not only 900 pounds of bankers notes based on that gold, but an additional let's say 810 pounds worth of secondary notes based on - or "derived from" - the 900 pounds worth of bankers notes. This brings the total value to 1000 + 900 + 810 = 2710 pounds of gold-equivalent value in all - some in storage, some in circulation.

We see that this system could go on forever, each new set of paper serving as the base for another set of paper spun off or "derived from" it by means of a debt/credit transaction that uses it as a "secured" value base. The money supply just keeps growing. As long as everyone believed they could get their value back when they wanted it, and as long as they didn't all want it at the same time, money was created out of thin air by means of debt and credit. And that is still how money is created. Economists can justifiably look upon this phenomenon as a "miracle." As John Ralston Saul puts it in his book On Equilibrium, "economics is at heart a truly romantic pastime."

Early in the 20th century, an economist named Schumpeter finally saw the light that let loose all the restrictions. He noted that not only solid things, like cattle, beaver pelts and gold were money, but that the promise to pay any of those things - the banker's notes, that were essentially a promise to pay out in those real things (if required) - were everywhere also recognized as money. Therefore, he reasoned, all debts (the promises or "bond" to pay money in the future) were also money. "Schumpeter's Equation" says that money is debt and debt is money, and it matters very little in what form you possess it - from gold to promissory notes to bonds to derivative bonds to land to mortgages to consumer loans - whatever. It is all debt, and it is equally all money because debt can be changed into money.

This system which we currently use works so well - even spun so far from its early basis in gold - that in the middle of the 20th century, a few modern day goldsmiths decided to do away with the need to have gold as the base for the system. As a result in the 1950s our dollar bills no longer noted, "The Bank of Canada will pay to the bearer $1.00 in gold" and began to say instead "This note is legal tender." Check the bills in your wallet and this is what you will see. Near the end of the 20th century, the Bank of Canada even stopped insisting on the 10% rule, and not even dollar reserves are needed now to underpin the value of bank loans. What now underpins our money is only the capacity we have to keep producing and buying - by going into debt - the goods and services that we need and want.

With this fantastic method of creating money out of the thin air of debt and credit by means of production and consumption, there are two dangers: inflation and depression. "Inflation" means the inflation of prices. "Inflation" of prices is actually a "deflation" of the value of money. If too much money is created, it loses its rarity and therefore its value. "Depression" is when people stop spending money (or going into debt). They don't buy the goods and services produced, factories and businesses close, and people lose their jobs and therefore their money incomes. Because people can't buy, prices fall and soon fewer goods are made. The economic cycle slows down towards a stop.

But the inflationary urge to create more and more money is very strong. Our bankers and lenders earn more by creating more money. We are partners in this creation of money because it happens by means of our capacity and willingness to borrow. The more in debt we let ourselves get to buy things that we can possess and consume, the more (we believe) we also benefit, as long as our future incomes live up to our promises to pay. If they don't, we face bankruptcy and, if that happens to a majority of people, depression.

However, there is an element of control. As new money is created by new debt, old debts (and therefore old money) are retired. Money is constantly appearing as new debt and constantly vanishing as retired old debt. By controlling debt, you can control the money supply. Interest rates are used to control debt, lower rates encouraging spending and debt creation (more money), higher rates encouraging saving and debt retirement (less money). But there is a trap here. We are caught balanced precariously between two roads to economic disaster. Worse yet, the road we are on between them also leads to disaster.

The money/debt creation and retirement cycle must be kept going pretty close to the rate at which new money created equals old money vanishing. The cycle must be stable and not tip either way. If it ever stops, the bottom will fall out and our monetary economy will collapse. If it ever balloons up out of control, it will go through the ceiling and the value of our money will collapse. We must continually make new goods to replace the old ones that wear out, and make sure that people can buy them, just to stay in the same place, maintain the cycle, and sustain the value base for our money. This necessity has led us to over-consume and to over-use our natural resources and the environment that contains them. It seems that if we continue in this direction, our world will soon be empty.

This is the way the world will end.
This is the way the world will end.
This is the way the world will end;
Not with a bang, but a whimper.

T.S. Eliot
"The Wasteland"

Acknowledgements
Thanks to Ross Dobson for his generous contributions to this article.