Credit money
Encyclopedia
Credit money is any claim against a physical or legal person that can be used for the purchase of goods and services. Examples of credit money include personal IOU
s, and in general any financial instrument or bank money market account certificate, which is not immediately repayable (redeemable) in specie
, on demand.
Credit money is naturally used as money
, and may even be the primary type of money. Banknotes which are not backed by specie (see fiat money
for the latter case), may be categorized as credit money, whether or not they are legal tender
, inasmuch as they are simply promissory notes issued by a certain bank, or system of banks.
Today many countries' central banks or financial regulators do not impose reserve requirements on banks during the day, such is the case in the United States, and in other countries like the UK there is no reserve requirement. In these cases, the textbook representation of fractional reserve banking becomes inapplicable. As Werner (2005) and others point out, this demonstrates that each bank has the power to create credit (and hence money).
, where banknotes from a well-trusted bank function as currency. Scotland technically recognizes no legal tender, and thus functions nationally on private banknote credit money, which is represented by promissory Pound Sterling
notes. These notes are issued by three major Scottish banks (among them the Bank of Scotland
), however these banks must hold deposits with the Bank of England
to cover the notes they issue. Bank of England notes are also not legal tender outside of England and Wales, however they are universally accepted in the rest of the UK, and legally are obligations of the Bank.
In the United States during the Great Depression
, trust in banks dropped very low, and there was the risk of a bank run
on a private or state-banks. In the United States, the Federal Deposit Insurance Corporation
was created in 1933 to insure
deposits in checking and savings accounts, thus effectively making the federal government the final creditor for bank-drafts and promisory notes issued by all participating banks and credit unions.
In the case of legal-tender banknotes, the issuing bank is generally the central bank
or reserve bank of a government, which, by authorizing the note as legal tender, assumes the role of creditor. For example, in the United States, paper currency consists of Federal Reserve note
s, which are banknotes issued by the Federal Reserve system of privately owned central banks. These banknotes are liabilities of the Federal Reserve, and obligations of the United States.
In terms of the money supply
, credit money is generally associated with that part of M2 which is not M0.
During the Crusades
in Europe, precious goods would be entrusted to the Roman Catholic Church
's Knights Templar
, who effectively created a system of modern credit accounts.
IOU (debt)
An IOU is usually an informal document acknowledging debt. An IOU differs from a promissory note in that an IOU is not a negotiable instrument and does not specify repayment terms such as the time of repayment. IOUs usually specify the debtor, the amount owed, and sometimes the creditor...
s, and in general any financial instrument or bank money market account certificate, which is not immediately repayable (redeemable) in specie
Coin
A coin is a piece of hard material that is standardized in weight, is produced in large quantities in order to facilitate trade, and primarily can be used as a legal tender token for commerce in the designated country, region, or territory....
, on demand.
Credit money is naturally used as money
Money
Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past,...
, and may even be the primary type of money. Banknotes which are not backed by specie (see fiat money
Fiat money
Fiat money is money that has value only because of government regulation or law. The term derives from the Latin fiat, meaning "let it be done", as such money is established by government decree. Where fiat money is used as currency, the term fiat currency is used.Fiat money originated in 11th...
for the latter case), may be categorized as credit money, whether or not they are legal tender
Legal tender
Legal tender is a medium of payment allowed by law or recognized by a legal system to be valid for meeting a financial obligation. Paper currency is a common form of legal tender in many countries....
, inasmuch as they are simply promissory notes issued by a certain bank, or system of banks.
Today many countries' central banks or financial regulators do not impose reserve requirements on banks during the day, such is the case in the United States, and in other countries like the UK there is no reserve requirement. In these cases, the textbook representation of fractional reserve banking becomes inapplicable. As Werner (2005) and others point out, this demonstrates that each bank has the power to create credit (and hence money).
Examples of credit money
An example of a credit money banknote which is not legal tender is seen in ScotlandScotland
Scotland is a country that is part of the United Kingdom. Occupying the northern third of the island of Great Britain, it shares a border with England to the south and is bounded by the North Sea to the east, the Atlantic Ocean to the north and west, and the North Channel and Irish Sea to the...
, where banknotes from a well-trusted bank function as currency. Scotland technically recognizes no legal tender, and thus functions nationally on private banknote credit money, which is represented by promissory Pound Sterling
Pound sterling
The pound sterling , commonly called the pound, is the official currency of the United Kingdom, its Crown Dependencies and the British Overseas Territories of South Georgia and the South Sandwich Islands, British Antarctic Territory and Tristan da Cunha. It is subdivided into 100 pence...
notes. These notes are issued by three major Scottish banks (among them the Bank of Scotland
Bank of Scotland
The Bank of Scotland plc is a commercial and clearing bank based in Edinburgh, Scotland. With a history dating to the 17th century, it is the second oldest surviving bank in what is now the United Kingdom, and is the only commercial institution created by the Parliament of Scotland to...
), however these banks must hold deposits with the Bank of England
Bank of England
The Bank of England is the central bank of the United Kingdom and the model on which most modern central banks have been based. Established in 1694, it is the second oldest central bank in the world...
to cover the notes they issue. Bank of England notes are also not legal tender outside of England and Wales, however they are universally accepted in the rest of the UK, and legally are obligations of the Bank.
In the United States during the Great Depression
Great Depression
The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...
, trust in banks dropped very low, and there was the risk of a bank run
Bank run
A bank run occurs when a large number of bank customers withdraw their deposits because they believe the bank is, or might become, insolvent...
on a private or state-banks. In the United States, the Federal Deposit Insurance Corporation
Federal Deposit Insurance Corporation
The Federal Deposit Insurance Corporation is a United States government corporation created by the Glass–Steagall Act of 1933. It provides deposit insurance, which guarantees the safety of deposits in member banks, currently up to $250,000 per depositor per bank. , the FDIC insures deposits at...
was created in 1933 to insure
Insurance
In law and economics, insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the...
deposits in checking and savings accounts, thus effectively making the federal government the final creditor for bank-drafts and promisory notes issued by all participating banks and credit unions.
In the case of legal-tender banknotes, the issuing bank is generally the central bank
Central bank
A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...
or reserve bank of a government, which, by authorizing the note as legal tender, assumes the role of creditor. For example, in the United States, paper currency consists of Federal Reserve note
Federal Reserve Note
A Federal Reserve Note is a type of banknote used in the United States of America. Federal Reserve Notes are printed by the United States Bureau of Engraving and Printing on paper made by Crane & Co. of Dalton, Massachusetts. They are the only type of U.S...
s, which are banknotes issued by the Federal Reserve system of privately owned central banks. These banknotes are liabilities of the Federal Reserve, and obligations of the United States.
In terms of the money supply
Money supply
In economics, the money supply or money stock, is the total amount of money available in an economy at a specific time. There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits .Money supply data are recorded and published, usually...
, credit money is generally associated with that part of M2 which is not M0.
Credit money in history
Credit money is at least as old as banking, namely about 5,000 years. In ancient Babylon (3rd Millennium BC), temples often acted as banks. Banks have for centuries served as the main creators of the money supply. This also has given them powers to allocate credit. Prominent banking systems with flourishing credit money supplies include ancient Egypt, Greece and Rome.During the Crusades
Crusades
The Crusades were a series of religious wars, blessed by the Pope and the Catholic Church with the main goal of restoring Christian access to the holy places in and near Jerusalem...
in Europe, precious goods would be entrusted to the Roman Catholic Church
Roman Catholic Church
The Catholic Church, also known as the Roman Catholic Church, is the world's largest Christian church, with over a billion members. Led by the Pope, it defines its mission as spreading the gospel of Jesus Christ, administering the sacraments and exercising charity...
's Knights Templar
Knights Templar
The Poor Fellow-Soldiers of Christ and of the Temple of Solomon , commonly known as the Knights Templar, the Order of the Temple or simply as Templars, were among the most famous of the Western Christian military orders...
, who effectively created a system of modern credit accounts.
See also
- Fractional-reserve bankingFractional-reserve bankingFractional-reserve banking is a form of banking where banks maintain reserves that are only a fraction of the customer's deposits. Funds deposited into a bank are mostly lent out, and a bank keeps only a fraction of the quantity of deposits as reserves...
- Money creationMoney creationIn economics, money creation is the process by which the money supply of a country or a monetary region is increased due to some reason. There are two principal stages of money creation. First, the central bank introduces new money into the economy by purchasing financial assets or lending money...
- CreditCredit (finance)Credit is the trust which allows one party to provide resources to another party where that second party does not reimburse the first party immediately , but instead arranges either to repay or return those resources at a later date. The resources provided may be financial Credit is the trust...
- Credit creation