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Most money is really credit
A tab as credit
Pay for a beer with cash and the transaction is settled on the spot. Put it on a tab and the bartender is holding a promise to be paid later, which makes it an asset for him and a liability for the drinker. Nothing existed a moment before, and any two people who agree on a loan can create credit this way.
How credit ends
Credit turns into debt the instant it exists, and it disappears only when the borrower repays the principal plus interest. If the drinker never pays and defaults on the tab, the bartender's asset turns out to be worth nothing.
Credit versus money
Money is what settles transactions, and most of what people call money is actually credit. In the United States the total amount of credit is about $50 trillion, while the total amount of money is only about $3 trillion.
How do banks create money by lending?
When a bank approves a loan, it credits the borrower's account with a new deposit that did not exist before. The bank is not handing over other customers' savings. It adds an asset, the loan, and a liability, the deposit, to its own books at the same moment.
A 2014 Bank of England quarterly bulletin article titled Money creation in the modern economy set this out and said most money in the economy takes the form of bank deposits created this way.
Why does repaying a loan destroy money?
The deposit that a loan created is wiped out when the borrower repays, because the loan asset and the deposit liability are cancelled together on the bank's books. If repayments outrun new lending, the stock of deposits shrinks.
Milton Friedman and Anna Schwartz found in A Monetary History of the United States that the US money stock fell by about one third between 1929 and 1933 as banks failed and loans were repaid or written off.
Why did credit exist before coins?
Clay tablets from ancient Mesopotamia record debts of grain and silver, kept by temple and palace scribes, as far back as the third millennium BCE. The anthropologist David Graeber argued in Debt: The First 5,000 Years that credit systems came first and coinage followed.
The earliest coins were struck in Lydia, in what is now western Turkey, around 600 BCE.
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