Wednesday, 1 August 2012

Different kinds of money

It is reasonably well-known that banks create money to lend to their customers. Someone in the blogosphere said this can't be true because Northern Rock went bust. But he's wrong. The money that banks lend each other is a different type of money. Clearly, the other banks wouldn't have accepted money created out of thin air by Northern Rock it settlement of their debts, anymore than NR would have accepted money that I create out of thin air as a deposit.

These different types of money are all denominated in the same currency name (eg pounds) but the 'terms and conditions' attached to them are different. You can't spend government bonds in Tesco's.

Daily life reveals examples of types of money that we understand or at least get along with. Money off coupons are an example. They are very restricted as to where, when, and on what youi can spend them, but they are money of a sort. Oyster Pay-as-you-go credit is another example. In practice, you can only spend it on bus and train journeys. You can't readily spend it as freely as cash, but it is denominated in pounds.

Mobile phone companies use this phenomenon. They make it easy to buy the special money that lives on your phone and can only be spent on calls, SMS and data, but converting it back or spendiong it on anything else is difficult if not impossible. O2 offers me a "free" £1 top up when I put £10 on my phone. I have to accept the offer, but it is largely meaningless as this is in effect O2 creating money for me to spend with them.

But because it is not part of daily life for most people, they don't tend to think, I suppose, of the different types of money used in banking. I'm going to try for a generalised list of "Ts and Cs" of types of money to draw this out:

1) Who may hold the type of money. Day to day example - money on a PAYG mobile phone may be held by anyone with a SIM card on the appropriate network. Banking example: Only banks can hold the interbank money that they use to settle net transactions between them.

2) With whom the money may be spent. Day to day example - a money off coupon is typically limited to a particular supermarket. Banking example - the clearing banks and Bank of England have a kind of money that they accept amongst themselves. This is the kind of money created by quantitative easing (I think).

3) On what the money may be spent. Day to day example - Oyster PAYG may only be spent on train / bus fares. (It may be possible to get stored value refunded, but only in special circumstances). Banking example - Government Bonds. Apart from trading the bonds themselves, they are pretty much restricted to buying currency for the banks to circulate amongst themselves (I think).

4) By when the money must be spent. Day to day example - a money off coupon will usually have an expiry date after which it is useless. Banking example - can't think of one.

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