How Banks Create Money When Purchasing Assets

How Banks Create Money When Purchasing Assets I have previously written about the unique legal powers given to commercial banks and credit institutions in general, that allow them to create new currency, thus increasing its supply. For banks, this also extends to their open market operations, such as when they buy securities and other assets from the open market. If the bank’s counterparty happens to be a non-bank, or more generally an entity without an account at the central bank, then the bank will create new currency to pay for that transaction. I described this in my thread/article titled "when a bank buys an asset from a non-bank it creates broad money": https://illya.sh/threads/@1755863018-1.html I received a question about it via e-mail, so I’m writing a follow-up with clarifications. The flow that I was describing the thread linked above is what happens when a bank buys an asset from a non-bank. Let’s assume the bank ABC wants to buy an asset from you. Let’s forget about US government bonds for now, let’s say the bank wants to buy 100 shares of Tesla from you. The current market price for 1 Tesla share is ≈$450, so the ABC bank would pay you $45000 and you will give the bank the 100 shares. Let’s also assume you have an account in that bank (this is not mandatory!) Let’s say that right before the bank makes a purchase from you (a microsecond before that transaction/sale happens) there is a total of $1 million ($1000000) of US dollars in circulation. The moment right after the transaction is made, and the bank crediting your account with $45000, the total money in circulation would become $1 000 000 + $45000 = $1 045 000. The main point here is that those $45000 didn’t exist in circulation before. They were not taken from someone else’s account, nor from internal bank reserves. Those $45000 were created “out of thin air”, and that money was credited into your account. I say “credited” because it’s from the point of view of the bank - your deposit account at the bank is a liability to the bank - it sits on the liabilities side of the balance sheet - a credit increases liabilities. Now, I referred to “money in circulation”, but I actually meant Broad Money. There is another form of money - called Broad Money. There is a great paper from the Bank of England that describes them, alongside how commercial banks create money: https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf . But in short, Broad Money is the money available for use by the larger economy (individuals, companies, etc), while Base Money is physical currency and currency held in reserve accounts at the central bank - the reserve accounts portion doesn’t touch the broader economy directly. If instead a bank ABC purchases an asset from another bank DEF - then the total money does not change. The bank ABC would just debit their reserve account at the central bank and credit the reserve account of the bank DEF. So money moves accounts, but total quantity does not change. In the same manner, when a commercial bank buys bonds directly from the government, there is no creation of “new money” - the money moves within the central bank’s reserve accounts. The general rule is: if the transacting entities have reserve accounts in the central bank the transaction is made within the central bank’s reserve accounts. Commercial banks, governments and sometimes select financial institutions (like in the US) have reserve accounts at the central bank, so transactions within them move Base Money The following article on how commercial banks work will be very helpful to understand how they operate and create money: https://illya.sh/threads/@1754426330-1