BackOpinion | The alchemy of aggregation: Let’s keep calm and create some cash
Money represents payment promises which add up so robustly that its availability can be expanded by the central bank
PremiumIn a crisis, central banks often “print money". How can they do this with such alacrity? Doesn’t it violate some basic laws of economic physics? How can value come from nothing?
There is no alchemy here, just the crisis-driven centralization of a social machine we use daily— the banking system. As working people, we mainly live in the store-of-value dimension of money, which is why the mind rebels when we hear more of it can just be printed—or created—by the central bank. Our individual experience of money makes such an operation appear against the rules, somehow, both economic and ethical.
But social and natural aggregations have “emergent" properties: What is true at the individual level is not necessarily true at the aggregate or social level. At the broader level, money is a social claim on a collective enterprise, a promissory note of the State’s bank against the entire economy. What appears as alchemy is in fact just the operation of banking.
Seen this way, banks are not moneylenders. They are dealers in their own “promissory notes", our bank accounts, which trade so seamlessly and at par with central bank money (“cash") that we are entirely unaware of the difference. When we go to an ATM, we do not think of ourselves as calling back a loan. But what we call a “deposit" is actually a credit operation, a loan to a bank that is “callable" on demand. The aggregation of deposit-loans enables the bank to credibly promise to repay cash on demand to depositor-lenders. The bank’s promise is so credible that we don’t even see it. We think we are merely retrieving our money from storage.
What’s going on is the alchemy of aggregation, the turning of a promise into a value-bearing instrument, “money." There is no transubstantiation here, just high degrees of probability that appear to us as certainty and therefore thing-like. Enabling this daily magic is an elaborate and ancient system of sharing liquidity through promises to pay, banking.
Banks arrange their balance sheets to make our bank account “units" look and feel like money. What we call “money" is a liability of the central bank; bank accounts are not literally money, but promises to pay money. Yet, so solid are these promises that they are the functional equivalent; most money in an economy takes this form.
The near-money nature of bank liabilities enable these special businesses to operate in ways we find troubling. If bank liabilities are almost money, then banks can “print" near-money merely by creating more such accounts. This is what banks do when they make loans: they create a checking account for the borrower; they “print money."
When an illiquid but solvent borrower pledges to make payments to the bank over a specified term, that borrower is also “printing money" in the sense of issuing IOUs (I Owe You), the kind that only a banker would accept after due diligence. This screening of individual creditworthiness is costly and time-consuming. Given these costs, the public is unlikely to accept a borrower’s personal IOU as payment. Hence the business of banking, which is not money lending but accepting or guaranteeing an individual’s promissory notes as creditworthy. The bank has signed your personal IOU; now it’s money.
In the act of making the loan, the bank transforms the borrower’s idiosyncratic and illegible promissory note into something people will accept as payment. No alchemy, just banking. The asset backing this creation of money is the future earning capacity of the borrower. Money has expanded, but so might the economy if the borrower’s project takes off.
This is, of course, a risky operation: the loan asset might not perform. But apply the law of averages, prudence from experience, and incentive-compatible regulations, and the advantages of borrowing from our collective future can be... like alchemy. Again, this is merely the magic of aggregation over many loan assets.
Luckily for us, governments long ago acquired one of these special businesses. We the people own a bank. The central bank operates on the same basic principles, just at greater scale and with State backing. If government bonds are backed by future taxes raised in an economy, and these bond-loans constitute the central bank’s assets, then the central bank’s liability—money—is ultimately a promissory note written on the future national economy.
Unlike regular banks, a central bank aggregates at nation-state scale and is backstopped by legitimate coercion. The aggregation of taxation claims makes the IOUs of our central bank orders of magnitude more robust than a regular bank’s near-money, which is itself a quantum leap from our personal IOUs. As we increase scale and robustness, aggregation across an entire economy hardens mere promises into the social metal we call money.
Maybe the notion of “printing money" shocks us because what we see as “real" turns out to be a set of promises. But promises are also real, only in a different sense: they embody the industrial strength of sociopolitical relations that lock in future value. There is a different physics of the aggregate, one that becomes apparent in crises as black boxes break. Central bank money indexes a different order of reality, a social order. Our daily transactions obscure this order from us, so we’re unsettled when a crisis reveals it. But right now, so long as it does not threaten to set off inflation, perhaps we would do well to keep calm and print some money.
Anush Kapadia is faculty member at IIT Bombay in the humanities and social sciences department. These are the author’s personal views
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