Monetary Theory
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11
way be “original.” The belief of conventional money and banking theory on
cash, the imagination of exogenous cash, and the instinctive resistance to the
analysis of the source of cash are very much like
the understanding of piggy
banks in childhood.
A further development of piggy banks is the act of depositing money into
bank by teenagers, giving rise to the preliminary understanding of banks.
Based on their understanding of piggy banks, they would naturally con-
sider banks as nothing but bigger piggy banks into which their deposits are
absorbed, and the money deposited is the “original deposit” of banks. When
they grow up a little and would ask why banks pay them interests, their par-
ents would explain the reason that banks make more interests by providing
the money you deposited to other people in the form of loans, and after giving
you
some interests, the remainder becomes the profit of banks. Thus people’s
concept of banks as reselling intermediary of “capital” for the so-called indi-
rect financing is formed. The understanding of money in upbringing is “cash
before deposit” and “deposit before loan.” This direction of understanding is
just in the opposite order with that of the real operation of money.
After the formation of such conventional money and banking concepts
with cash as the starting point accompanied by a vague definition of “cash,”
it is extremely difficult to have a change of idea; therefore, the description
of money from the perspective of conventional theory is oriented toward
commodity money. Even when credit money is mentioned, the emphasis is
on its relation with commodity money, while no
attention is paid to such a
critical issue that credit money relies on the liabilities of other entities as its
own money.
In fact, the monetary system develops from the commodity monetary sys-
tem to the mixed monetary system, followed by the credit monetary system,
so the money and banking theory attaches great importance to the funda-
mental role of gold in the mixed system of commodity money and credit
money and also to the fundamental role of cash in the credit monetary sys-
tem. Yet cash cannot be generated out of nothing, nor can it be explained
with a simple sentence that “central banks put cash into circulation.” Cash
comes from deposits withdrawn from banks by customers,
while deposit
comes from loans. In this regard, cash is not the monetary starting point
of the credit monetary system; rather, loan is the starting point. In prac-
tice, the cash withdrawn from banks by customers is much more than the
cash they deposit in banks, and cash withdrawal is more common than cash
deposit, which can explain why cash circulation in society is going up, but
not the opposite. Cash is not simply irrelevant to money creation, let alone
a prerequisite for money creation. In
the actual operation of banks, cash is
not important at all. The conventional money and banking theory sets the
12
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Reforms in China’s Monetary Policy
starting point of money creation at the cash deposited by customers that
is absorbed by banks, which makes the mistake of putting the nonessential
before the fundamental. As shown in Figure 1.1 , the genuine basis of money
creation and bank operation is the lending of banks, beginning from a loan
issued to Company A from Bank (A), which forms the deposit of Company
A in Bank (A), and after the
transfer and cash withdrawal, a teenager deposits
cash in the bank—the concept of “original deposit” and the source of bank
operation comes to his mind.
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