I. Analysis of the Basic Concepts in the Conventional Money Theory and

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Reforms in China’s Monetary Policy
than that on the outstanding deposits. For any bank, the remaining deposit 
is equal to total deposits minus required reserves, and can be stated as: 
deposits * (1—required reserve ratio) (Fabozzi, 1994). Or it can be under-
stood as “using excess reserves to grant loans,” which refers to how banks 
reduce excess reserves to increase loans. “Banks do not necessarily lend all 
excess reserves” (Huang, 1998). According to the above reasoning, when 
banks make loans, deposits will be reduced on the liability side of the balance 
sheet, while loans will be increased on the asset side, which will result in an 
unbalanced balance sheet. In fact, in the conventional money theory, there 
is a concept of “fund” that can be held by both banks and clients. This fund 
exits only in people’s minds, similar to the “ether” in physics, or is sometimes 
deemed as excess reserves. The implied core principle is that when granting 
loans to clients, banks should give clients a certain amount of fund. 
However, in reality, the accounting entry of bank loans is: 
Debit: loans to clients 
Credit: clients’ deposits 
Banks’ lending activity is in itself a self-balancing behavior of the double-
entry bookkeeping. When clients receive loans from a bank, their deposits in 
the bank will increase at the same time. Banks’ credit (i.e., deposit liabilities) 
is accepted by the public, so banks can create deposit money by lending. In 
the commodity money system, gold is the asset to both the “ Qianzhuang ” (in 
this chapter, it refers to the credit institutions in the commodity money sys-
tem) and the clients. Their status is equal. Gold is the fund of both the public 
and the Qianzhuang . But in the credit money system, money is the asset to 
the public but the liabilities to banks, and therefore the status of banks and 
the public are unequal. So there is no universal definition of the fund. Banks 
and the nonbank public are totally different in nature: banks are creators of 
money, while clients are holders of money. If we regard money as a kind of 
assets, it is the money of the public, but not the money of banks. Banks’ lend-
ing activity gives clients funds, but this fund is neither the deposit absorbed 
by banks nor the excess reserves of banks; it is the deposits produced by the 
lending activity. 
Therefore deposits are not social resources available to banks. The con-
ventional money theory holds that deposits are the funding sources of banks, 
and if the savings deposits of residents drop steadily while the loans of banks 
rise steadily, it will create pressure on the growth of the money supply. If 
the trend of small increase in deposits and large increase in loans continues, 
it will affect the liquidity of commercial banks and may possibly force the 
central bank to increase the monetary base. As far as banks’ lending activity 
is concerned, deposits are created at the same time when loans are made. 
Deposits do not constrain lending activities; the only constraint on lend-
ing activities is the requirement to hold reserves, which only come from the 

Monetary Theory
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asset business of the central bank. Banks’ lending activities therefore are not 
directly restricted by deposits and deposits are not social resources available 
to banks; on the contrary, all deposits are created by bank loans. The deposits 
can provide many conveniences for their holders and are regarded as a kind 
of social resources, but they are social resources provided by banks to the non-
bank public, instead of resources provided by the nonbank public to banks as 
is stated by the conventional money theory.

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