Is there a magic money tree?
Early in 2014 the Bank of England issued a report called “Money Creation in the Modern Economy”. In it, they pointed out that most money today is created by banks making loans. Money is – apparently – conjured out of thin air when a loan is created (getting technical, by debiting the bank’s asset account and crediting a borrower account)
At first glance, this does look like ‘magic’ money.
A few people sensed that there might be seismic implications for our understanding of how the economic world turns. The idea that banks are just intermediaries between savers and borrowers does not hold (although they do serve that function too).
Much of what economists – and accountants, bankers and politicians – think about how the economy works needs to be rewritten in the light of this. It wasn’t a new revelation. A few people had written much the same across the centuries. The insight was just lost, overturned temporarily during the Twentieth Century.
What did we accountants think before 2014? We were taught that money is, at bottom:
- A store of value
- A means of exchange
- A unit of account
And money does have those properties, but if you ask anyone – banker, accountant, economist or politician – what money is, where the value is derived from, they would be hard pressed to give you an answer that goes any further.
Where is the value coming from?
The Bank of England paper gives us an insight, if we think it through. Does a commercial bank just create money out of thin air by entering debits and credits in its books?
Let’s think about what is going on.
The bank’s crucial role here is that of gatekeeper. It assesses the borrower very carefully. Its credit checking is vital to ensure that the money created is backed by assets or realistic future potential. The loan that results has a call on real assets, or on the future earnings potential of the borrower. The bank creates accounting entries, but not out of thin air – there is a very important gatekeeping going on so as to ensure that the new money that results has backing.
And there it is: money is a call on the assets in the economy. Those assets include the future earnings potential of borrowers – that potential is an asset to the economy too.
If you hold money, its value derives from that call on the real economy. We trust that society will recognise that call, and that there will be assets to allow us to realise that value. In future articles we will look at some of the implications of the new understanding of this magic that is money.
Firstly we, yourselves and FD4, are company directors, making economic decisions. It’s useful to be able make those decisions with an improved grasp of the economy, both for ourselves and society at large.
Also, you don’t have to be the best, just better than the competition – you know the joke about not having to run faster than the bear, just the other guy. FD4 are here to help you with that.
In particular, if you are a company director looking for a commercial loan, you need someone on your side who can think like a banker, who can speak their language and translate for you. What are the things going on in the banker’s mind: Will the loan be backed by collateral? Is the collateral what it appears to be? If there is no collateral, does the borrower have an income stream that will pay back the loan? Do they earn a safe salary, or, if a company, have a good use for the money that will generate a return?
Above all, will the bank get the money back?
The FD4 team have years of experience at this. We can make sure that you avoid giving the wrong first impression, that you can present credible information that tells the story of your business. Credible things such as a commercial model of the business, with an integrated P&L and balance sheet that shows cashflows under a variety of scenarios; that makes explicit what is going with prices, costs and margins; a model that ties the real commercial world KPIs in with the finances; that has had the sales forecasts pegged to real actions likely to bring them to fruition.
FD4 are here to help you land the lucre, and power forward as a commercial success.