 Hi, my name is Dirk Beismar at the University of Groningen in the Netherlands. I will explore with you what money is and how money, credit and debt and the financial sector are important to our economy. We are now in a credit crisis or a debt crisis. So it seems a lot of money disappeared recently and we are in trouble. Where has this money gone? Where did it come from in the first place? What is money? Now, Woody Allen supposedly joked that economics is about money and why it is good. So let's ask some economics students here at my university. Well money is just a tool to improve or let's say make life easier. It substitutes barter trade. Money is just a means for trade. It represents a kind of value. We are paying for some services or some products or some goods. The coins pay for money, but also my bank card. Too little money. I think with the crisis it is always too little money. You may think that money was invented to make exchange easier. You could imagine that at some point in prehistory a hunter just shot a deer and a farmer has some carrots and they want to exchange. But the meat is worth much more than the carrots so they need to invent something to pay each other the difference. In this story that something would be money. Be it in the form of shells or lumps of gold or silver or whatever. And then later in the story banks would appear to store the money and to lend out money from people who have too much money who are the savers. To those who have too little money the investors. And that's when credit and debt systems appeared. So money came first and then credit and debt in this story. The problem with this story is it may sound plausible but there is very little historical or archaeological evidence for it. Because it has some logical problems. There is a lot of evidence and arguments to believe that debt came first and money later when people started to use their debt tokens, their debt symbols as money. Now why would this be the case? Well in the first place it would be logical because of seasonal production. In ancient societies dependent on seasonal production food and other products come onto the market at different times of the year. So the farmer has perhaps not yet harvested the carrots while the hunter already shot the deer with no fridge to keep it in. So what did they do? The farmer accepts the meat now on the promise that he will pay the carrots later as they come available. So at this moment the farmer has accepted a debt which is a promise to pay the hunter in the future. So here we have a relation between a creditor and a debtor. Now with more people than just these two in any one society and with different products you can imagine you quickly get a complex web of credit relations. Also each debt contract may have a lot of detail not only how much is owed but also when it needs repaying in what form, what the interest is and so on. For all this you will need a system to record it. So the upshot is as soon as you had specialization of production with different people producing different things at different times of the year then you need to record credit and debt what we now call double entry bookkeeping. Albert Einstein seems to have said that humanity made three great inventions in prehistory, fire, the wheel and double entry bookkeeping. Now this is all really interesting but how does money come in and why do we need to know all this? Well money is simply debt symbols, debt tokens which are used as payments. After all a debt is a claim on future goods and services as we just saw so it's really worth something and that means you can pay with it. Let's say the debt is written on a clay tablet. The hunter can now use the tablets to pay someone else like a fisherman. And as the debt tokens are moved out of that particular trading relationship there will also be the need for some external authority to assert their value like kings or chiefs proclaiming the value of money. This also opens up the possibility of central clearing which greatly simplifies things. If A has a claim on B and B has a claim on C and C has a claim on A then they could all physically pay each other the clay tablets but it's also possible to settle without any of these debt tokens changing hands so the clay tablets can be left in a central storage only the ownership over the clay tablets over the debt tokens would change hands. Now suddenly society can easily manage a much larger number of credit and debt relations by central clearing. You don't need to carry it all around. In fact that's why in an ancient society called Sumer in what is now Iraq thousands of clay tablets were found in the desert sands stored in temple ruins, the central banks of their day. People did not carry clay tablets around but their ownership just changed hands while they were stored in temple vaults. Just as today we pay by transferring ownership of part of our bank accounts. So our modern financial system is in fact very old. Credit, debt, interest, denominations of money, clearing systems, central banks they all go back thousands of years. Now here is why all this matters to us today. Just as in ancient times money still is debt and just as in ancient times this is why money which for us is bank credits money is so important for exchange and economic growth. Just look at the modern British five pound notes. On it you can read I will pay to the bearer on demand the sum of five pounds signed by the chief cashier of the Bank of England. Now no one will actually take this note to the Bank of England to get five pounds because what would the chief cashier give you in return? Of course five pounds so another note. But these words on the pound notes clearly show the origin of our modern money. Money is a form of debt, an obligation to pay on demand. There is another way to see that money is debt also today. And this is that new money comes into existence as people increase their debt. The quantity of money in circulation increases as banks make new loans. There's nothing secret about this. You can read about this on the websites of central banks for instance. But it is a bit confusing. Since the word lending suggests this is about something that already exists you can only lend out what you have after all. But this is not the case with money which banks lend out. It's better to say that banks create money. They lend it into existence. They make it out of nothing as some people like to say. Well out of paper and ink that is. Or out of the bits in their computers nowadays. So how does the quantity of money increase as banks make loans? Let's look at an example. Suppose I want to buy a red Maserati which is an expensive sports car. This costs €220,000 which I do not have at the moment. So I go to a bank and ask for a loan in this case a consumption loan. If the loan officer knows his job he will say no. But five or six years ago he would have offered me a cup of coffee and settled the business for me. Now if they do that what happens? Do they wait until someone comes in through the back door with a bag of money so they can give me my money for the loan? Of course not. All that happens is I have to show my credit card or passport maybe and there will be some typing on computer keyboards, some signatures. That's it. Now the bank has given me a €220,000 loan. What this means is that the bank promises to pay my bills up to the maximum of €220,000. They increased my current account balance. They did this by changing some numbers in their computer. New money has been created. Now I cross the street to the Maserati dealer and buy the car. Again I do not give the dealer a bag of money but I show my credit card and ID. I sign a form and that is it. What happens is that the bank people transfer €220,000 from my account to the account of the Maserati dealer. Again by changing some numbers in their computer. I have now spent the money that was earlier created. This is real money. The Maserati dealer can use it to go shopping, to pay his employees, to decorate his house or whatever as real as you like. So new money has been created because I took out a loan and the bank wanted to lend. Suppose that I decided in the morning that borrowing €220,000 to buy an expensive car was really a stupid idea and I wouldn't have done it. Then in the evening there would be €220,000 less in the economy compared to the case where I did go ahead and took the loan. And the Maserati dealer would not be able to spend it on shopping or decorating. It wouldn't exist. So lending really does create new money. We can use this story to see a number of important things about money. First, we don't need to save before lending can take place. On the contrary, it's the loan which creates new money by moving that money into other people's current accounts at the bank as I pay. It can then be saved or used for payment again. So loans create deposits and savings, not the other way around. Our Maserati dealer, for example, can choose not to spend his money but save it for a rainy day. However, this is only possible because I borrowed the money first and the bank created it. The other thing we can see is that money creation in itself does not lead to imbalances or instability. It's not scary. What happens is that when the Maserati has been bought, the bank has an additional asset, which is its claim on me. I need to repay the loan. It also has an additional liability, which is the €220,000 now in the Maserati dealer's account, remember. The bank must pay this to the Maserati dealer on demand, so it's a bank liability. Now, the bank's business is to manage these long-term assets and short-term liabilities, and that is why we have banks, among other things. But there is no imbalance in the system because of money creation. What we learned here about money is that banks like ancient producers and traders and kings make debt out of nothing. Because we use bank debt as money, you can say banks create money out of nothing. Many people think this is scary or worrisome or that it is new, something that bad governments have allowed after the fall of the gold standards, and that only gold is real money. But in fact, money has always been debt for 5,000 years and probably much longer. Once we recognize that money is debt symbols, debt tokens, that we exchange if we want to pay or trade, then we see that actually it's logical that money is made out of nothing. It's not worrisome. Debt itself is, of course, made out of nothing because it's an agreement. And just as debt can appear by agreement, think about the farmer and the hunter, it can simply disappear when the agreement stops, when debts are paid off or defaulted on. So debt comes and goes and by implication money comes and goes. There's no mystery about that and nothing new. So the important insight is that money is not a thing. It is not clay or wood or gold or silver or computers or whatever material is used to record lending and borrowing transactions. Nothing else is needed for the creation of money than mutual trust, a system of accounting and some symbol of the loan transaction and a credit relation. And just like relations are very valuable and important, even though they appear out of nothing. So money is important even though it can be created out of nothing just by computer keystrokes. In fact, credit and debt is what makes production possible and exchange and economic growth. Imagine the hunter and the farmer in my story would have thought that debt is bad. They would have refused to take on any debt or to use debt symbols for payment because they believed you shouldn't make money out of nothing. No exchange would have been possible. No specialization of labor would have been possible. No innovation, no development or economic growth. We would still be in prehistory. That's how important the innovation of double entry bookkeeping was and credit and debt. But if debt is so helpful for economic growth, how is it possible we have a debt crisis? This is what we will explore in the next episode.