Money and Credit

“I think, that a consensus on definitions must be achieved some time. Of course, things can constantly be mixed up, so that someone may call money, what another calls asset and a third credit.”

Werner Ehrlicher 1

What are assets and how do they grow?

When a housewife lends her neighbour a pound of salt, it is no longer in her possession. But she has a claim for the return of a pound of salt: She is ‘owed a pound of salt’, or expressed in other words, she has a ‘salt asset’. If her neighbour gives her a pound of salt back, the asset vanishes, and at the same time, so does the debt. Nothing has changed in the quantity of salt.

The course of events is not very different in the process of lending money. If anyone lends 1,000 Dollars to someone else, he does not have the money any longer. Instead, he has a claim for the return of his money, that is to say, a positive credit balance or a monetary asset, and the borrower of the money has a debt of the same amount. If he wants to pay his debt back, he has to save the money from his earnings. This means that he has to offset the amount that originated from the savings of the lender through a similar process of saving as that of the lender.

Therefore, through these processes of lending, neither the amount of money involved is altered, nor the amount of demand in the economy. There is only an interim transfer of surplus from the earnings of one participant to another in the economic cycle. This closes a demand gap, which otherwise would have arisen in the money and business cycle.

Even if the lending process is repeated, it does not alter the amount of money involved. An example to illustrate this point:

Two neighbours have a monthly income of 3,000 Dollars each and one of them regularly lends 1000 Dollars to the other.

After one year, the credit balance of the lender amounts to 12,000 Dollars and at the end of ten years to 120,000 Dollars. Correspondingly, the amount that the neighbour is obliged to return, that is, his debt, has also increased to 120,000 Dollars. Nothing has changed in the output and the earnings of the two people involved in this transaction, just as little as their common expenses and the amount of money used by both of them: In spite of their constantly growing credit and the debt, they continue to earn together 6,000 Dollars and spend the total of 6,000 Dollars as before.

Exactly the same logic is applicable to a political economy. Even here, with an unchanging economic output and demand, all the monetary assets and debts can increase without having any influence on the total amount of money present in the economy or on the purchasing power. Credit balances and debts merely reflect the degree of lending out purchasing power. In short: the increase in the money assets and liabilities (which do not have any influence on the purchasing power in the economy), depend solely on the readiness to save, lend and borrow by the participants in the economic cycle. The increase in the amount of money (and which influences the purchasing power), on the other hand, depends only on the issuing banks.

In addition, all bank deposits result from some sort of money transfers on a loan basis or credit grants to a bank, which in turn, passes it on to a third party. Even the European Monetary Institute acknowledged in its annual report of 1997, and this was later reaffirmed by the European Central Bank (ECB), “that the business of credit institutes is to receive deposits and other repayable funds from the public and grant credits on their own account”

Why can money and credit balances
not both be considered as money?

An adage tells us that one cannot add apples and pears together. Just as one cannot put apples and pears together under the heading “apples”, far less can one put money and reserves together under the heading “money”. In the case of apples and pears, we are dealing with similar concrete products and in the case of money and credit balances, we are dealing with a concrete and an abstract phenomenon. Money, as a means of exchange is not only a firm claim on the economy, but it is also a concrete commodity in the form of paper or metal. In contrast, a credit balance is only a confirmation of the transfer of money to a third party with a claim for its return.

With deposits, we are dealing with the pictures of apples that have been transferred to a third person. No doubt these pictures have something to do with apples, but are not really themselves, apples, even when one could – analogous to “book money” – call them “book apples”. The assumption, that with “book money”, the “money supply” has increased, is just as questionable as a corresponding assumption for apples. The same is applicable for clubbing together money with “credit money”, or apples with “book apples” to form a new, larger money or apple supply.

For this reason, such subsuming of money and deposits would be unhelpful in monitoring the actual quantity of money, and as an aid or a point of reference for stabilizing the purchasing power of money, it would contribute more to confusion.

Can money and deposits still
be grouped together?

Different items with different names can, of course, be put together under a generic name. Thus one can refer, for example, to apples and pears as ‘fruit’, to fruit and vegetables as ‘garden produce’ etc. In a similar fashion, money and deposits can be grouped together, i.e. under the name ‘monetary assets / investments’. A person with 1,000 Dollars in his purse and 8,000 Dollars ‘in the bank’, has a monetary asset of 9,000 Dollars. However, to talk of 9,000 Dollars of ‘money’ would be factually incorrect here. Moreover, such careless use of terminology in reference to money and currency leads to confusion, the consequences of which are not always predictable. The comparison between speech and writing – as is shown in the following table – clarifies the difference between primary and secondary phenomena.

Table B

1. Classification of terms of speech and writing


Main terms

Generic term

Primary phenomena




Means of communication

Concomitant phenomena


Sign language

Secondary phenomena




2. Classification of terms of money and deposits


Main terms

Generic term

Primary phenomena


Bank Notes


Monetary assets

Concomitant phenomena

Demand funds

Credit money

Secondary phenomena

Bank deposits

Direct lending

Monetary deposits / funds

One can of course extend such comparisons further, for example, to any medium of transfer. Letters, newspapers and books would belong to means of transferring messages, and cheques, credit cards and money-transfer-forms would be the means for transferring monetary assets.

In both cases, the means that have been characterized as concomitant phenomena fall somewhat out of line. In the case of monetary assets, it is credit money that is officially called demand funds or sight/demand deposits.

What are demand deposits and
how do they come into existence?

In general, bank deposits are differentiated according to their validity periods and interest terms. The shorter the validity period and the lower the deposit, the lower is the interest rate.

Bank deposits can be further differentiated depending on their modality of redemption. There are some deposits for which the date of maturity is fixed at the time of depositing, for example, for fixed-deposits or time deposits. In the case of others, the redemption is open and notice of withdrawal is required. In contrast to demand deposits, a one-days notice and daily withdrawal up to the full amount is possible – as long as the bankers have it in the cash box. For amounts in the millions, prior notice is recommended.

The development and increase in demand funds takes place just as with other bank deposits, i.e. through a cash deposit by the market participant. But they are different from other bank deposits in that, with their help, one can transfer a part of the balance from one account to another. Specifically, for discharging liabilities one does not need to go to a bank in order to withdraw money, hand it over to someone, who in turn would have to go to his own bank in most cases to deposit it again. These transfers of balances can be carried out on a regular basis (standing order) or through direct debit mandate (authorization). It is clear that this cashless payment process is an enormous convenience for the parties, especially when the amounts are huge and the distances involved are long. Nowadays, a lot of time is also saved as the transactions are settled on the same day.

How do transfers from one account
to another get executed?

Everyone knows how cash payments are made. Handling of payments through accounts – contrary to widespread belief – is not carried out, in fact, without cash. And this is true not only for a replenishment of an account as a prerequisite for carrying out a credit transfer, but it is also true for the transferring process itself. This is so, because the transfer will be accepted by the receiving bank and credited to the account of the receiver, only if it receives either cash or central bank or issuing bank money to the same amount from the remitting bank. By this one understands it to be either currency or the usual central bank money reserves, which can be converted into currency at any time. This means that during every transfer from a customer’s current account in one bank to another, central bank money flows – behind the screens of the bank, as it were, but in another form – to the recipient of the payment. Just like cash payments made by us, even the transfers carried out from account to account, replacing cash payments, depend on central bank money. We ourselves just don’t have to carry it to the recipient. It is clear that these transfers, from one account to another, do not influence the total volume of demand funds, but lead only to relocation within the respective balances. The total volume of the demand funds does not change due to daily transfers, just as the quantity of money does not change in the daily to and fro of transactions payments.

Can one increase his demand
with demand funds?

A person can spend his income only once. To date, no one has ever been able to break this rule, unless he has a workshop in the basement producing counterfeit money.

Irrespective of whether one receives ones income in cash or as credit to ones account, or whether one settles ones expenditures with cash payments or by cheques and remittances, or however one might mix these facilities or change them, an increased demand over and above income is not really possible for anyone. Changing the habitual way of payment from cash to cashless or the other way round, leads to only a shift between the two demand amounts, or the number of payment methods. The chief political economist of the European Central Bank, Otmar Issing, also confirms this in his textbook “Introduction to the Theory of Money”.2 Referring to the switch between the two methods of payment, he wrote: “nothing has changed … in the total quantity of money (cash and commercial bank money) which the non-banking sector has at its disposal as a result of these processes… since only a transformation from one type of money to another type is taking place here.”

Let us make this clear with the help of an example: if somebody has received his income to date in cash and plans now to make half of his payments cashless in the future, he has to open a current account and have half his income paid into it or totally remitted to it. If he had his income to date credited to his current account and had always withdrawn it completely, he would now leave half of it on the account. In both cases, his need for cash has diminished by the same amount as the increase in his need for demand deposits for the purpose of payment.

If all the market participants in a political economy were to reduce their existing cash payments by half and, instead, pay by bank transfers, then the total amount of cash requirement in this macro-economy would come down by half. And if all the citizens were to make all their payments cashless, then all the cash would have been paid to the bank, the demand deposits would get expanded, thus causing the cash to completely disappear from circulation. But even then, the total demand potential has not changed: the purchasing power in the economy – without any intervention by the issuing banks – would be practically frozen.

The transfer of money from one account to another, which has become very common today, has resulted in a second method of payment, which is carried out occasionally in place of cash payments. Including cash and demand deposits under the umbrella term “means of payment” is therefore factually justified, especially since the term “chequeable deposits” or “demand deposits” can no longer be done away with.

What are the consequences of an increase
in credit transfers for the banks?

An increase in credit transfers with the accompanying reduction in cash requirement has many advantages for the banks. Firstly, with cash becoming
superfluous, they can reduce their debts with the issuing banks, which are subject to interest, and thus reduce costs. Secondly, the expenditures arising due to the transactions involving depositing and disbursement of cash is reduced, which – due to the lack of other possibilities – finally has to be borne by the borrower, who mostly does not need cash at all. Thirdly, the banks can bill the costs of transactions involving chequeable deposits – in contrast to cash
transactions – to customers through charges (or the positive interest difference generated). Fourthly, the potential to grant credits increases for the banks with an increase in the demand deposits and, along with it, their revenues from the resulting interest.

Even though there is no change in the purchasing power as a result of using these demand deposits for the holder of these accounts, an additional investment potential results in the economy through the use of these funds as a credit potential. Since the currency notes that a person carries in his pocket cannot be used by anyone else between receiving and spending, the banks have the opportunity to lend, to a large extent, the received demand deposit amounts during that time. This means that demand deposits are more effectively used than cash holdings. A comparable increase in the usage of cash balances would result when each holder of cash were to lend out the money to another between receiving and passing it on, i.e. during the time he himself does not need it.

Because of this possible interim usage-potential of demand deposits, any changes in methods of payment result also in changes in credit granting potential. As payment habits are relatively stable or change only very slowly, an increase in the effectiveness of money utilization is relatively normal and manageable by the central banks. Problems can arise, however, when at short notice, a speculative balance shift occurs between cash – chequeable deposits or between the remaining holdings or monetary assets and chequeable deposit amounts.

What came first – assets or debts,
money or credit?

In contrast to the question of what came first, the chicken or the egg, such a question regarding assets and debts can be easily answered. Both always arise simultaneously with each lending operation, just as they always vanish from this world simultaneously with each repayment of the amount borrowed. But something else precedes the emergence of either of these phenomena, namely the process of building up savings on the part of the lender and his willingness to surrender the money that he can spare, and does not need, to another on a loan basis. Conversely, something precedes also the extinguishing of the assets-debts relationship, namely a re-saving effort on the part of the borrower showing thus a preparedness and capability to offset the amount to be cleared in addition to the continuing interest payments from his existing income.

For the question regarding the relationship between money and credit, however, the answer is different: something can be lent only if it already exists. That is just as true for the lending of a bicycle or a packet of salt as it is for the lending of money. This means: money is not created by credit, as many still assume, but it must already be there, irrespective of whether the bank obtained it from the customer or from the issuing bank.

The fact that the largest proportion of circulating currency has been put into
circulation by central banks through credits to commercial banks does not make any difference. The credits of the issuing banks only serve the purpose of supplying money to the economy. The credits that commercial banks grant to customers, in contrast, serve to provide credits to the economy. In order to provide credit, it is necessary that customers build up savings. And savings can – as has been shown with the example of the case of the two neighbours – continuously increase even without the expansion of the quantity of money by the issuing banks. Because this is so, credits of banks to non-banks are many times larger than credit raising of central bank money of issuing banks to commercial banks. This difference gets bigger with constantly increasing savings in a political economy.

How great is the difference between cash supply
and bank credits?

The difference in the amounts of cash and bank deposits or bank credits can be seen in figure 2. The growth in both sectors is given in terms of the percentage of the national product with reference to the situation in Germany.

As can be seen, deposits placed with banks in Germany rose from 38 to 140 per cent of the aggregate output between 1950 and 1990. The growth of bank-deposits stagnated in the year of reunification because the growth of the monetary assets was relatively less than the added economic output, in spite of the generous exchange rate for the savings of the former GDR-citizens. Afterwards, however, it continued with increasing acceleration, up to 230 percent of the GNP by 2000. This means that in Germany in the period from 1950 to 2000, bank deposits together with credits granted from them, grew eight times faster than the economic output!

Figure 2


If one were to take a look at the growth in the amount of cash and that of demand deposits, which have been inserted in the figure and to the same scale together with the so-called money supply M1, that results from adding up the two, a totally different picture is revealed. In contrast to the rocketing deposits and credits, the quantity of this means of payment developed to a large extent in step with the economic output in the first four postwar decades, fluctuating between 16 and 18 percent of the GNP. Only from 1985 onwards was there a clear rise, which, after reunification, continued with increased vigour.

Regarding demand deposits, the trend here reflects the enormous increase in stock exchange transactions. They inevitably necessitate larger speculation funds and thus demand funds. The surprising increase in the amount of currency that became clearly visible from 1985 onwards may be, in contrast, primarily due to the increasing DM-holdings and its usage abroad. This is particularly true for East European countries where the citizens of those countries increasingly tried to escape the losses in their savings due to inflation by exchanging them for more stable currencies. In Yugoslavia the DM became a sort of second currency by the end of the 80s, and in a few constituent republics of this disintegrating country it even became the established official means of exchange in the 1990s. The fact that the amount of cash declined relatively during the period of reunification , might be due to the low need for currency in the newly joined states as well as the activation of DM stocks which had already been there before reunification.

The difference in the growth of money and credit becomes clearer when the eight years between 1991 and 1999 are examined more closely. Whereas banks credits during this time increased by an annual average of 336 billion DM (from 3,438 to 6,129 billion DM), the money supply expanded by the Deutsche Bundesbank by an annual average of only 10 billion DM. This means that the annual increase in credits was 34 times higher than the quantity of money! Between 1996 and 1999, the cash supply even slightly receded, whereas credit grants continued upwards. Exactly these facts show that there has to be a strict differentiation between credit grants by issuing banks, through which new money enters circulation, and credit grants of commercial banks through which money-savings are lent to others.

None of these facts alter the views of a few economists who see the origin of money not in its function as a means of exchange but rather in its function as promissory notes, which originated in places of worship and temples or the origin of which is connected with private property. These explanations for the origin of money may be of great interest sociologically or historically. For the functioning of today’s money as a means of payment and credits, especially for the present day problems that are linked to money, they do not, however, hold good.

What do savings and payment mean?

Saving means: to consume less, to use less than one has at ones disposal. The money so saved may be collected in a piggy bank or in a safe, or can even be taken to a bank. Such banks are very often called savings banks. Many believe that their money is stored there exactly as at home, only kept safer in large vaults, from which the saved money is taken out at withdrawal.

The technical terminology even reinforces such an impression by talking about ‘money collection points’. In reality, nothing is collected there. The bank only acts as an agent who passes the money which it had received from the saver on to a third person as credit.

Actually nothing else happens when a saver lends money, not needed by him, directly to his neighbour. As this process is not called ‘saving’, the person taking spare money to the bank should not be called ’saver’, either. Saving, i.e. not spending surplus earnings, is rather the prerequisite for transferring money on a loan basis to the bank or to his neighbour, instead of accumulating it at home and hoarding it.

Starting from real processes, the term ‘payment’ (to pay, to count out) should actually be used only in association with money. Because, strictly speaking, for cashless transactions, no payment takes place, but ‘transfers’, namely a transfer from one credit account to another. These transfers, which the German Federal Bank (Deutsche Bundesbank) calls ‘credit funds’3, lead even today – in contrast to payment with cash – to a slight delay in settling a claim, something that everyone can ascertain from his bank statement. Besides, they depend – in contrast to cash that can be passed on anonymously – on the accounting bank and are verifiable at any time.

The way the concept of money has been transferred to demand funds, the concept of payment by using these funds will establish itself more and more. Strictly speaking, this equalization would imply, that the balances in current accounts – similar to bank notes a hundred years ago – will be declared official money and issued by issuing banks. As long as this is not the case, one will accept (private) chequeable money only when one is sure of being able to exchange it for (official) cash at any time. This means that cash and demand deposits cannot yet be made equivalent at every stage, as can be seen from Table C.

Table C

Differences between money and deposits


Demand funds


means of payment

means of transfer

Aids / agents

money, bills

cheques, transfers


issuance by the state

private deposits

Specific differences

immediate settlement from hand-to-hand.

help of a third party not necessary

transaction not documented

only expanded by the central bank

excess increase leads to inflation

partly delayed settlement from account to account

help of third party and technology necessary

transaction is documented

expandable by anyone

excessive increase leads to cash depletion


1 Money theoretician at the University of Freiburg, in a panel discussion “What is money”, Wangen/Allgäu, 1991

2 Einführung in die Geldtheorie, Munich 1995

3 German: ‘girale Verfügungen‘ (Ed.)

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