Understanding the Difference Between Bank-Created Currency and Fiat Currency
In today’s complex financial landscape, the terms bank-created currency and fiat currency often come up. While the two concepts overlap in certain areas, they have distinct characteristics that set them apart. This article aims to clarify the differences and provide a comprehensive understanding of both types of currency.
What is a Bank-Created Currency?
A bank-created currency is a form of money that comes into existence through the process of lending. When a bank issues a loan, it creates a corresponding amount of money in the borrower's account. This process is often referred to as the Mandrake Mechanism, a term that highlights the creation of money out of thin air.
The Banks’ Role in Currency Creation
Banks play a pivotal role in the creation of currency through fractional reserve banking. When a deposit is made, only a fraction of that money is kept in reserve, while the rest is lent out. This practice allows banks to create new money, which forms part of the broader money supply. For example, if a bank takes a $1,000 deposit and only keeps $200 in reserve, it can lend out the remaining $800. The borrower can spend this money, which further circulates in the economy, leading to the creation of even more money.
What is a Fiat Currency?
Fiat currency is a type of currency that is declared as legal tender by a government but has no intrinsic or fixed value. Unlike other forms of currency like gold or silver, fiat currency does not have a tangible backing. The value of fiat currency is derived from the faith and trust of the public in the government that issued it.
Examples of Fiat Currencies
Common examples of fiat currencies include the pound sterling, the euro, and the US dollar. Any national currency that is not backed by a commodity like gold or silver falls under the category of fiat currency. It's important to note that very few world currencies are truly commodity currencies, with most relying on the confidence and trust provided by the issuing government.
Comparison: Bank-Created Currency vs. Fiat Currency
While bank-created currency and fiat currency both exist within the broader money supply, they have distinct characteristics and origins.
Similarities
One significant similarity is that both types of currency can be created through the process of lending. In the case of bank-created currency, this creation is more explicit, while in the case of fiat currency, it is more abstract. Another similarity is that neither type of currency has an intrinsic value; their value is based on trust and supply.
Differences
Bank-created currency is closely tied to the banking system and the creation of loans, whereas fiat currency is a creation of the government and has no intrinsic value. The process of creating bank-created currency is more decentralized and relies on the lending and borrowing activities of banks, while fiat currency is tightly regulated and managed by central banks.
Case Study: The USD and the Mandrake Mechanism
The US dollar, or USD, is a prime example of a fiat currency that is both bank-created and fiat. When the Federal Reserve issues a loan to a bank, the bank can then lend out the newly created money to individuals and businesses. This process creates a larger money supply, supporting economic growth and financial transactions. As the economy grows, more loans are issued, and more money is created.
Point Systems and Their Characteristics
There are instances where currencies are neither strictly bank-created nor purely fiat. For example, credit card points are considered bank-created currencies but are not fiat currencies. Credit card points are created when a credit card issuer provides rewards as a form of loyalty, and these points can be redeemed for services or goods. However, they are not considered legal tender and do not have the same widespread acceptance or regulatory oversight as fiat currency.
Conclusion
In conclusion, understanding the differences between bank-created currency and fiat currency is essential for navigating the complex financial world. While both types of currency exist in the broader money supply, their origins and characteristics set them apart. Bank-created currency is a result of lending activities, while fiat currency is a product of government decree. Both play crucial roles in modern economic systems, and a clear understanding of their functions can help individuals and organizations make informed financial decisions.