Activity title | Aktivity 3: Create money through a loan – and buy a bicycle |
Overview | In groups of two or three persons we do a money-creation role-play. In teams with the help of simplified T-accounts to fill in, we simulate how a loan is granted in a bank and new money is created in the process. The money is then transferred to buy a bicycle. Later, the loan is paid back, and the money disappears again. The T-accounts make the money-creation, the transfer and the expiring of the money visible and feasible. The teams develop the solution together. |
Objectives | The following should become visible through the game:
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Materials | Worksheets with simplified T-accounts, eventually a black/white-board |
Time | 1,5 hours |
Group size | 2 to 30. |
Instructions for trainers | Preparation Form teams of 2-3 players: a bank employee, a client who asks a loan and eventually the bicycle dealer who will get the transfer. Step 1: Creating Money by granting a loan Explain how money is created by giving out loans. You can explain and at the same time showing the procedure already at the blackbord. Then clear away and let the teams repeat the operation in a role play. Or, for more advanced students: Let the teams figure out by themselves how loan and money creation could be registered in the T-accounts (Giving them the information that every party gets two entries, one of the asset and one of the liabilities side). Visit the teams, let them explain their thoughts, give tips. When all have finished, show them again step by step on the blackboard. Step 2: Transferring the money to the bicycle dealer Explain basic facts on how money is moving through bank accounts. And that net assets are entered strangely on the “wrong side” to make the balance balance. Let them try on the T-account-sheets in teams Step 3: Paying back the loan Explain that paying back a loan means reversing the whole process. And that by repaying not only the debt but also the money expires. Let them try on the balance sheets in teams. Step 4: Discussion about the bank’s deposit money creation In the end the students should have understood: 1. There are two real obligations (one for each party) that back up the money. 2. There is the state money behind the bank’s money that gives it worth. 3. There is a functioning legal order that guarantees the claims of both parties. |
Debriefing and evaluation | |
Tips for trainers | Role play and teams Also, if there is an element of role play, the more important part is, that the team should work together on the solution, discussing and explaining it to one another and to themselves. You could for example tell them, that the bank employee is new to her job, the bicycle dealer is a friend who has come along, and all try to help together to fill in the T-accounts. Possible connection to Activity 1 “Creating a new state” If you have done the Activity 1 “Creating a new state” with this group. They will already now that the state has the money monopoly and will understand easily how the state money can back up and give worth to the deposit money. They might ask: why banks are allowed to create money. See in long article “3.Why do we have two kinds of money and why are private banks allowed to make money?” If the group has not done Activity 1 “Creating a new state”, you will have to explain more in detail why state money as the money of first order, can back up the bank’s deposit money. Challenges that might occur: . Net assets The notation of the net asset on the „wrong“ side is counter-intuitive and has to be explained well. In Step 2: How does the bank’s T-account develop If anybody asks what happens with the bank’s account after the transfer to the bicycle dealer, try to keep it simple: the bicycle dealer has her account at the same bank. The bank now owes the same amount of money to another client. So for the bank it’s only a change of the creditor which does not change the net assets. (As background information: This is also true if the money is transferred to another bank, but it gets more complex. If the bicycle dealer has its account with another bank the bank now owes central bank money to this other bank. To pay the other bank it might have to borrow more central bank money from the central bank. This means a liability to the central bank instead. Therefor the type of liability the bank has, can change, but until the loan is paid back the bank will have one more claim as well as one more liability.) Interests are left out Explain right from the beginning, that you will teach them, how banks create money. That banks are motivated by interests to do this business. But that this lecture leaves out the interests, as the act of money creation is already a very complex topic. Apart from Detailed Instructions for teachers below, reread also the following chapters of the long article: 3.Why do we have two kinds of money and why are private banks allowed to make money? 4. How does deposit money emerge through lending? And how does it disappear again? 5. Is the bank rich because it can create an unlimited amount of deposit money? |
Detailed Instruction for teachers
Step 1: Granting and registering of a loan:
Essential facts to explain:
- When banks give loans, they don’t hand out money that they already have. But they create the money exactly in the moment the loan is granted and the money is being registered.
- But there is a counterbalance to that newly created money. It comes with debt. The client know owes to repay the sum. Thus, the client gets an asset and an obligation at the same time.
- For the bank as the money creator it’s the same: it also gets an asset and an obligation: it now has the claim to be paid pack the money. But on the other hand, also the bank has now a new obligation. It has to pay out the money to the client if she wishes. Both obligation and liability have to be entered into the account of the bank.
- We presume that the client in this very moment has neither money nor debts in his account.
- Explain that interests are the motivation for banks to do the money creation business. But that this lecture leaves out the interests, as money creation is in itself a complex and very little understood phenomena.
Template / solution:
Account of Client before loan of 1000 Euro is granted: Registration loan of 1000 Euro in the Client’s account:
Assets Client Liabilities Assets Client Liabilities
deposit money debt to bank
1000 1000
Account of the Bank regarding the client: Registration loan of 1000 Euros in the Bank’s account:
Assets Bank Liabilities Assets Bank Liabilities
receivables from loan deposit money
1000 1000
What we learn:
- Banks create our deposit money by granting loans.
- Deposit money really is nothing else than a claim of the client against the bank to pay out central bank cash. Or the right to ask a transfer the claim to another account.
- Deposit money gets its worth from the state money that you can get for it.
- Until the money is paid out or transferred both parties have merely seen a balance sheet extension, thus, an equal amount to both the liabilities and the assets side. The net assets have not changed.
Step 2: Buying a bicycle:
Essential Facts to explain:
All money (apart from cash) travels through balance sheets.
- Every time you credit one account you have to debit another
- To determine the net assets, you subtract all the liabilities from all the assets. That is why the net assets are the last thing that you enter.
- You enter the net assets on the “wrong side”. It’s a counter intuitive convention. But balance sheets have to balance! And who knows something about accounting will know: if they find net assets on the assets side, it really means: net debts.
- We assume that the bicycle dealer has neither assets nor liabilities at the moment.
Template / solution:
Account of Client after loan before transfer: Account of Client after transfer:
Assets Client Liabilities Assets Client Liabilities
deposit money debt to bank Net assets debt to bank
1000 1000 -1000 1000
Account of Bicycle Dealer before transfer: Account of Bicycle dealer after transfer:
Assets Bicycle Dealer Liabilities Assets Bicycle Dealer Liabilities
Deposit money net assets
1000 +1000
We have learned:
- A transfer means to debit one account and to credit another
- The entries of one are the outgoings of others. The outgoings of one are the entries of others.
- With the transfer the net assets of the client became negative.
- The net assets are entered “on the wrong” side to make the balance balance
- When the client has an entry of 1000 we have exactly the same situation as after the loan was granted.
Step 3: Repaying the debt
Facts to explain:
- The client has an entry of 1000 Euro from a transfer of her employer.
- After this entry we have exactly the same situation as after the loan was granted.
- The bank again owes to pay out 1000 Euro to the client. This time because of the transfer she got.
- When the client decides to use the money to repay the loan, all liabilities are fulfilled.
- But “repaying” deposit money to a bank does not work like a normal transfer that goes from asset side to asset side (as happened between client and bicycle dealer). That is because a bank can never have deposit money on its asset side. For a bank the deposit money, that it can create, is always and exclusively a debt to its clients.
- Thus, when a client “pays” money to the bank: instead of getting an asset, the bank loses a liability. That is because after the “repaying” the bank has lost the obligation to pay out this amount of deposit money to the client.
- By paying back, the client loses the duty to pay back the loan, as well as the claim to get this amount of money from the bank. And the bank loses the claim of the loan – as well as any obligation to give or transfer this amount of deposit money that has been paid back.
- Therefor the money expires from the bank’s liabilities side. As well as from the client’s asset side. The money disappears with the fulfilment of the two obligations – as it came into existence with the inverse
Template / solution:
Account of Client after earning 1000 Euro: Account of Client after paying back the loan:
Assets Client Liabilities Assets Client Liabilities
deposit money debt to bank
1000 1000
Account Bank after client’s new entry: Account Bank after Client has paid back the loan:
Assets Bank Liabilities Assets Bank Liabilities
receivables from loan deposit money
1000 1000
We have learned:
- Deposit money is created when banks grant loans. It expires again when loans are paid back
- A bank can never have the deposit money on its asset side. But for the net assets losing a liability is as good as getting an asset.
Step 4: Discussion on deposit money
Questions:
- What is deposit money?
- What is it for the client? What is it for the bank?
- How can numbers written in a balance sheet become money?
- Where do this numbers get their worth from?
- Why do we trust the numbers in our bank accounts?
- Why do we consider them real money?
- Do we value bank accounts as highly as cash? Also in a crisis?
Reassume these elements:
- 1. There are two real obligations with real practical consequences that back up the money. There is one for each party: The client is legally obliged to pay back the money in the future. If she cannot, she will have serious legal problems. And the bank is legally obliged to pay the money out to the client or to transfer it on its behalf. In this case the bank has to hand over central bank money that it cannot produce just by itself.
- 2. There is the state money behind the bank’s money that backs it up and gives it worth. (The state money gets its worth by the whole economic power of the state, its power to tax and functioning institutions that guarantee its rules.)
- 3. There is a functioning legal order that guarantees the claims of both parties. So, they can rely on the fact, that the numbers in the bank accounts and contractual obligations can be always realized.
