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Part 6. How money is destroyed

Just as banks create the money people and businesses borrow from them, money is destroyed when it is paid back. This can be demonstrated through a simple example loan of £1000 from a bank, paid back over 10 months. To keep things uncomplicated, we will assume that the loan is free from interest payments. We will take these other factors into account in the next part.

We will create two new accounts: a loan account called Loan Account, and a deposit account called Current Account. These will be at the same bank and owned by the same customer. As before, the loan is created with a single double entry as shown in Figure 6.1.

Loan Account Description Debits Credits Balance Starting balance £0 Loan debited £1,000 £1,000 (DR) Current Account Description Debits Credits Balance Starting balance £0 Loan credited £1,000 £1,000 (CR)

Figure 6.1. £1000 loan creation.

We know from the previous part that creating a loan creates the money in the deposit account (Current Account). The customer now has £1000 to spend. However, for demonstration purposes, we will assume that the money isn't spent and simply used to pay back the loan. The first month's loan repayment is shown in Figure 6.2.

Loan Account Description Debits Credits Balance Starting balance £0 Loan debited £1,000 £1,000 (DR) Month 1 received £100 £900 (DR) Current Account Description Debits Credits Balance Starting balance £0 Loan credited £1,000 £1,000 (CR) Month 1 loan repayment £100 £900 (CR)

Figure 6.2. The 1st month's loan repayment.

After paying the 1st month's loan instalment we now only have £900 available to spend. And as we pay off the loan each month, the money available to spend decreases by £100 each month until, finally, both accounts have zero balances as shown in Figure 6.3.

Loan Account Description Debits Credits Balance Starting balance £0 Loan debited £1,000 £1,000 (DR) Month 1 received £100 £900 (DR) Month 2 received £100 £800 (DR) Month 3 received £100 £700 (DR) Month 4 received £100 £600 (DR) Month 5 received £100 £500 (DR) Month 6 received £100 £400 (DR) Month 7 received £100 £300 (DR) Month 8 received £100 £200 (DR) Month 9 received £100 £100 (DR) Month 10 received £100 £0 Current Account Description Debits Credits Balance Starting balance £0 Loan credited £1,000 £1,000 (CR) Month 1 loan repayment £100 £900 (CR) Month 2 loan repayment £100 £800 (CR) Month 3 loan repayment £100 £700 (CR) Month 4 loan repayment £100 £600 (CR) Month 5 loan repayment £100 £500 (CR) Month 6 loan repayment £100 £400 (CR) Month 7 loan repayment £100 £300 (CR) Month 8 loan repayment £100 £200 (CR) Month 9 loan repayment £100 £100 (CR) Month 10 loan repayment £100 £0

Figure 6.3. An example loan transaction repaid over 10 months.

So, as you can see, paying money back to a bank has the opposite effect of borrowing from a bank. Borrowing creates money and paying debt back destroys money. Because loans are paid back with regularity, new loans have to be created to keep the money supply from decreasing — or even disappearing.

We will look at how debt circulates in Part 10; however, money, as well as debt, circulates only for a period of time before it is finally destroyed, as depicted in Figure 6.4; and new money needs to be created through issuing new loans so that people and businesses have the money they need to go about their daily transactions.

Loan taken out −£ Money created Debt created Money circulating −£ −£ −£ −£ −£ Debt circulating Money destroyed Debt destroyed −£ Loan paid back Time

Figure 6.4. Money and debt being created, circulated, and finally being destroyed.

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