Money 101: Inside Versus Outside Money

Summary:

In this episode, the host discusses the concept of "inside money" versus "outside money" in the financial system. Inside money refers to commercial bank money created through the extension of credit, while outside money refers to central bank money such as cash, coins, and central bank reserves.

The host explains that inside money, created by commercial banks, is the primary driver of the economy and how most transactions are facilitated through this form of money. In contrast, outside money created by central banks has limited use and cannot directly enter the economy. This highlights how monetary policy conducted by central banks is an indirect process, as they cannot simply "print money" to inject into the economy.

The host emphasizes the importance of understanding the differences between these two forms of money, especially as we transition towards new digital asset systems. He argues that to effectively replace the current banking system, one needs to have a clear grasp of how the existing system operates, with commercial banks being the true "doers of money" rather than central banks.

Detailed Analysis:

The host begins by introducing the concept of "inside money" and "outside money," which he states is not typically discussed. Inside money refers to commercial bank money created through the extension of credit, while outside money refers to central bank money such as cash, coins, and central bank reserves.

He explains the mechanics of how inside money is created, using the example of a car loan. When a borrower takes out a loan, the bank creates a liability on the borrower's balance sheet, but also an asset (the loan) on the bank's balance sheet. As the borrower deposits the loan proceeds, this creates a liability for the bank in the form of a deposit. The host emphasizes that this process is not simply "money is debt," as the double-entry accounting system shows the creation of both an asset and a liability.

The host then contrasts this with outside money, which is created by the central bank without a corresponding liability in the commercial banking system. He notes that while bank notes and coins are legal tender (outside money), central bank reserves are not legal tender and can only be exchanged for physical cash, not used directly in the economy.

This distinction is crucial, the host argues, as it highlights how the central bank's monetary policy tools are indirect and limited in their ability to directly influence the money supply. He suggests that the central bank's primary tool is "propaganda," as it cannot simply "print money" to inject into the economy.

The host then traces the historical evolution of money, noting that even in the past when cash was more commonly used, the majority of transactions were facilitated through inside money, such as checks. He emphasizes that as our financial systems and technologies have evolved, the dominance of inside money has only increased.

Finally, the host stresses the importance of understanding the differences between inside and outside money, especially as we enter the era of digital assets and cryptocurrencies. He argues that to effectively replace the current banking system, one needs to have a clear grasp of how the existing system operates, with commercial banks being the true "doers of money" rather than central banks.