Money. Do you know how it’s created?

Written by: Marie-Claude Brown | CEO Townsville Chamber | November 29, 2019

Hard work, I hear you say. While that is true, it’s not the whole truth.

Over the past few years, the Chamber mentioned on several occasions that every dollar spent locally exchanges hands 13 times. But where does that first dollar come from? How was it created? The Reserve Bank of Australia (RBA) produces the physical bank notes, about 95% of Australia’s currency. The rest, 5%, are coins made by the Royal Australian Mint. 

Banks and other financial institutions purchase banknotes from the RBA so that when you withdraw from your account, you receive actual cash to buy a paper or a parking space. 

Banks purchase even more money from the Reserve Bank when they make loans. For example, if you want to expand your business, you apply for a loan. If the bank accepts to lend you money, it credits it from its ledger and deposits the amount in your account. You then withdraw it and make the purchases necessary for the expansion of your business. 

In this example, what is a credit for the financial institution is a deposit for you. When you withdraw to buy a service to improve your business, that is a credit for you and a deposit for the service provider.  

 

“The more financial institutions lend, the more money circulates and the better the economy performs.”

 

Simply put, that’s how the cycle of credits and deposits work. The more financial institutions lend, the more money circulates and the better the economy performs. That is why loans are important to the overall economy. They keep the wheels turning. 

Several factors have slowed financial institutions’ ability to lend money; some are national like the Royal Commission into banking misconduct, and some international like the trade war between the US and China. That has affected the Australian economy in general, and North Queensland in particular. There is less money circulating and exchanging hands, which slows down the economy. 

In response, the Reserve Bank of Australia lowered the interest rate paid for cash, to help stimulate borrowing. Unfortunately, borrowing money has become more difficult.

The Federal Government even made changes to income tax this year so many would end up with more cash in their pockets. Instead of spending that money, stimulating the credit versus deposit cycle, most of us saved it or used it to repay our loans, taking it out of circulation altogether. 

There is no easy answer to stimulate the exchange of money and the lending conundrum. History has shown, however, that the economy tends to behave like a pendulum and that it eventually swings back the other way. 

Success North Queensland