The incorrect assumption of the endless system certainly arose from a gap in our knowledge of credit creation. If one wanted to fill this knowledge gap, one should know how a bank's balance sheet was roughly structured. On the assets side were reserves at the central bank, possibly the interbank balance, customer loans and assets. On the liabilities side were liabilities to the central bank, possibly the interbank balance, customer deposits and equity. For the sake of simplicity, the items in the bank's balance sheet could also be called differently. On the assets side were claims on the central bank, possibly claims on private banks, claims on customers and assets. On the liabilities side were liabilities to the central bank, possibly liabilities to private banks, liabilities to customers and equity. The interbank balance was the sum of all claims on and liabilities to other banks. Which side it ended up on depended on whether a claim or a liability remained on the bottom line. Equity was the difference between the total assets and all liabilities. The sum of both sides of a balance sheet was always the same.

When a bank granted a loan, it entered the basic amount on the assets side of its balance sheet as a loan claim and on the liabilities side as a customer deposit. The loan claim was the basic amount with an interest premium and therefore higher than the customer deposit on the liabilities side. The difference therefore increased the bank's equity. The bank thus already made its interest profit when the loan was granted. The bank was able to use its newly increased equity to pay the salaries of its employees, for example. If you had access to this money, you could theoretically repay your loan without anyone else having to take out a loan. The prerequisite was, of course, that the bank also used its new capital.

There were also other ways in which additional money could come into circulation. When a bank acquired an asset, it did so with created money. On the bank's balance sheet, the new asset was entered on the assets side and a liability to customers, in other words a customer deposit for the seller of the asset, was entered on the liabilities side. The purchase was not a profit for the bank. The bank had received assets and liabilities in the same amount. It was an extension of the balance sheet. Both sides of the balance sheet became longer.

Of course, a private bank could not simply create an infinite amount of money and buy everything it wanted, because private banks had a fixed minimum equity capital. It was a variable percentage that depended on the risk assessment of their assets, or in other words on the risk assessment of their existing claims and assets. The share of equity in the liabilities side decreased with each money creation, so the bank might have to increase its equity first if it wanted to buy more assets, for which it granted loans, for example. However, it could not give a loan to everyone who wanted one, because the loan may be too risky for the bank's equity. Defaults would reduce the bank's equity even further. The bank first had to concentrate on loans with a high level of security.

The banks all increased their equity by granting loans, but if all loans were fully repaid, then all banks would be screwed.

If a loan was repaid in full, the bank would cancel the money. It erased the basic amount and also the interest. Nothing remained.

At this point, the bank's equity did not decrease. Claims on customers were offset against liabilities to customers. In other words, loan claims were offset against customer deposits. The bank did not make a loss. The bank had lost assets and liabilities in the same amount. It was a balance sheet contraction. Both sides of the balance sheet became shorter.

Where the customer deposits came from was decisive in this case. Looking at the entire monetary system, there were three possibilities: Either the bank had already spent its interest profit or someone got hold of the money from the purchase of assets or someone had taken out a new loan. If a loan was not repaid, the bank seized the money. If that did not work, it seized assets instead. If everything failed, the bank destroyed the money anyway, only now it was its own. The bank lost equity in the amount of the remaining claim.

In general, the entire monetary system was designed in such a way that if you were to offset all debts against all assets on the world's balance sheet, you would get a zero at all times. Every piece of money anyone had meant that someone else could not pay their debts, but if everyone paid their debts, there would be no more money. Money needed someone who lacked it to exist. Every debt was matched by a fortune. Everyone who rose to wealth pushed someone else into poverty. That was intentional. Not everyone could have money. Someone had to shoulder the debt. - That was the debt money system. That was the system of credit creation.

In general, the entire monetary system was such that if you netted all debt against all assets on the world's balance sheet, you would get a zero at all times. Every piece of money that anyone had meant that someone else could not pay their debts, but if everyone paid their debts, then there would be no more money. Money was needed by someone who lacked it in order to exist. Every debt was matched by wealth. Everyone who rose to wealth pushed someone else into poverty. This was by design. Not everyone could have money. Someone had to carry the debt.

That was the debt money system. That was the credit creation system.

If a state truly wanted to repay its debts, it meant that it wanted to destroy this amount of its citizens' wealth. But to whom did a state actually owe its debts?

Like the private banks, a state had its account with a central bank. If, for example, a construction company needed to be paid, the state paid from its central bank account with central bank money to the central bank account of the private bank where the construction company had its account and the construction company was credited with book money.

If the state ran out of money, it could overdraw its account at the central bank for a certain period of time. This was usually one day. If there was no revenue the next day and the state wanted to spend more money, it had to issue bonds. A government bond was an interest-bearing security with a fixed term. You paid an amount for the bond and received interest over the term and then a repayment of the full amount at the end of the term.

The government bonds were auctioned within a selected group of buyers. This group consisted exclusively of private banks. There was no one else in the group. If you held a government bond as an ordinary person, then you had received it at the end via one of these private banks. The private banks paid for the bonds with central bank money and the state had new central bank money for its expenses. If a private bank did not have enough central bank money for this, it could simply obtain some from another private bank or from the central bank. How well the auction of the bonds went depended on many factors. Roughly speaking, the higher the key interest rate at the time of the auction and the lower the credit rating of the state, the worse the interest rate for the state. As already mentioned, the central bank might set a deposit rate. This could lead to the state possibly earning money on its bonds because it was still cheaper for the private banks to buy the bonds than to hoard too much central bank money.

Stolen content warning: this tale belongs on Royal Road. Report any occurrences elsewhere.

If the state was unable to pay its interest, it had to sell even more bonds. When the bonds reached maturity, they were auctioned off again. If things went very badly and or the private banks had too little interest in the government bonds, a central bank sometimes bought government bonds itself.

There were various ways to do this. The central bank bought the bonds from a private bank. This was called the primary market. The central bank bought the bond via a private bank from a person that had bought it from a private bank. This was called the secondary market. The latter was an open market transaction.

For purchases, the central bank credits an account with new central bank money for the bond. The central bank money was created for the purchase. The central bank did not make a profit. In the central bank's balance sheet, the new asset was added to the assets side and a liability to customers was added to the liabilities side. This was also an extension of the balance sheet.

In open market transactions, the private bank subsequently created book money for its client. Regardless of whether the seller was a private bank or a client of a private bank, the seller had not made a profit. He had made an asset swap. He had received claims on a bank and given an asset. The balance sheet did not change in amount.

In all cases, the new holder of the bond was the central bank. In other words, the state no longer paid its interest to a private bank or a third party, but to its own central bank. At the end of a settlement period, the central bank distributed its income to its owner, in other words back to the state.

If a state could simply have its central bank buy its bonds and then pay itself interest, how could a state go bankrupt in the first place?

It could not.

But of course a central bank could not simply create an infinite amount of money and buy everything it wanted, because...

No, it could.

No, it could not. Reyji didn't know for sure. The state did not want that. Purchases on the primary market were forbidden. The state did not even want to be in control. Purchases on the secondary market were not in the hands of the state, but controlled by the central bank. Reyji only knew a little economics. She had only picked up everything else from Marah over the years. The answer to this question was certainly known to Marah. Regardless of that, it was not quite true that a state could not go bankrupt.

Many countries had a weak economy and or low exports, which meant that their currency was not accepted abroad. However, if they still wanted to import gas, for example, they had to take out loans in foreign currency. It could happen that payments to the lenders were no longer possible because the state no longer had enough of this foreign currency and could not obtain it. Some of the triggers for this could be that tourism had declined, that exports had decreased or that the prices of essential imported goods had increased. If no additional loans could be taken out, then there was a sell-off, seizure or finally bankruptcy. This of course required that the creditors also had the means to collect their money... So a state could only go bankrupt in foreign currencies. Many smaller states did not even have their own currency. Such a state could go bankrupt even more quickly, but still not nearly as quickly as a simple company.

A private bank could go bankrupt if it no longer had enough central bank money for necessary payment transactions and could not obtain any because it could offer the central bank no or only insufficient collateral. The central bank dropped the private bank because it was no longer creditworthy in its eyes. But the private banks were not irrelevant. As a rule, it was wiser to simply give them a loan in central bank money anyway while also giving them a slap on the wrist.

All this was well known. However, the conclusions that were drawn from this knowledge were not always the same...

This is how a two-tier monetary system with private banks under the management of a single central bank functioned.

In Baele it was a little different and a little more complicated, because Baele was a member of the association of free banks.

The free banks was an association of eight world banks and forty-one chains of private banks. World bank was simply the name for a central bank within the free banks. At the same time, the name Free Banks was also the name of the overarching and governing organization of this association, the name of the island state on which this organization was based, the name of the world bank of this island state and the name of a private bank of this island state. The island and the island state were often also called Riverta.

In such a supranational system, it was usually the case that in addition to a leading central bank, there were other national central banks subordinate to it. This was only partly the case in the free banks. One world bank was new and the other seven of the world banks had been state banks before their respective countries joined the free banks.

While a central bank was a bank more or less independent of the government, a state bank was a bank controlled by the government. In a state bank, the state determined everything itself. Every state bank issued its own currency. A state bank created money for state financing without the involvement of private banks. A state with a state bank could buy anything it wanted until the money was no longer accepted, for example because its value was very unstable due to high inflation.

Baele used to have only a state bank and everything else were private banks. The term private banks came from this contrast.

All seven countries wanted to join the free banks and have a common currency, but none of the countries wanted to give up their own currency. The supreme organization also wanted to establish its own currency that everyone would use. This was the eighth world bank and the free currency or the Fee. It was supposed to be one currency for all, so that everyone was equal, but no agreement could be reached. Points of contention included the production of cash and concerns about loss of control, but the bottom line was power. Rich countries had valuable coins with their symbols or the heads of their rulers. Forcing the weaker ones to use them would be a demonstration of might.

After years of negotiations, they eventually gave up and simply decided to use all eight currencies. The supreme organization controlled all eight world banks and all world banks were a leading central bank of one currency and seven restricted national central banks of seven other currencies at the same time. An enormous bureaucracy was the result of stubbornness. They preferred to let the market decide and had agreed on various hard criteria as to when a currency would be discontinued. Most of them did not even survive the first year in their own country. Today, only the three most popular currencies remain:

Baele's Black Mark (SM/S-Mark), Delxawe's Nitzia (NI) and the Free Currency (FEE).

*TL-Note: The original name of the currency is Schwarze Mark and Schwarz is Black. Most of the time and in all other books it is just called S-Mark. Which is why I will leave it as S-Mark.

.../ End Part