Credit – A positive (favorable) balance. An amount loaned to a person or organization by a bank or other entity. Receipt of credit creates a debt that must be repaid, usually with interest.
Dark money – The most frequent usage refers to hidden money supporting political campaigns. Used more broadly in this blog, it refers to dark or hidden aspects of money in general, such as the shadow banking system, dark investment pools, the vagaries of monetary policy, and the not-well-understood nature of money itself.
Dark pools – In finance, this refers to trading that happens away from an exchange. Trading occurs directly between financial institutions or participants, often through electronic means. Dark pools are established or facilitated by broker/dealers, dark pool aggregators, or even exchanges themselves.
Debit – A subtraction from the balance of an account, or a record of indebtedness.
Debt – An obligation or a state of owing something to someone, either in the form of money or some other form of repayment. If the debt is monetary it is specified as an amount owed in some accounting unit.
Fiat money – All money in general use today is fiat money. Fiat means “let it be” and just refers to the authority of the government to define the monetary unit, assert that the money can be used to pay debts and taxes, and to fix the denominations of coins and currencies
Fractional reserve system – A system which limits the quantity of money which banks can create through loans to some multiple of their customer deposits and cash on hand. They hold most of their reserves with the central bank. A typical multiple might be 10 or 12 times, thus their reserves are a fraction of around 8 or 10 percent of their loan book. The assumption, which is usually correct, is that not all customers will demand their full checking account balances on the same day. A fractional reserve system is essentially a fraudulent process, since banks are able to create and lend money at interest out of thin air. Nevertheless it is legal in virtually all nations today.
Money – Money is first and foremost an agreed upon unit of account adopted to measure the value of debts, goods and services. The Mesopotamians and Egyptians had elaborate accounting systems with monetary units thousands of years before coinage appeared. Money is used not only for trade in goods and services but also to repay debts, pay taxes, to make gifts, and as capital stock for investment. Modern money is established by national authorities by fiat (“let it be done”). National monies have always been established by fiat, even when they consisted of gold and silver coins, whose intrinsic value must necessarily be less than the stated value in order to remain in circulation. In addition to being a unit of account, money is a medium of exchange and store of value.
Monetary base – Also known as high-powered money and M0. The monetary base consists of balances that the commercial banks keep in reserve with the central bank, plus currency and coins either in circulation or bank vaults. While the reserve component, which dominates, serves as a base for lending and money creation, this money is not circulating out in the real economy. Basically, central banks control and create reserves and commercial banks create the overall money supply through loans. Central banks can influence the banks through the setting of interest rates.
Quantitative easing – Quantitative easing is the process of creating reserves at the central bank and then using those reserve to buy securities, such as treasury bonds or bills or mortgage backed securities held by commercial banks or other private financial institutions or funds. QE does not print money in the sense that we understand money in common use. QE does not create “circulating” money; it creates monetary reserves. Whether there is an increase in circulating money is left to the banks. Under fractional reserve banking, banks print money inside computers, not central banks.
Shadow banking system – Non-bank financial intermediaries and off-balance sheet activity by investment banks comprise the shadow banking system. Hedge funds, money market funds, structured investment vehicles are considered shadow banks. Activities by investment banks may be constrained by the central banking authorities, but their off-balance sheet activities may not be so constrained. These include credit default swaps, as one example.
Velocity of money – The average rate at which money turns over in the economy during one year. If defined in terms of M2, the equation is GDP = M2*V where GDP is the gross domestic product and V the velocity of the M2 money stock. Currently the velocity of M2 money in the U.S. is about 1.6 and it has been generally falling since 1998 when it was around 2.1. Velocity tends to fall rapidly during recessions.