You know that banks make loans to people all the time for a variety of purposes. When banks hand out such money so that you can purchase a home, car, boat, or other large ticket item, they commonly issue a promissory note along with it.
While you are probably familiar with the basics of loans, you may not understand what a promissory note is exactly. In the article that follows, you will learn not only what these notes are, but also how a bank is able to create money with promissory notes in an action that resembles an amazing magic trick.
What Is A Promissory Note?
Loans from a bank can be used for many different purposes, such as to pay for education, to consolidate debts, or to buy houses, cars, boats, etc. The promissory note is a critical part of the loan package. When you sign this promissory note, you give your promise to pay back all of the money that you borrow to the lender.
It states the names of the parties who are involved, the debt total amounts, and the interest rates. The note details all of the information on the terms of how and when you will repay the borrowed principle and the means that the bank will use to determine how much every payment will actually be. These promissory notes are legally binding documents. This signifies that a court of law can enforce the terms.
How Does the Bank Create Money from a Promissory Note?
When you go sit down at your local bank branch and ask for a loan, you probably have not considered whose money they loan you. They certainly do not loan you their own money. They also do not loan you the other depositors’ money, although they could, if they obtained the permission of every depositor whose funds would be involved.
When you sign your promissory note, your bank enters a deposit into their books and creates a Demand Deposit Account for the precise amount of your promissory note. This note will appear as an asset to the bank from this moment forward. As all credits must be negated by equal debit amounts, now the bank has to offset this credit entry with a matching liability entry into their ledgers.
For example, if you borrow one hundred thousand dollars from the bank, then you will sign a promissory note for this amount of money The bank will set up a credit of one hundred thousand dollars from the promissory note and offset it with a one hundred thousand dollar ledger liability.
Banks are able to make money seemingly out of thin air when they put these promissory notes to work with clever, creative, and completely legal bookkeeping entries. You probably do not know that banks are able to credit funds not only from deposits and federal reserve notes, but also from promises to pay, such as checks and promissory notes that you give them.
They open their books and enter this promissory note as an asset. They then have to balance this out with a liability entry on the other side of their ledger. To this effect, they create a Demand Deposit Account to be the liability that offsets the promissory note credit. Now the bank shows a zero balance.
Watch closely to see where the sleight of hand magic trick comes in. The bank has this demand deposit account of money that they have created out of thin air to offset the promissory note, but this money is not yet in circulation. They next happily place it into circulation when they give it as a check or bank draft to the seller of the house.
Now the bank has just created an asset for itself when it deposits your promissory note against the Demand Deposits Account that it created from nowhere. The bank then uses the demand deposit account that it conjured up against the promissory note asset to pay the seller of the house or property.
The beauty of it from the bank’s point of view is that they still get to keep your promissory note as an asset even after they use the money that they created against your asset to pay off the seller. Yet their bank books show a zero balance between the promissory note and the Demand Deposit Account with which they pay off the seller.
The bank can use this asset of your one hundred thousand dollar promissory note in various ways. First, they created funds out of thin air to pay the seller and kept your asset of the promissory note. So now they have created and enriched themselves with a 100% asset in the value of your promissory note. They can choose to hold this promissory note asset and continue to receive income from it as you make the payments.
They might also choose to sell your one hundred thousand dollar promissory note to another bank or servicing company at a slight discount and obtain yet another payment for this asset that they sell. In practice, banks typically do this, pocket the extra money, and move on in search of still more people like you who are willing to sign additional promissory notes in exchange for incredible magic money payoffs to sellers.
If you do not believe that a bank can do this, then ask them sometime to show you the original, unaltered, and unmarked promissory note that you signed for them way back when you took out your one hundred thousand dollar loan. The odds are something like ninety percent that not only do they not have the note any longer in their possession, but also that they do not even know who holds it at any given time. More to the point, they no longer care, since they have been compensated generously when they sold it and have happily moved on in search of new promissory note participants.
Is The Magic Change of Promissory Notes into Additional New Money Legal?
If this sounds like a Ponzi scheme, or shady accounting to you, then you will be in good company with many other people who scratch their heads when they hear about this miraculous money creation that banks engage in every day of the year.
The shocking truth is that it is not only a legal means for them to create new money, but it is also a highly favored method that the Federal Reserve and Treasury not only know about, but actively encourage the banks to perform. This is called oiling the machine of the economy. If the economy does not see banks both create and circulate this new money on a regular basis, then it freezes up and stalls out entirely.
The beauty of the system is that it is actually in the interest of all parties who are involved to keep this magic trick of promissory notes going. After all, you the home buyer were able to get your loan with which to purchase the house. The seller was able to sell his house, thanks to the financing that the bank provided. The bank obtained an over one hundred percent gain on the value of your promissory note. Everybody wins.
In light of all these parties that stand to gain from these creative and clever accounting tricks, do you think that the promissory note into money magic will disappear any time soon?
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