Money creation outside the banking system

In the last few decades, money markets and financial markets have been undergoing a major modernization. Transactions can be transferred faster than ever before and it has become more attractive for people to participate in the different markets because of easier information acquisition via the internet. Inter alia, the use of credit and debit cards and the fact that commercial banks make loans led to money creation in the commercial banking sector that by far exceeds central banks’ money creation. Now it is the case that the commercial banking system can create money out of nothing (credit creation theory) – contrary to the mainstream theories: the financial intermediation theory and the fractional reserve theory. Central banks lose control over money supply. In addition, innovations in payment methods with service providers like PayPal or Google Wallet and newly developed virtual currencies like Bitcoin have come up. The interesting question is whether – and if so how – these developments affect money supply, too. The objective of this paper is to investigate whether these kinds of payment service providers are also able to create deposits out of nothing analogously to commercial banks yet not regulated by any banking law, and whether virtual currencies are or will become an extra money supply in the economy. Should this be the case, this could intensify the loss of control over money in circulation for central banks.

Hence, we firstly describe and analyze both modern payment service providers and virtual currencies with regard to their set-up and their functioning. In this context we also check whether or not virtual currencies fulfill the common money functions. Secondly, we shortly explain regular money creation within the banking system in general. Afterwards, we combine the results of the two before mentioned sections and discuss whether money creation is really going on outside the banking system, and if so to what extent effects can be expected on money markets and on financial markets.

One of our main results is the fact that virtual currencies really are additional money as they are mined out of nothing and can be exchanged for national money. Therefore, they are parallel currencies concerning the means of payment function and the unit of account function for the growing community which accepts and uses them. A not so clear conclusion can be drawn for the payment service providers. For these we find an “it depends” result.