The bankers notices that as the economy has evolved absolutely no one ever comes and redeems PHLs. There no longer seems any point since they can just deposit them and earn interest. PHLs have been so successful people are no longer viewing them as worthless paper but as valuable in and of themselves.

They take the final step and say that you cannot redeem them for hours, they are now FIAT. Their value is based on trust and the backing of the community through the Central Bank.

For the bankers this removes the final bind. They are now free to print more money and leave it in circulation as there is no connection with anything physical. As the economy grows there is need for infrastructure to be built for all. A government is formed to co-ordinate this and given rights to raise taxes to pay for the work. For big big projects they go and borrow from the bank and pay interest from their tax revenues.

Please observe

• Growth is even more inherent in this system now as the government is paying it’s interest charge out of Tax revenues so it needs those revenues to increase
• Money can now be quite literally printed. This is what makes government debt so safe, they can always print money to pay it.

This brings me to Quantative Easing which is a posh name for printing new money and injecting it in the economy somehow. I want to illustrate this in two ways – an unrealistic way (perhaps) which should illustrate it’s effect and how it is being done currently.

Scenario One – The central bank prints a load of new money and distributes it equally to everyone. Potentially it has no impact, everyone buys the same things and ends up with surplus cash and deposits it. Alternatively (more likely) people can now afford products they didn’t used to, or can afford more resulting in shortages which pushes up the prices which can be paid as everyone has more cash. We have inflation.

Quantative Easing is inflationary.

Also note that a large proportion of this new cash ends up deposited at the bank which can then leverage it up by lending it out using Fractional Reserve Banking. Thus the total increase in money is much greater than that printed.

Scenario Two – the Central Bank prints money and buys back some of the government debt from the Bank. This means the bank has increased reserves, reduced it’s lending and thus credit availability increases. He can lend out more allowing more people to borrow to produce things or buy things. Thus increasing money in the economy. This still increases money in circulation running the risk of inflation. Of course if there is general inflation this reduces the real cost of all debt thus making it easier for the government to pay back it’s debt.