Like many other countries, the U.S. money supply consists primarily of deposits created by private commercial banks. How we understand bank money creation matters enormously. We are currently witnessing a debate between two competing understandings. On the one hand, a long-standing conventional view argues that bank money creation originates in individual market transactions. Based on this understanding, the conventional view narrowly limits the scope of banking regulation to market failure correction. On the other hand, authors in a new legal literature emphasize the public aspects of bank money creation, characterizing it as a “public franchise,” a “public-private partnership,” and part of the “social contract.” This new legal literature has a broader vision of banking regulation, and has raised ambitious proposals in areas including financial stability, civil rights, climate action, and financial technology.
This Article bridges a gap in the new literature that has held it back from achieving its full potential. While the new literature recognizes bank money creation as public in important ways, it has dedicated little attention to the question of how banks are able to engage in money creation in the first place, thereby leaving key aspects of the conventional account unchallenged. The Article fills this gap by focusing on the process of clearing, through which banks pay trillions of dollars in obligations they owe each other every day. To assess the conventional account, the Article presents a case study of daily clearing practice in an environment that seems as market driven as possible: the New York Clearing House Association prior to the creation of the Federal Reserve system. Building on novel primary sources, the case study demonstrates that daily clearing presented NYCHA banks with serious challenges. Addressing these challenges required governance both at the level of the state, and through bank cooperation on nonmarket terms. These findings expand our understanding of how bank money creation occurs and how it should be regulated.