Modern money mechanics
A number of years ago, the central bank of the United States, the Federal Reserve, produced a document entitled: “Modern Money Mechanics“. This publication detailed the institutionalized practice of money creation as utilized by the Federal Reserve and the web of global commercial banks it supports. On the opening page, the document states its objective: “the purpose of this booklet is to describe the basic process of money creation in a fractional reserve banking system”. It then proceeds to describe this fractional reserve process through various banking terminology. A translation of which goes something like this:
The United States government decides it needs some money. So it calls up the Federal Reserve and requests, say 10 billion dollars. The Fed replies, saying: “sure we’ll buy ten billion in government bonds from you”. So the government takes some pieces of paper, paints some official looking designs on them and calls them Treasury bonds. Then, it puts a value on these bonds to the sum of 10 billion dollars and sends them over to the Fed. In turn, the people at the Fed draw up a bunch of impressive pieces of paper themselves. Only this time calling them “Federal Reserve notes”. Also designating a value of ten billion dollars to the said. The Fed then takes these notes and trades them for the bonds. Once this exchange is complete, the government then takes the ten billion in Federal Reserve notes and deposits it into a bank account. And upon this deposit, the paper notes officially become legal tender money, adding ten billion to the US money supply. And there it is: ten billion and new money has been created.
Of course, this example is a generalization for: In reality, this transaction would occur electronically with no paper used at all. In fact, only three percent of the US money supply exists in physical currency. The other 97 percent essentially exists in computers alone. Now government bonds are by design instruments of debt. And when the Fed purchases these bonds with money it essentially created out of thin air, the government is actually promising to pay back that money to the Fed. In other words: the money was created out of debt.
This mind-numbing paradox of how money or value can be created out of debt or a liability will become more clear as we further this exercise. So the exchange has been made and now ten billion dollars sits in a commercial bank account. Here is where it gets really interesting: for is based on the fractional reserve practice, that ten billion dollar deposit instantly becomes part of the bank’s reserves, just as all deposits do. And regarding reserve requirements, as stated in modern money mechanics, a bank must maintain legally required reserves equal to a prescribed percentage of its deposits.
It then quantifies this by stating under current regulations the reserve requirement against most transaction accounts is 10%. This means that with a ten billion dollar deposit, 10% or 1 billion is held as the required reserve, while the other nine billion is considered an excessive Reserve and can be used as the basis for new loans.
Now, it is logical to assume, that this nine billion is literally coming out of the existing ten billion dollar deposit. However, this is actually not the case. What really happens is that the nine billion is simply created out of thin air on top of the existing ten billion dollar deposit. This is how the money supply is expanded, as stated in modern money mechanics.
Of course they the banks do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do, when they make loans, is to accept promissory notes (loan contracts) in exchange for credits (money) to the borrower’s transaction accounts. In other words: the nine billion can be created out of nothing, simply because there is a demand for such a loan and that there is a ten billion dollar deposit to satisfy the reserve requirements.
Now let’s assume that somebody walks into this bank and borrows the newly available nine billion dollars. They will then most likely take that money and deposit it into their own bank account. The process then repeats for that deposit becomes part of the bank’s reserves. Ten percent is isolated and in turn, 90 percent of the nine billion or 8.1 billion is now available as newly created money for more loans.
And of course, that 8.1 can be loaned out and redeposited, creating an additional 7.2 billion to 6.5 billion to 5.9 billion, etc. This deposit money creation loan cycle can technically go on to infinity.
The average mathematical result is that about 90 billion dollars can be created on top of the original 10 billion.
In other words: for every deposit that ever occurs in the banking system, about nine times that amount can be created out of thin air.
So, now that we understand how money is created by this fractional reserve banking system, a logical, yet illusive question might come to mind: what is actually giving this newly created money value?
The answer: the money that already exists. The new money essentially steals value from the existing money supply. For the total pool of money is being increased irrespective to demand for goods and services. And as supply and demand finds equilibrium, prices rise diminishing the purchasing power of each individual dollar.
This is generally referred to as “inflation”. And inflation is essentially a hidden tax on the public.
“what is the advice that you generally get and that inflates the currency? They don’t say debase the currency, they don’t say devalue the currency, they don’t say cheat the people who are saved, they say lower the interest rates. The real deception is when we distort the value of money when we create money out of thin air.
We have no savings, yet there’s so-called capital. So, my question boils down to this: how in the world can we expect to solve the problems of inflation, that is the increase in the supply money, with more inflation?”
Of course, it can’t.
The fractional reserve system of monetary expansion is inherently inflationary, for the act of expanding the money supply without there being a proportional expansion of goods and services in the economy, will always debase a currency. In fact, a quick glance at the historical values of the u.s. dollar versus the money supply, reflects this point definitively for the inverse relationship is obvious.
One dollar in 1913 required $21.60 in 2007 to match value. That is a 96% devaluation since the Federal Reserve came into existence. Now, if this reality of inherent and perpetual inflation seems absurd and economically self-defeating, hold that thought, for “absurdity” is an understatement in regard to how our financial system really operates for in our financial system: money is debt and debt is money.
For the more money there is the more debt there is – the more debt there is, the more money there is.
To put it a different way: every single dollar in your wallet is owed to somebody by somebody. For remember: the only way the money can come into existence is from loans. Therefore, if everyone in the country were able to pay off all debts, including the government, there would not be one dollar in circulation.
In fact, the last time in American history the national debt was completely paid off, was in 1835 after President Andrew Jackson shut down the central bank that preceded the Federal Reserve. In fact, Jackson’s entire political platform essentially revolved around his commitment to shut down the central bank, stating at one point: “the bold efforts the present Bank has made to control the government are but premonitions of the fate that awaits the American people should they be deluded into a perpetuation of this institution or the establishment of another like it.”