All the perplexities, confusions, and distresses in America arise, not from defects in their constitution or confederation, not from a want of honor or virtue, so much as from downright ignorance of the nature of coin, credit, and circulation. – John Adams, letter to Thomas Jefferson (1787-08-25), The Works of John Adams
If all the bank loans were paid, no one could have a bank deposit, and there would not be a dollar of coin or currency in circulation. We are completely dependent on the commercial Banks. Someone has to borrow every dollar we have in circulation, cash or credit. If the Banks create ample synthetic money we are prosperous; if not, we starve. We are absolutely without a permanent money system. When one gets a complete grasp of the picture, the tragic absurdity of our hopeless position is almost incredible, but there it is. It is the most important subject intelligent persons can investigate and reflect upon. – Robert H. Hemphill, Credit Manager of the Federal Reserve Bank of Atlanta, 1934 foreword to 100% Money, by Irving Fisher. Fisher was a Yale economist whose proposal for monetary reform lost to Keynes’ deficit spending plan during the Great Depression.
Without knowing how money is created and managed, all other topics concerning money are out of context. This is crucial: regarding trillions of dollars of economic power, you have no idea where money comes from.
It’s time for you to learn.
I teach Advanced Placement (AP) Macroeconomics. The following is what I provide to students, AP colleagues, and non-controversial in its first four points of content. While textbook economics provides the information of what we have as a monetary system, citizens need to take the last step to see for themselves what the private banks that own the Federal Reserve will never admit: their monetary system provides parasitic profits to leading Wall Street banks, bailouts in the trillions, and that an honest cost-benefit analysis proves their system should immediately be retired and replaced.
When people don’t know how money is created and managed, the only thing between them and tyranny is trust in ethical government. American democracy is founded upon cautious distrust of government. To compensate for temptations of power and personal profit in government, the US Constitution is designed with checks and balances. However, because checks and balances can be thwarted if politicians are unethical, the only real protection of liberty is citizen responsibility.
American democracy is dependent upon our taking personal responsibility for understanding our most important economic and political issues. This is one of them.
A mere demarcation on parchment of the constitutional limits (of government) is not a sufficient guard against those encroachments which lead to a tyrannical concentration of all the powers of government in the same hands. – James Madison, Federalist Paper #48, 1788 (more here)
Political parties exist to secure responsible government and to execute the will of the people. From these great tasks both of the old parties have turned aside. Instead of instruments to promote the general welfare they have become the tools of corrupt interests, which use them impartially to serve their selfish purposes. Behind the ostensible government sits enthroned an invisible government owing no allegiance and acknowledging no responsibility to the people. To destroy this invisible government, to dissolve the unholy alliance between corrupt business and corrupt politics, is the first task of the statesmanship of the day. – Theodore Roosevelt, “The Progressive Covenant With The People” speech (August, 1912)
Many Americans believe in the US without understanding our major economic and government policies. Collectively, American’s trust in our government to ethically create and manage money is so pervasive that few of us ever give this multi-trillion dollar issue a moment’s thought. As a teacher of economics, I hope this brief is helpful for your responsible citizenry.
There are five topics to understand for civic competence in creating and managing money. The first four are standard to economics curriculum; the last is rational analysis. Points 1-3 are below, 4-5 in Part 2 of the article:
Money and bank credit.
Fractional reserve banking.
Debt (public and private) and money supply.
Historical struggle between government-issued money and private bank-issued credit.
Cost-benefit analysis for monetary reform in your world of the present.
I promise you can easily understand each topic and that your understanding will give you an informed policy voice over trillions of dollars. I encourage you to verify and supplement the information in this paper through additional research. My experience as a teacher is that the best tool to visualize this information is to literally see it through an online 78-minute video, “Money As Debt II: Promises Unleashed” (and for your use: background and transcript of Money as Debt). Four other sources of information that I recommend: an excellent overview of our monetary system from Want to Know.info, incisive articles from the most-read authors on this topic, Ellen Brown and Stephen Zarlenga, and the most-viewed documentary, Zeitgeist: Addendum.
“The process by which banks create money is so simple that the mind is repelled.”
– John Kenneth Galbraith, Money: Whence it came, where it went (1975), p.29. Galbraith wrote five best-selling books on economics (best-selling to the public), was President of the American Economic Association, economics professor at Harvard, and advisor to four US Presidents.
Please be advised that the ideas most people have about how money is created and managed are false. Because the facts are so different from what most people believe, cognitive dissonance will push some people to reject the facts. Please reaffirm your commitment to embrace the facts.
Here we go:
Money and Bank Credit:
“A great industrial nation is controlled by its system of credit. Our system of credit is privately concentrated. The growth of the nation, therefore, and all our activities are in the hands of a few men who, even if their action be honest and intended for the public interest, are necessarily concentrated upon the great undertakings in which their own money is involved and who necessarily, by very reason of their own limitations, chill and check and destroy genuine economic freedom. This is the greatest question of all, and to this statesmen must address themselves with an earnest determination to serve the long future and the true liberties of men.” – President Woodrow Wilson, The New Freedom, Section VIII: “Monopoly, Or Opportunity?”, p. 185.
“I too have been a close observer of the doings of the Bank of the United States. I have had men watching you for a long time, and am convinced that you have used the funds of the bank to speculate in the breadstuffs of the country. When you won, you divided the profits amongst you, and when you lost, you charged it to the Bank. You tell me that if I take the deposits from the Bank and annul its charter I shall ruin ten thousand families. That may be true, gentlemen, but that is your sin! Should I let you go on, you will ruin fifty thousand families, and that would be my sin! You are a den of vipers and thieves. I have determined to rout you out and, by the Eternal, (bringing his fist down on the table) I will rout you out.” – From the original minutes of the Philadelphia committee of citizens sent to meet with President Jackson, February 1834, according to Stan V. Henkels, Andrew Jackson and the Bank of the United States, 1928
Money is broadly defined as anything generally accepted for trade. However, in the real world something is money only when the government authorizes it as “legal tender.” Its purpose is to facilitate trade. Fiat money (not exchangeable for a commodity that “backs” the currency) is all that’s required for this purpose because the government enforces its acceptance as payment. Commodity money is the attachment of money to a thing, like gold or silver. This is not needed for legal enforcement and introduces fluctuation as the value of the attached commodity changes. If you’re aware of the violent swings of the price of gold, you’ll understand the risk of a wildly fluctuating value of commodity money. Its proponents, like my friend Ron Paul, argue that linkage to a thing of limited quantity is an acceptable tradeoff compared to their prediction of inevitable corruption of any system designed to limit the supply of fiat currency.
Bank credit is the legal power government has given banks to create quasi-money out of nothing and lend it to the public at interest. Your deposits to a bank are loans to them. The bank can legally take a percentage of your deposit (90 to really 100% through clever manipulations of regulations) and create new credit to lend to the public at interest. They are not lending your deposit, as most people envision. They are making the new credit out of thin air! Bank credit increases the supply of money, causes inflation (by definition as the supply increases), and devalues the money already possessed by the public. Inflation is a hidden tax on your money because purchasing power decreases with inflation. The banking industry benefits from this policy of creating credit out of nothing and lending it to us at interest, while the public has the costs of paying banks to “so-called borrow” credit at interest while existing money is devalued. I use the term “so-called borrow” because the loan wasn’t something possessed by the bank. The loan was created out of nothing when you asked for the loan. This can be difficult to grasp. Watching “Money As Debt II” will walk you through the process.
The fact that banks create credit out of thin air is verified by the Federal Reserve’s Publication, “Modern Money Mechanics.”[1] Excerpts:
“The purpose of this booklet is to describe the basic process of money creation in a ‘fractional reserve’ banking system…The actual process of money creation takes place primarily in banks.”
“[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 in exchange for credits to the borrower’ transaction accounts. Loans (assets) and deposits (liabilities) both rise by [the amount of the “loan”].”
When you understand the power of creating credit out of nothing, your mind will probably take the next logical step: why don’t we create money out of nothing to pay for public goods and services directly rather than surrender this awesome power to the banks? You’ll begin to realize: isn’t it insane for a government that has the Constitutional authority to create money to not do so when we have unemployed workers, work that needs to be done, and the resources to do the work?
Fractional Reserve Banking:
“This proposal will of course be opposed by the bankers from whom it takes the lucrative privilege of creating purchasing power. It would however insure the safety of deposits, give large revenues to the government, provide complete social control over monetary matters and prevent abnormal fluctuations in the capital market. At the same time it would permit the allocation of productive resources…to remain primarily in private hands. All in all it seems the most promising program for the reform of our monetary and credit system…” – Paul Douglas in the Chicago Plan booklet. The Great Depression in the US (1929-1941) motivated professional economists to comprehensively and creatively address its causes. Upon consideration of previous US economic depressions in 1837, 1873, and 1893, prominent economists led by Henry Simons at the University of Chicago proposed monetary reform as the nation’s most effective and practical policy response, known as the Chicago Plan (and here). This proposal was endorsed by Simons’ colleague, Paul Douglas, Frank Graham and Charles Whittlesley of Princeton, Irving Fisher of Yale, Earl Hamilton of Duke, Willford King of NYU, and sent to a thousand academic economists for their input. Three hundred twenty responded to the mailed proposal and survey (an impressively high number for a cold-call proposal and survey) from 157 universities, with 73% in full agreement with the proposal, 12.5% in approval with various considerations in its implementation, and only 14% in disagreement. The proposal ended fractional reserve banking and replaced it with government-created money with no debt or interest cost.
“The bankers will favor a course of special legislation to increase their power…They will never cease to ask for more, …so long as there is more that can be wrung from the toiling masses of the American People…The struggle with this money power has been going on from the beginning of the history of this country.” – Peter Cooper, famous American inventor in his letter to President Hayes, June 1, 1877.
This is the term for how banks and the banking industry create credit. An individual bank creates credit and “so-called lends” it to the public as a fraction of the deposits the public puts in the bank. Because the money so-called lent ends up in another bank that then so-called lends the money again, the effect in the overall economy is a multiplier effect rather than an individual bank phenomenon of a fraction. It works like this: the definition of “fractional reserve banking” is that banks keep a regulated “fraction” of their total deposits “on reserve,” called their reserve ration (RR) that they cannot “lend,” and can create new credit out of thin air up to the total of all their customers’ deposits minus their RR. Again, because my teaching experience agrees with John Kenneth Galbraith’s quote above that this is difficult to grasp: once a bank is established, they must hold a percentage (ratio) of their total deposits “on reserve” that is not leant to customers. This rate is set by the Federal Reserve (Fed), 10% for established banks and less for smaller ones (however, banks get around these limits and will always make credit on terms profitable to the bank).
This means that if you deposit money into your bank, they can then create credit up to their limit in new “loans.” If you deposit $100, the bank can create new/thin-air credit of $90 to anyone asking for a loan. That’s the micro picture.
The macro picture is that the new credit then circulates to other banks and is “re-leant” at 90% and so on. Let’s say that someone borrows the $90 from your bank, purchases something, and then the $90 ends up deposited in another bank. The receiving bank can create credit, let’s say 90% of up to $81 in new credit. The injection of increasing the money supply comes from the Federal Reserve. They create money out of nothing and then use it to buy government securities or non-voting shares of banks, etc. If they buy a government bond for $1,000 from money they create out of nothing, this new money increases the money by the formula 1/RR. Assuming a simplified textbook understanding of a RR of 10% of deposits that banks cannot create credit from, in this case of the Fed creating $1,000 the new credit/money multiplied from the banking system is $1000 x 1/10%, or $1000 x 10 = $10,000. This is the macro effect if all receiving banks create credit up to their reserve requirement and all “lend” out the new credit.
Because the Federal Reserve is owned by the banking industry, this causes a classic conflict of interest: the banking industry’s profit comes from expanding the money supply and then creating credit to “lend” to us at interest. Expanding the money supply is in conflict with the public’s interest to limit the supply of money to guard its value from inflation.
Some people are confused by the Fed’s ownership. What’s in agreement in all curricula and publications is that the Fed is owned by their member banks; over half the stock is from the New York area (also known as Wall Street banks). Court cases have found in each instance that the Federal Reserve is not a government agency. You cannot find them in a government agency organizational chart in any branch of government. They are listed in the business section of phone books shortly after Federal Express.
Debt (public and national) and the Money Supply:
“When our Federal Government, that has the exclusive power to create money, creates that money and then goes into the open market and borrows it and pays interest for the use of its own money, it occurs to me that that is going too far. I have never yet had anyone who could, through the use of logic and reason, justify the Federal Government borrowing the use of its own money… The Constitution of the United States does not give the banks the power to create money. The Constitution says that Congress shall have the power to create money, but now, under our system, we will sell bonds to commercial banks and obtain credit from those banks. I believe the time will come when people will demand that this be changed. I believe the time will come in this country when they will actually blame you and me and everyone else connected with this Congress for sitting idly by and permitting such an idiotic system to continue. I make that statement after years of study.” – Wright Patman: excerpts from September 29, 1941, as reported in the Congressional Record of the House of Representatives (pages 7582-7583).
“One of the most astounding facts about our American life is that the wealth and property of the country and the control of the machinery of government are in the hands of less than 2 per cent of the inhabitants. That is to say, a small group of excessively wealthy individuals, members of the Republican and Democratic Parties alike, have, through the exercise of powerful, sinister and, too often, unlawful influence, usurped the government and seized public property on such a wholesale scale that they have become the virtual dictators of the destinies of more than 110,000,000 people (the US population at the time). That is a situation which, to my mind, constitutes the greatest menace to the safety of our republic.
A small group of international bankers and money lenders, public utility exploiters and tariff beneficiaries have actually dictated nominations for offices up to the Presidency. They have placed the slickest, cleverest, and most cunning manipulators in official positions, even in the minor posts, where they could be of service when called upon by the invisible power which, utterly devoid of all humanity, seeks but to wallow in riches.
… Woe to the public officials who dare to resent their dictatorship! If there be such public officials who will not submit to their imperious dictation, then the flood-gates of lying press propaganda are released, sweeping the unhappy public servant to an earthly as well as political grave, or compelling him to compromise with his conscience and become their subservient tool to the end of his term.” – New York City Mayor John F. Hylan, 1922 (his office was a half-mile from the New York Stock Exchange)
When banks “lend” credit, the interest charge can double the amount the customer must repay. Through fractional reserve banking, only the amount leant is created (principle) but not the interest. Because our US money is only created as debt in our current monetary system, and the interest is never created, we can now explain some extraordinary but predictable outcomes. Money is debt, created out of thin air by private banks, and then “leant” to us to repay at interest. The debt will always be greater than the money supply. It’s impossible to ever repay total debt; we are in debt forever in this monetary system. Please let this important fact have a place of honor in your understanding and think through it’s implications in our economy.
In fact, when you understand the mechanics, the engineering, the proper terms to understand what we have shift in Orwellian degree:
The US does not have a “money supply,” but a “debt supply.”
What we call “money” is actually “debt.”
To put the significance of this understanding in numbers, the total debt of the US public is currently over $50 trillion.[2] The total US money supply is somewhere around $13-15 trillion.[3] We don’t know the exact amount anymore because the Federal Reserve stopped publishing that figure in 2006, claiming it was unimportant and “too expensive to tabulate and print.” This decision was made without consultation from Congress or opportunity for comment from professional economists or the public. Critics responded that this number is among the most important because inflation is a function of the money supply, tabulating its cost is negligible, and not keeping track of the total money supply is potentially crippling to our overall economy through the risk of inflation. Critics suspect that the Fed is hiding how much they’re increasing the money supply.[4]
The Fed is privately-owned by the banking industry with their meetings closed to Congress and the public. The purpose of all business is to maximize their own profit with limited interest in the public good. The Fed is only audited by giving their accounting books to an independent firm to verify their math is correct in the books. Because the Fed is not strictly and transparently regulated by Congress, we have to trust the Fed that the numbers on their books are accurate. As I’ve gently suggested, trusting people in positions of power is un-American from the view of the Founding Fathers. The only “oversight” from Congress is semi-annual interviews for questions and answers with the Chair of the Federal Reserve. Presidents appoints the seven Board of Governors to help manage the Fed, but historically these selections always come from a short-list of candidates selected by Fed ownership.[5] The term of office for Board members is 14 years. As you may know, Congresspersons Ron Paul and Dennis Kucinich had bills to fully audit the Fed (HR 1207 and HR 2424, respectfully) that the Fed is opposing to protect its “independence.”
Because the Federal Reserve can always create money out of nothing to buy US government securities, the federal government is tempted to increase the national debt rather than operate a balanced budget. The current national debt of over $14 trillion[6] has an annual interest cost to the American taxpayers over $400 billion (with danger of going much higher if interest rates rise).[7] US taxpayers only pay the interest and never pay down the principal of the debt. When the securities are due to be paid, additional securities are sold to cover the cost. There is no government plan to pay the national debt or reduce it rather than vague promises to reduce spending and reduce the debt from higher tax revenue of a strong economy. This rhetoric has no track record of performance since Andrew Jackson enacted partial monetary reform in his administration that ended in 1836.
Please let that sink-in: we only pay the interest on the debt and actually cannot pay the debt because it’s far larger than the money supply. Of course, you’re now thinking there has to be a more intelligently-designed monetary system, you’re feeling good in your citizenry that you’re reading this article, and are excited to discover a better policy in creating money!
But let’s allow the costs of our current system to be fully understood to fuel your passion for monetary reform. The interest payment cost of $500 billion every year to Americans is enormous. As we learned in my article, “The economics of ending poverty,” the investment to fund the UN Millennium Goals that would save a million children’s lives every month while decreasing population growth rates is estimated by professional economists from a low of $40 billion/year to a maximum of $150 billion/year at the project’s most expensive phase.[8] This is a ten-year investment, as sustainable and self-funding development is the project’s goal. Even if we wanted to repay the debt, the average cost to the ~100 million American households is about $110,000. We’ll consider alternatives to this monetary system in our cost-benefit section shortly.
To put this in another perspective, the US Bureau of Engraving and Printing (BEP) has two buildings, one in Washington, D.C. and one in Fort Worth, Texas. Imagine each building has two halves: both print pretty pieces of paper. In one half, money is printed; in the other half, US Treasury Securities. Securities are mostly T-Bills, Notes, and Bonds; they are auctioned to the public every week as loans to whoever buys them and are repaid with interest. Bills are loans for a year or less, Notes are two to ten years, and Bonds are ten to thirty years. These are mostly all marketable, meaning that they can be resold.
If Congress wants to buy government programs beyond their tax revenue, they may print and sell as many securities as they wish but cannot get money directly because that is illegal in our current monetary system. If the Fed wants money, they request as much as they wish at the cost of the paper and then charge the taxpayers as an operating expense. Of course, the Fed can also enter money electronically into accounts. We have no way of knowing if the Fed abuses their power to create money by entering money into accounts and not reporting this on their books. The only safeguard the public has is their word that they would never ever create money for themselves, even though that is possible with a few computer keystrokes and undetectable.
And please let the above facts and risks sink-in.
For comparison, imagine if your family was a nation with the power to print its own money. I offer to take this job from you with the following spin: I’m a banking expert. Whomever you appoint from your family to create money will combine ignorance with inevitable corruption that will be incapable of managing your family’s money no matter what transparent safeguards you enact. Therefore, I will print money to lend to your family at interest. With your family’s increased education and economic productivity, you can only increase the money supply by additional lending from me. As a “government,” your family need never pay off the loan, only the interest. Your family will work for me in paying the interest, and my family will manage the money to lend to your family. This is fair because printing your own money will lead to your ruin.
Your family becomes increasingly in debt to me. After decades of this practice, your family doesn’t give this system any thought and whines about the interest payment and debt without taking any action to understand the system and look for alternative structures. This is our Federal Reserve system today.
Carl Herman is a National Board Certified Teacher in economics, government, and history. His hobby is research, education, and lobbying for improved public policy. A principal project of his 30-years’ experience working with US “leadership” in government, economics and corporate media was to grow the citizen’s lobby, RESULTS, that led to two UN Summits (1990 World Summit for Children – the largest meeting of heads of state in world history – and the 1997 Microcredit Summit – topic of the 2006 Nobel Peace Prize). Because US political leadership of both parties reneged on each and every public and private promise to end poverty, and US corporate media behaved as their political propagandists, Carl shifted his hobby to “follow the money.” His conclusions are explained and documented in these two articles (academic/professional voice, and more passionate citizen voice):
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