THE CURRENT MONETARY SYSTEM BEFORE THE VOTE
December 23, 2013 marked the 100th Anniversary of the Federal Reserve Act, which created the Central Bank for the United States. The Federal Reserve is called a central bank. Other important central banks are: The Bank of Japan, The Bank of England, and the European Union’s Central Bank. These central banks are basically the fourth branch of government, which has more influence on the economy than tax and spend (fiscal policy).
The Federal Reserve is NOT a federal agency. It is primarily a private agency that regulates commercial banks. These commercial banks generate the majority of our money in circulation. The Federal Reserve is NOT a reserve; it directly creates the rest of our money supply by a stroke of a computer key.
In its 100 years of existence, we have had 16 recessions, the Great Depression, the Great Recession, and excess inflationary periods creating extensive human hardships. It is time to end these extreme downturns or at least make them less severe.
Increasing and/or changing banking regulations and breaking up or nationalizing the banks is not a substitution for reform, as it does not alter the unsustainable system by leaving monetary creation with the banks. In fact, there have been many government owned banks that experience the same failures as privately owned banks. Many central banks are actually owned by the government such as the Bank of Japan and the Bank of England. We need a 21st Century, modern monetary system to create a quality Win-Win economy!
The major source of new money in an economy is generated by the commercial banking system, i.e. Wells Fargo, Citibank, Bank of America, Chase, and the smaller local banks. They don’t loan out your deposits. They loan out far more. This excess is new money created out of thin air! This is a very important concept to understand. This is called “debt” money—where new money is created and distributed by only a loan.
Congress gave the power to the Federal Reserve in 1913, to operate the monetary system. This system creates new money only by issuing debt – private and government. Private debt-money is only created by the commercial bank loans under the regulation of the Federal Reserve. Government debt money is only created directly by the Federal Reserve’s open market operations, at the Fed’s bank in New York.
The Fed gradually buys U.S Treasuries from the banks with newly created money. This is forced money creation by issuing Treasuries to fund deficit spending. This is called, “Monetization of the Debt.”
Basically, someone—or government—has to go into debt to release new money into the economy.
This is the main reason you see a very slow recovery and growth when we have a financial collapse like 2008. In reality, there is no cost of creating new money except for creating too much in circulation, thus creating excess or hyperinflation. Creating too little with narrow circulation severely costs the economy in recessions, depressions, and extreme human hardships. In reality, there should be no cost for creating new money; there should only be the nominal cost for distribution.
When commercial banking lending slows down or freezes up, as in 2008, new money ceases to be issued and is reduced at the same time, whereby the lesser system of money creation takes over. This lesser system is deficit spending by the Federal government. Yes, deficit spending forces the Federal Reserve to create money by monetizing the debt. They digitally create money (a touch of the computer keys) and buy Treasuries and other assets from commercial banks. No, it is not all borrowed from China.
The newer policy of buying other assets from commercial banks started as a result of the 2008 crash. This is called quantitative easing, which basically creates new money by buying the suspect mortgages that the banks still hold. This process of monetizing the debt is a substitute or an addition for the lack of money in circulation from the banking system. Federal spending is also more diversified in its distribution. Deficit spending has kept us out of severe depression! There was no fiscal spending in 1929 and the Federal Reserve tightened money, which caused the Great Depression.
The next question is: When do you reduce this substantial deficit spending? If reduced too early, as Japan did in 1997 and the U.S. did in 1937, the country goes back into recession. This
reduction of deficit spending is labeled “austerity”.
The following example gives you a brief overview of the steps involved in creating money under our current system of government debt. The U.S. Government needs $1,000 to pay the salary of a federal employee. The U.S. Treasury issues a $1,000 Treasury Note, Bill, or Bond to the private government bond brokers for sale. This note is then purchased by commercial banks. The check is recorded by the Fed as a liability against the government, and the Note becomes an asset of the Fed.
The Fed has created the $1000 check with simple keystrokes on their computer without actually getting the money from any specific place. In other words, the Fed issued this money against no funds of its own. Thus we see why many call this money creation process “money created out of nothing or thin air”. This is also called “fiat money”, which all countries use. It is in reality, debt money, debt backed money or bank money.
The process for making a loan by commercial banks, which is the largest source of new money, is called a fractional reserve system. This system allows a bank to create new money on a fraction of deposits made with that bank. This fraction is determined by the Federal Reserve Board, as part of its monetary policy, and is called the reserve requirement. If the reserve requirement is 10%, then the banking system can loan $900 from the deposit of the $1000 salary check or 90% of the value of the $1000.
This new $900 loan is then deposited in another bank, which can make another $810 loan. This process repeats itself until a maximum of $9000 is loaned out by the commercial banks from the initial deposit of $1000. All the new money created was created out of nothing; or to describe the process more correctly, it was created using debt. Therefore, it can be labeled debt backed money. (With the merger of commercial and investment banks and loans driving the creation process, the supposed restrictions provided by the reserve requirement are very limited.)
In other words, every loan or overdraft creates money and every repayment of these financial instruments destroys money.
In reality, banks issue the loans first, creating deposits in the process, and then they look for reserves by raising capital, deposits, or borrowing from the Federal Reserve. Therefore, it is almost pure credit money, not fractional reserve creation, much of which was created for themselves for their trading departments —investment banks attached to their commercial banks—because of the cancellation of the Glass-Steagall Act, which separated the commercial banks from the investment banks. In other
words, they violate their own rules.
This process is intentionally kept invisible! There is no reason for you to comprehend all the lingo and complicated operations of the Federal Reserve System. It is just the gyrations of a faulty, incomplete and monopolistic system to issue and control the supply of money in circulation. The point is that you know about its basic function of “new” money creation and distribution.
The big questions are: If all money is created through debt principle, where does the money come from to pay the compound interest charges by these banks? Where is it written that we have to create and distribute money only through debt? Nowhere! This debt system of money creation and distribution has been going on since about the 12th Century.
My audiences have always asked me, “Why have they not changed this unsustainable system by now?” There are many reasons:money only through debt? Nowhere! This debt system of money creation and distribution has been going on since about the 12th Century. My audiences have always asked me, “Why have they not changed this unsustainable system by now?” There are many reasons:
• People are reluctant to change• The banking system is very opaque and politically powerful• The academic world is dominated by the neoclassical philosophy, which has money as a minor or neutral factor in their theories and formulas; but in reality, it is the major factor• “Illusion of reality”, coined byDaniel Kahneman, is the irrational behavior of doing the same thing over and over and expecting different results Because the debt money system has been around since the 12th century, it has become a religious beliefTruths about MoneyDebt (loans) is the only way we currently get new money into circulationMoney is not scarce!