"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. This is a staggering thought. 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 situation is almost incredible -- but there it is." Robert Hempstead, Credit Manager of Federal Reserve Bank of Atlanta in the foreword to 100% Money by Irving Fisher
Government is always about power and money. Since the Philadelphia convention of 1787 which wrote the US Constitution, the nature of American money and how it's created have been the chief concern of the powers that control our government and us.[1]
After the adoption of the Constitution, Alexander Hamilton pushed the idea of a central bank as a way to weaken the states and tie them to a strong central government, earning his place on a $10 FRN. The first central bank lasted 21 years, after rewarding speculators in Revolutionary War debt. Andrew Jackson (D) killed the poorly managed second central bank because he hated paper money not 100% backed by gold or silver. It wasn't until December 23, 1913 that the powerful money interests of the world succeeded in giving Americans a central bank again with the Federal Reserve Act of 1913, telling Americans it was necessary to avoid business cycles and preserve the value of the dollar.
The Federal Reserve system and the federal government have controlled our money system ever since. With what results? The dollar has become a fiat currency, no longer redeemable in gold, America is now sinking in the midst of a second depression, and the purchasing power of the dollar is 1/20th of what it was in 1913. The Fed has not delivered on the promises of its 1913 proponents, but those promises were lies, also known as doublethink. The Fed is a tool for the powerful to control the productive in America and nothing more.
Austrian economist Murray Rothbard explains the two main roles of the Federal Reserve system:
- To help finance the government's deficit;
- To cartelize the private commercial banks in the country.
The Fed finances the government deficit, allowing it to overspend its revenues every year and giving it access to every aspect of our lives.
A cartel of private commercial banks in the market allows the banks to unite and control the expansion of money (i.e. counterfeiting). But cartels are difficult to sustain unless the government enforces the cartel. In fractional-reserve banking, the Central Bank assists cartelization by removing or alleviating the two basic free-market limits on banks' inflationary expansion of credit: public "loss of confidence in banks leading to bank runs; and the loss of reserves should any one bank expand its own credit."[2]
In the current economic crisis, big banks get wealthier, buying up millions of dollars of good assets from failed banks, while the FDIC and Congress pick up the tab for the bad assets. They'll pay with money created by the Fed from nothing. Even in good economic times, Fed-created money enriches those who create the new money and those who get that money first. Everyone else suffers. Rothbard explains how counterfeiting hurts everyone but the counterfeiter because the counterfeiter gets the new money first:
"Counterfeiting, in short, involves a twofold process: (1) increasing the total supply of money, thereby driving up the prices of goods and services and driving down the purchasing power of the money-unit; and (2) changing the distribution of income and wealth, by putting disproportionately more money into the hands of the counterfeiters." [3]
Counterfeiting is robbery. The effects of creating money from nothing are identical whether done by an enterprising counterfeiter, a fractional reserve banker, or the Treasury and the Fed.[4] When it's done well, the audience doesn't even know it has been robbed, sitting and clapping for the magically appearing rabbit.
How Do They Do It?
The Bureau of Engraving and Printing, a branch of the US Treasury, creates paper FRNs for the Federal Reserve Bank to support public withdrawals of currency. But emitting paper currency isn't the most effective way for the Fed to create money out of thin air. The Fed has largely replaced paper currency with computer entries at Reserve banks.
Rothbard explains the money creation process:
"Suppose that the Fed decides it wishes to expand the nation's total money supply by $10 billion. If the money multiplier is 10, then the Fed will choose to purchase $1 billion of assets, generally U.S. government securities, on the open market."[5]
In a fractional reserve banking system, the money multiplier tells commercial banks how much money bank magicians can create out of thin air. The product of the money multiplier times the total reserve deposits a commercial bank has in its own vault and as computer entries in a reserve account at a Federal Reserve bank tells a commercial banker by how much the commercial bank can expand its reserve account.
"...In the first step, the Fed directs its Open Market Agent in New York City to purchase $1 billion of U.S. government bonds. To purchase those securities, the Fed writes out a check for $1 billion on itself, the Federal Reserve Bank of New York. It then transfers that check to a government bond dealer, say Goldman Sachs, in exchange for $1 billion of U.S. government bonds. Goldman Sachs goes to its commercial bank—say Chase Manhattan—deposits the check on the Fed, and in exchange increases its demand deposits at the Chase by $1 billion."[6]
Did you see the money get created? The Fed writes a check "on itself" or simply credits the commercial bank's account at a Federal Reserve bank. When you write a check, you need money in your account to back the check; the Fed just creates the money in its account to back the check it writes "on itself." Everyday people go to jail for counterfeiting if they create their own money, and for check fraud if they pass bad checks. Since the Fed is our money god, and gods can create something from nothing, the Fed can write a check on itself because it alone can create money in the US.
Also notice the importance of a Goldman Sachs to the process of creation, showing why it was so important to former Treasury secretary and former CEO of Goldman Sachs, Hank Paulson recently, that taxpayers bail out Goldman Sachs.
If you weren't watching closely enough, Rothbard gives a slow motion instant replay:
"Where did the Fed get the money to pay for the bonds? It created the money out of thin air, by simply writing out a
check on itself. Neat trick if you can get away with it!
"Chase Manhattan, delighted to get a check on the Fed, rushes down to the Fed's New York branch and deposits it
in its account, increasing its reserves by $1 billion...
"The nation's total money supply at any one time is the total standard money (Federal Reserve Notes) plus deposits
in the hands of the public. Note that the immediate result of the Fed's purchase of a $1 billion government bond in the
open market is to increase the nation's total money supply by $1 billion. But this is only the first, immediate step. Because we live under a system of fractional-reserve banking, other consequences quickly ensue. There are now $1 billion more in reserves in the banking system, and as a result, the banking system expands its money and credit, the expansion beginning with Chase and quickly spreading out to other banks in the financial system. In a brief period of time, about a couple of weeks, the entire banking system will have expanded credit and the money supply another $9 billion, up to an increased money stock of $10 billion. Hence, the leveraged, or 'multiple,' effect of changes in bank reserves, and of the Fed's purchases or sales of assets which determine those reserves."[7]
Commercial banks create money when people assume debt. We have a debt-based money supply. Do you have a mortgage on your home? When the bank loaned you the money to buy your home, it maintained 10% of the loan value in a reserve account and created the money it loaned to you out of nothing. Our fractional reserve banking system lets the bank create money to loan to home buyers as a bookkeeping entry. When it makes the loan, the bank increases the money supply by paying the home builder with newly-created electronic FRNs.
One reason tax incentives exist for people to assume the debt in a mortgage is that's how money is created in our economy. A lot of magicians are involved in the process, each pocketing some of the money for waving their hands and moving some paper around. Many magicians benefit when productive people go into debt.
Why do you have to pay interest on the entire loan to the bank and also pay the entire loan off when the bank kept only 10% of the loan value in a reserve account?
Are you having a tough time making payments to the bank on your mortgage? Why does the bank own your home if you default when the bank didn't really put its own money into the loan?
Why Do They Do It?
Because we let them. And they'll continue until enough Americans realize that just as magicians don't pull rabbits out of thin air, the Fed can't create value out of nothing.
“None are more hopelessly enslaved than those who falsely believe they are free.” Goethe
_________________________________________
[1] Holton, Woody, Unruly Americans and the Origins of the Constitution, 2007, p. 186.
[2] Rothbard, The Case Against the Fed, 1994, p. 58. (pdf)
[3] Ibid. p. 22.
[4] Ibid. pp. 24, 28-29, 59, 62, 119.
[5] Ibid. pp. 139-140.
[6] Ibid. pp. 140-141.
[7] Ibid. p. 141.
US Money Timeline
1637 Wampum (seashell) legal tender in Massachusetts More details from the New York Fed: (pdf).
1661 Wampum no longer legal tender in New England, still used elsewhere in America
1690 Massachusetts Bay Colony issues paper money
1760 Wampum factory in New Jersey
1775-1791 Continental Congress prints paper money to finance American Revolution
1791 First Bank of US in Philadelphia given 21 year charter. New York Fed gives more details on the history of the US central banks.
1792 US Coinage Act
1794 US Mint in Philadelphia starts operation
1811 First Bank of US charter is not renewed
1816 2nd US Bank founded
1832 President Jackson vetoes early renewal of 2nd Bank of US charter
1833 Jackson moves US deposits from 2nd Bank of US to state banks
1836 2nd US Bank charter expires
1861 Under Lincoln, US suspends convertibility of notes into gold and silver
1862 US Legal Tender Act: US Notes first printed
1863 National Banking Act provides for nationally chartered banks with circulating notes backed by Treasury securities
1878 Silver Certificates authorized by Congress
1908 Aldrich-Vreeland Act establishes National Monetary Commission to lobby for central bank
1913 Federal Reserve Act. The Boston Fed supplies more details (pdf).
1914-1918 World War I
1926-1931 Gold Exchange Standard
1931 Britain no longer redeems pound with Gold
1933 Glass-Steagall Act separates commercial and investment banking, requires Treasuries as security for Federal Reserve Notes; creates FDIC
1933 April - Under FDR, US demonetizes gold, US citizens cannot own gold, given $20/oz at bank
1934 US Gold Reserve Act: gold set at $35/oz for bank dealings
1935 Banking Act creates Federal Open Market Committee (FOMC), removes Treasury secretary from Fed governing board
1964 Silver certificates no longer redeemable in silver
1967 Silver certificates redeemable in bullion for one more year
1971 Under Nixon, US stops redemption of foreign-held $ in gold.
US notes no longer issued--only Federal Reserve Notes printed
1974 Ford repealed prohibition on public ownership of gold or engaging in gold transactions. Today, no country bans private ownership of gold.
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