The Money Power

Hardly a day goes by when I do not get a posting or read an article by somebody complaining about the government “creating” money and thereby causing inflation. Now, the people who write these articles are absolutely correct about there being too much money created; they are absolutely wrong about who creates it. Only 5% of the money in circulation is created by the government; the rest is created by the banks. And if that were not astounding enough, even more astounding is how they create it: They create it out of thin air, out of nothing.

Most of us believe that when we get a loan from a bank, the bank is lending us money that comes from the depositors. But this is not true. The banks lend out 10 times the amounts on deposit. Where does this extra 900% come from? From nowhere. They just make an accounting entry and create the money. This means that all money is debt, and that without debt there would be no money.

Look at your dollar bill. At the top is says “Federal Reserve Note.” This has several implications. One, a “note” means that it is a debt. When you buy a home or a car on credit you normally sign a “note” for the loan. The dollar bill is exactly like that. The second thing about this is that the Federal Reserve Bank is not, as most people believe, a department of the federal government. Rather, it is a privately-owned bank. Or rather, 12 privately owned banks. These banks are owned by all of the federally chartered banks. The president does appoint the chairman of the board of the Fed Banks governing body and seven of the directors, and the law gives the FedBank certain powers. But for all that, it is a privately owned and operated system of banks.

Look to the left of Washington, and you will see the stamp of one of these 12 banks. That is to say, that it is one of these private banks, and not the government, that issued that particular dollar (The stamp has been removed from the new issues of higher denominations, but the system works the same way.) Up until 1913, that stamp would have borne the name of your local bank, rather than the local federal reserve bank, but the system is the same.

By having the power to create money from nothing, the banks have tremendous influence and control over the economy, and indeed over political life as well. Most people have difficulty believing that this is the way money works. As Marshall McLuhan noted, “Only puny secrets need protection; Big discoveries are protected by public incredulity.” And it is certainly hard to believe that all money is debt, created out of thin air by a private group with no responsibility towards the public good. Further, it is obvious that such a system must be (and is) unstable, one that requires constant “bail-outs,” bail-out that the government has no choice but to perform if the entire system is not to collapse.

No of what I have said here is particularly controversial. Any economist, of whatever stripe or ideological bent, will, if pressed, admit that this is the way money works. Few, however, will face the implications. Indeed, the whole subject is usually pushed to the back burner; like the dead mouse in the kitchen, it is considered gauche to bring the subject up in public. Therefore, the subject of money remains a complete mystery to the general public. Yet, no other issue affects them in their daily economics lives as does this one. It is important that each of us understand it.

Paul Grignon has brought up the subject; he has put together an interesting film on this topic. It is 47 minutes long, but it is well-worth your time. You can view this film at I think it is important to take the time to view this film, and even to buy it and share it with your friends and neighbors.


BobC,  Tuesday, September 9, 2008 at 11:10:00 AM CDT  

That video has some problems in the economics. I could go into more detail, but that would make a really long post. So I'll keep it short.

Using their example. A bank with $1111 of capital is created. They "lend" 9 to 1 to someone a car loan for $10,000 by writing him a check. He goes to a second bank and deposits that check.

Now, here's the problem that the video never talks about.

That $10,000 goes through the check clearing system and gets to the first bank. They only have $1,111 in capital. What now? How is that check paid? It can't be paid, the bank only has $1,111 in capital. The check would bounce.

They make it sound like money is created out of thin air by private banks. No, the only one who can do that is the US Treasury when they print money and make coins.

If a bank gets $10,000 worth of deposits, they can lend out $9,000 and keep $1,000 in reserves on deposit at the Fed. This is not the same as what the video says, where a bank gets $1000 in deposits and lends $9000 more. There is just not enough currency to make that possible.

I'm not pro-Fed - I think it is unconstitutional, but that video has some serious flaws in it, and doesn't represent what goes on in the banking system.

The problem with our banking system is that it is built on a system of fiat money. This wasn't done by the private banks, this was done by our government which spends money out of control.

Our government defaulted on its debt in 1933 when it ran out of gold to pay all the gold bonds, and gold certificates. It responded by confiscating private gold.

Our government then defaulted again on its debt in 1971, when it ran out of silver to pay all the silver bonds and silver certificates.

Again, both times because the government was spending out of control.

Now, we are heading into the third default. When we can't pay our fiat money debt, what then?

Three strikes, you're out.

John Médaille Tuesday, September 9, 2008 at 6:54:00 PM CDT  

bobc, the film is correct. Currency is not the issue, since neither you nor I nor the Fed nor the banks use very much of it.

As far as not being able to cash checks, that happens every single day; the banks borrow from each other, or from the Fed discount window, on overnight loans. But the money flows through the system and eventually comes back to them.

I must totally disagree on who creates the money. The federal gov't only creates coinage, a tiny fraction of the money in circulation. The banks create everything else. And it says so on the dollar bill. If you look to the left of President Washington, you will see the stamp of one of the 12 private banks authorized to issue money, which they do in behalf of their member banks. The gov't prints the money and sells it to the banks at four cents/bill, the cost of printing it.

Before 1913, the money bore the name of your local bank in big prominent letters where the presidents' picture now stands. The banks wanted everybody to know that you were spending their money. This is still the case, they are just a bit more discrete about it, since most people think the Fed is some sort of government dept. It is not.

Charles P. Friday, September 26, 2008 at 7:22:00 PM CDT  

I am so thankful for your blog. I really enjoy reading it, and I plan to purchase a copy of your book when/if you publish it.

I did not realize exactly how money was made (I regretfully did not pay much attention in econ), and when I told my friend, her response was, "Well, yeah. How else is money supposed to be made?" And so I ask you: I know it's ridiculous, but how else is money supposed to be made?

John Médaille Monday, September 29, 2008 at 10:37:00 AM CDT  

Charles, An excellent question to which I must give a brief and inadequate answer. Money can be called into being in two ways: as debt or by production. For the second way, the government simply prints the money and either spends or lends it into circulation to support productive enterprise. In the first way, the current way, banks create the money when they make loans. This would actually work pretty well, if they only made loans for productive purposes. Credit and production would be related to each other. But as they loan more and more for speculative and consumer purposes, they create more money than the economy needs, and hence must then lend even more money to ensure that their will be enough money to pay off the speculative loans. It is an insane system, which always leads to the current kind of insanity.

Money is really an accounting system (see Usury: Wealth Without Work), which currency the visible credits and purchases the debiting of the those credits. The money needed to circulate all the goods and services for sale is exactly the value of all the goods and services for sale. More than this leads to inflation, and less to deflation. The banks are a poor way of matching the need to the reality, and sane economics is based in the reality.

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