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Tuesday, August 30, 2011

Monetary reform: reclaiming $1 trillion every year through public creation of money

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. 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.
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:
  • 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.” These video segments follow the brief; and for your use: background and transcript of Money as Debt. Two other sources of information that I recommend: an excellent overview of our monetary system from Want to, and incisive articles from the most-read author on this topic, Ellen Brown.
“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: 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 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 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.
To put this 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 have current 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 $11 trillion[6] has an annual interest cost to the American taxpayers over $500 billion.[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.
Historical struggle between government-issued money and private bank-issued credit: As you can imagine, privately-owned banks would love to have the legal right to create and manage a nation’s money. This authority gives a whole new meaning to “taking your work home with you.” For an excellent comprehensive history, watch “The Money Masters” online (made in 1996: among many) and/or read the updated 2006 transcript: .[9] Watching “Money As Debt II” will give you a general appreciation of the history, as will the historical quotes at the end of this lesson.
Watching “Money As Debt II” is important. From my conversations among AP Economics teachers, their reports are in agreement with my experience that students (of all ages) will not be able to understand our monetary system and creation of debt without a walkthrough demonstration. I highly recommend that you watch the beginning of “The Money Masters;” if you like what you learn, keep watching. The entire video is 3.5 hours, so you might want to watch in chapters. A short written parable might also help: The Money Myth Exploded.[10] The bottom-line of the history is a centuries-long struggle of wealthy bankers who have endeavored for the ultimate banking job. In the US, this struggle was won by the banks with the passage of the Federal Reserve Act in 1913. This allowed for the legal practice of fractional reserve banking and a monetary system of perpetual debt. Let’s consider the alternative envisioned for the Constitution but not included because the debate took so much energy and time at the Constitutional Convention that the members tabled the issue for Congress to resolve later.
Cost-Benefit Analysis for Monetary Reform: Monetary reform would nationalize the Federal Reserve (this name is deceptive so the public would perceive it as a government entity) and retain its use for bank administrative functions. Fractional reserve lending by private banks would be made illegal, with the US Treasury having sole legal authority to issue new money for the benefit of the American public rather than the benefit of the banking industry. About 40% of the national debt is intra-governmental transfers and 10% held by the Fed; this debt would be cancelled as it becomes a bookkeeping entry with nationalization. Of the publicly-held debt of various parties holding US Securities, the US Treasury would monetize (pay) the debt in proportion to fractional reserves being replaced with full reserves over a period of one to two years to monitor money supply and avoid inflation. The American Monetary Institute has a proposal called The American Monetary Act.[11] Ellen Brown has extensive articles, including how states can act now rather than waiting for federal reform.[12]
The governmental cost of this reform is negligible. The benefits are astounding: the American public would no longer pay $500 billion every year for national debt interest payments (because 40% of the debt is intra-governmental transfers, this is a savings of $300 billion/year). If lending is run at a non-profit rate or at nominal interest returned to the American public (for infrastructure, schools, fire and police protection, etc.) rather than profiting the banks, the savings to the US public is conservatively $500 billion.[13] If the US Federal government increased the money supply by 3% a year to keep up with population increase and economic growth, we could spend an additional $400 billion yearly into public programs or refund it as a public dividend.[14] This savings would allow us to simplify or eliminate the income tax.[15] The estimated savings of eliminating the income tax with all its complexity, loopholes, and evasion is $250 billion/year.[16]The total benefits for monetary reform are conservatively over a trillion dollars every year to the American public. One trillion is $1,000,000,000,000. I invite professional economists and committed citizens to analyze and comment on my observation of costs and benefits.
To give you an idea of this amount, imagine a new stack of $1 bills. New bills are about 200/inch. Imagine if you laminated bills in a horizontal stack; this would be the same size as a 2x4 board. Now imagine that this board of money was to travel on your nearest freeway. How far would the money-board go to equal $1 trillion? Make your guess, then check the footnote.[17]
The private sector economic costs of monetary reform are transfers of wealth from the banking industry to the American public. The replacement would be either non-profit banks operating as needed with minimum public cost such as fire departments and the postal service, for-profit banks lending time-deposits in regulated free-market competition, or a hybrid of the two (perhaps with government mortgages at a non-profit rate of 1%).
Monetary reform stops the current built-in increases of the money supply through fractional reserve banking, and redirects it for direct payment of taxes for public goods and services. Each dollar transferred from bank creation to public benefit is one dollar less in public tax payment.
Opponents of monetary reform claim that even if government issued money with transparency, any oversight created would be defeated; government would issue too much money and cause inflation. Ron Paul believes that gold should be used as a physical-limit barrier to creating money. Some fear that any change will make things worse. Some also claim that competition for large profits in the banking industry spur innovation that wouldn’t occur in a non-profit design. Improvements such as ATMs, on-line banking, instant purchasing are worth the cost of giving monetary power to the private sector.
The statutory purposes of the Fed are stable prices, maximum employment, and moderate interest rates. For prices, consider for yourself how well they’ve done since the Fed began in 1913. Ask parents and grandparents if prices have remained stable in their lifetimes or if they’ve increased just a teensy-weensy little bit. You could, of course, also check the data and confirm that the dollar has lost over 95% of its value since the Fed went to work for stable prices.[18]
For employment, consider that we have unemployed people in this country, resources to put to work, and infrastructure to improve; then judge the Fed’s effectiveness in creating money only as debt. For example, consider in California that 20,000 teachers were scheduled to be laid-off in 2008 and again in 2009 because of government budget cuts.[19] We have the need for teachers, the teachers are available, but we have unemployed teachers because the government must borrow its money to hire them rather than issue money directly. Nationally, the US had over 11 million unemployed workers at the end of 2008,[20] and perhaps up to 30 million in August 2009.[21] These millions of individuals are key income earners to a multiple average of 2.5 additional Americans. This unemployment rate puts these Americans livelihoods at risk. This only occurs because money is debt in our current system; we would not have this problem if government restored this Constitutional power and issued money directly. If we were serious about achieving the goal of full employment, OBVIOULSY the only way to achieve it is for government to be the employer of last resort. In market failure of what free-market capitalism cannot employ, we either put people to work on infrastructure/public service jobs or we don’t achieve our goal of full employment. Please ponder that idea to full realization. If the public jobs provided to the unemployed and funded by government-created money provide greater economic benefit than their cost, then inflation will actually decrease from creating those jobs. That is conservative definition of how inflation/deflation works.
Another angle of minimizing our costs: consider that the US Government Interagency Council on Homelessness has compiled every known study on cost-benefits of housing the homeless and providing food, medical care and job-employment services versus just leaving them on the streets. In every case study the costs are less to take action for their care.[22] Ponder that.
For interest rates, the non-profit rate of borrowing money is generally considered among economists at 3% in our current inflationary economy caused by fractional reserve banking. With monetary reform, the non-profit rate for a home loan would be less than 1%. Ask yourself if the value added by the banking industry is worth the amount you currently pay above 1%, understanding as you do that your total cost of a home loan has a higher cost of the interest than the principle. That is, you’re paying the banking industry more than your home is worth for them creating credit out of nothing on their bank books.
Thank you for your attention to this information. If the performance of the Fed is acceptable to you along with its trillion dollar annual cost, feel free to defend it. If you prefer monetary reform, a trillion dollars of benefit every year to the American public will go far to building a brighter future. Because it’s so important for your learning in the observations of people who teach this for a living, I gently request once more: please watch “Money As Debt II,” below.
My next articles document historical and sourced quotes to allow America’s brightest minds an opportunity to speak to you on this topic: here and here. Their contributions to our nation deserve a few minutes of your attention.

[1] Chicago Federal Reserve Bank. Modern Money Mechanics: .
[2] Washington Post. Phillips, K. The Old Titans All Collapsed: Is the US Next? May 18, 2008:
[3] Shadow Government Statistics. John Williams. .
[4] Wikipedia for overview: , alternative statistics: Shadow Government Statistics homepage. Williams, J. , and The Mess that Greenspan Made. M3, We Hardly Knew You. Nov. 22, 2005: .
[5] This has been the practice for as long as I remember. I wasn’t able to find documentation from the media; sorry!
[6] Treasury Direct. The Debt to the Penny and Who Holds it: .
[7] Seeking Alpha. Shedlock, M. National Debt and Interest Payments for 2008. Jan. 9, 2008: .
[8] Borgen Project: Poverty Reduction through Political Accountability. and The End of Poverty: Economic Possibilities for our Time. Jeffrey Sachs. .
[9] Many of their quotes from Presidents are not included at the end of this lesson because their sources are usually the Congressional Record. Members of Congress did not footnote their sources and we do not have other written sources to corroborate the quotes.
[10] Evan, L. The Money Myth Exploded: The Financial Enigma Resolved – A Debt-Money System:
[12] Web of Debt is Ellen’s book. My favorite state-solution article is California dreamin: how the state can beat its budget woes: .
[13] Of $50 trillion total debt, a conservative current interest cost of 5% is $2.5 trillion every year. The academic estimate of the true cost of borrowing is about 3%. A $500 billion savings if the profits are transferred to the American public rather than to the banking industry is probably low.
[14] The US GDP is ~$13 trillion every year. Three percent growth is moderately conservative.
[15] Of the US Federal government’s ~$2.5 trillion annual budget, about $1.2 trillion is received from income tax.
[16] Tax Foundation. Hodge, S, Moody, J, Warcholik, W. The Rising Cost of Complying with the Federal Income Tax. Jan. 10, 2006: .
[17] Over three times around the world at the equator. Yes, that’s a lot. Earth’s circumference is ~25,000 miles. There are 63,360 inches in a mile.
[18] US Bureau of Labor Statistics. CPI Inflation Calculator: .
[19] California Department of Education. State Schools Chief Jack O'Connell, Teachers, Support Staff, Administrators Announce More Than 20,000 Teachers and Support Staff Getting Layoff Notices Due to Budget Crisis. March 14, 2008:
[20] Bureau of labor statistics: .
[21] Huffington Post. What a jobless recovery today means for tomorrow? . August 17, 2009. Also consider economist John Williams Shadow Stats site: .

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