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)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.
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)
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.
“The process by which banks create money is so simple that the mind is repelled.”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.
– 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.
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.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.
“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
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.” 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.
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