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This report deals with modern money in the United States. The historical parts are carefully selected, hard-to-find reference materials which illuminate the present system. Almost all of this is taken from Wright Patman’s “Primer on Money”. For the original document, see
<< linked table of contents >> (at # 87) , where you can find a direct link to a 141-page .pdf of Patman’s “A Primer On Money”.
Money was not created by God. It is an invention of humans. All the money that exists now and has ever existed was created by humans. It may be the greatest invention ever made in that something is constantly being created virtually out of nothing. It certainly is one of the prime motivating forces and goals of the human race. It pushes and pulls everyone.
This report will attempt to answer the following questions and explain the reasoning behind the answers:
A. Where does money comes from?
B. Who decides how much money to make?
C. Who decides where the money shall be placed?
D. How did money first come to be?
E. What is good about the system?
F. What is bad about the system?
The answers to A to D below are as factual as anything I know. The answers to E and F are my opinions. You have as much a right as I do to form your own opinions.
Also see <<money facts>>
Here are the answers:
A. Where does money comes from? -- (1) Money is printed or minted by machines owned by the U.S. Government to fill the needs of the banking system and (2) Money is created when a bank lends money to an individual, corporation, government entity or company. When the loans are paid back, the money is extinguished. Presumably, if the loan is not paid back, the bank removes the balance of the money from their books and that effectively extinguishes the money representing that balance. I could be wrong on that last point. I have never read that in any authoritative source.
B. Who decides how much money to make in total? -- The Central Bank, in accordance with the Federal Law governing banks. The Central Bank can either be a private corporation, a public corporation or a part of the government. In the USA, it is now a private corporation operating under laws passed by Congress in 1913. Most Central Banks presumably try to set up a self correcting banking system which has rules that keep it operating without much day-to-day or year-to-year interference by the Central Bank.
C. Who decides where the money shall be placed? Individual banks around the country decide that. They do so by lending the money to individuals, corporations, private companies and government entities, including the US Government. Those loans create new money by lending that money to responsible individuals who will often use that money to create real wealth. In that sense, and only in that sense, -- the money is not truly created -- it is traded for wealth in the form of collateral and a promise to pay the money back at some interest rate. The money is extinguished when the loans are paid back -- but in the meantime most of the loans are invested by the borrowers to create wealth in the form of goods and services. Those goods and services can later be used as collateral for new loans and the system repeats itself endlessly, generating new wealth as it does so.
D. How did money first come to be?
1. In ancient times money was controlled by Kings and Rulers. It was mostly in the form of gold or silver coins which were minted under the control of the State.
2. Individuals also used raw gold or silver or privately minted gold and silver coins as money
3. Within the society, various individuals developed a trade which was called Goldsmithing. These people, called Goldsmiths, collected gold, stored it, and converted it to coins, jewelry and manufactured items.
4. The Goldsmiths kept their gold in secure caves which were guarded at all times by guards
5. As individuals came to acquire gold, they would naturally go to the local Goldsmith and ask him to hold their gold for safekeeping in the Goldsmith’s storeroom.
6. The Goldsmith would do this for a certain agreed-on fee.
7. The Goldsmith would give the depositor a signed, dated receipt for whatever gold he was holding for the depositor. That receipt might say “Mr. Trader A has 5 ounces of gold deposited in my storeroom.”
8. “Trader A” could then use that paper receipt more or less like the actual gold. If he, for instance, had a shipwright ship build him a ship for the price of 2 ounces of gold, he might write out a note which would say, “Pay Mr. Shipwright 2 ounces of gold out of my gold on deposit at Mr. Goldsmiths’s storeroom.” Mr. Goldsmith would honor these notes, charging a small fee for doing so. The goldsmith thus “cleared all such notes” much as the banks now clear checks.
9. Occasionally someone like Farmer A -- with a good idea and a need for gold to finance his idea, would come to Mr. Goldsmith and ask to borrow say 5 ounces of gold. Mr. Goldsmith and Mr. Farmer A. would agree to lend / borrow the gold at a certain rate of interest -- perhaps with the farmer’s land as collateral.
10. But Mr. Goldsmith would then usually say, “You don’t want to actually take the gold with you, do you? It would be much safer if you left it here for safekeeping and I will simply make out a note saying you have 5 ounces of gold on deposit in my storeroom.”
11. That would be agreed to and Mr. Farmer A. would leave with a note that said “Mr. Farmer A. has 5 ounces of gold deposited in my storeroom”
12. Notice that the note of the depositor (see #7 above) and the note of the borrower both said essentially the same thing (except the names of the “depositor” is changed) and both could be used in exactly the same way -- to buy goods and services. Thus, these handwritten “notes” were basically the first paper money.
13. Over time, it developed that only a small fraction of the people with the outstanding notes ever tried to retrieve the gold in the storeroom. Most people used the notes like they were the gold.
14. Mr. Goldsmith found out, that on the average, he could safely give out seven “one-ounce-of-gold” slips of paper for every one ounce of gold he had on deposit !
15. The only significant problem was that if everyone tried to cash in their slips at one time, Mr. Goldsmith would not be able to produce the gold needed to pay off those notes. He would need some time to call in his loans.
16. This was easily solved by bringing the King into the deal and explaining what was going on. The conversation might have gone something like this: “Mr. King, look at this great thing I have discovered. I have 1,000 ounces of gold in my storeroom and I have been able to issue slips for 7,000 ounces of gold. People are using those slips to buy good and services and create true wealth in the form of ships, farms and buildings, paying you taxes on all that created wealth. The only significant problem is that we can’t let everybody ask us to cash in their deposit slips at once. If you simply pass a law stating ‘any person creating a run on the bank is working for Rival Country X and is trying to ruin our money system and should be executed forthwith’ ”. Such laws were passed.
17. Later, those laws against runs could be done away with. If all the Goldsmiths cooperated, each could quickly provide a loan to any bank which was being hit by a run.
18. Along the line, the Goldsmiths became “Bankers” and the storerooms became “Banks.”
19. The original 7 to 1 ratio has varied over time and place and has historically fluctuated between 7 and 15 to 1. I think it is now almost always about 10 to 1 for very large amounts. See Table A on page B - 8 for current Reserve Requirements.
20. The system is now known as “Fractional Reserve Banking”
21. Over time the ownership of the banks have fluctuated between private ownership and ownership by the Government. It is now under private ownership.
22. The government prints whatever amount of paper money is needed by the banks to fulfill whatever demand exists for that paper money by depositors and borrowers. That money is given to the banking system at essentially no charge.
23. There is no theoretical limit to how much money can be produced because money created in one bank can be deposited in another bank and the 10 to 1 lending ratio starts again. Remember -- all the loans should be covered by collateral and should be paid back.
E. What is good about the system?
1. It creates real wealth and is the basic foundation for our economic system. Nobody has ever figured out a better way to create money and wealth.
2. The 10 to 1 fractional reserve ratio means that the bankers are operating with enormous leverage. For every $1 dollar they lose to bad debts, they must reduce their loans by $10. This means they must be very conservative and must be careful to only make loans that are safe. This probably keeps inflation in check -- because the created money has to be paid back. It forces borrowers to create wealth with their borrowed money -- so they can pay off the loan and the interest. If the government were able to create money without the obligation to pay it back, most people think that would probably lead to runaway inflation to the detriment of us all.
3. Under State laws, virtually anyone who is reliable and a good citizen can open a bank. You simply apply to the State and fill out some forms telling (A) why the community needs a bank where you intend to put yours, (B) that your plan is financially feasible and (C) the Federal Reserve system that you are honest and a good citizen. Once you deposit your starting capital, you have the right to operate as a bank and lend money to independent borrowers of your choice in accordance with the Federal Reserve rules. My friends and I could easily open the Bank Of Rancho Carlsbad here and start a full fledged bank in a short period of time.
4. Banking is a good job for people who would otherwise be trying to show their worth by subjugating others. Banking allows these people to show their worth and power by accumulating money and the things they can buy with money. Running a bank is a relatively safe outlet for alpha-male behavior.
5. It keeps a lot of people busy who might otherwise be causing trouble.
F. What is “bad” about the system?
1. The Central Bank lends money to the Government of the United States and collects interest on that debt. Many see that as an unnecessary expense of the Government.
2. The Constitution says “ Congress shall have the power to coin money and regulate the value thereof” (this may not be a precise quote). In 1913, Congress transferred the management of the banking system to the Federal Reserve System which is privately owned and operated corporation. At various times, our government has directly created money and controlled the money supply. The system could be changed to have the government create and control money directly -- thus saving the interest it pays to the Federal Reserve System --- but at the risk of inefficient government control.
3. Hardly anyone understands how the system works (even bank regulators and perhaps top-level bankers may not understand all the ramifications of the system). This is not a healthy situation.
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Section B -- page 2 to 5 / next page goes to B-6