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The Creation Of Money Out Of Thin Air -- A Vital But
Almost Unbelievable Part Of Our Money and Banking System
It is important to be able to show or prove that creating money out of this air is safe and good. Almost everything on the internet and in books suggest that such actions are harmful in a variety of ways -- for instance (1) such money-creation is invariably inflationary and (2) such loans create money but not the interest? -- so the loans can never be paid back.
Does the following deductive argument "prove" to you that "banks can safely and advantageously create money out of thin air?"
If not -- why not? -- where does my argument break down?
INTRODUCTION
A) -- Lots of people think creating money out of thin air is always a bad thing -- either (a) having no value or (b) being impossible.
B) -- This article is trying to prove through reasoning that such thoughts [(a) and (b) in "A"] are not valid in any way
C) -- The article is also trying to show that creating money out of thin air through loans is always advantageous, having no downside.
ASSUMPTIONS and REASONING ...
1) Paper Money is necessary -- because of various unique features which should become apparent after this exercise.
2) Sovereign nations have a right to create money
3) The United States has a right to create money
4) The United States has delegated that money-creating right to the Federal Reserve banking system and to Federal Reserve banks, Essentially the agreement is that the fed will run the system and make profits doing so -- in return for keeping the money supply running smoothly
5) The federal reserve has an agreement with all of its system banks that the Fed will cover all checks by the local member bank as long as the local member bank is solvent and obeying the rules of the Fed. That ability to write checks that will always be made good is the unique prerogative of the bank that makes the bank a bank
6) If a bank has $1,000 in its vault and that $1,000 is not pledged to anyone -- the bank can lend $500 of that $1,000 to a worthy borrower who has good collateral and and a good credit history as long as its lending is for a legitimate purpose. That type of lending is the main purpose of the bank.
7) CASH LOAN -- If a bank makes a $500 unsecured cash loan to Mr. Doe -- at the end of the transaction the bank will show a reduction of $500 in its cash account (an asset account) and a $500 increase in its notes receivable account -- (an asset account). Its book will be in balance
8) CHECK BASED LOAN -- If the bank makes the loan to Mr. Doe drawn on the bank's checking account, the accounting is basically the same and the bank winds up with a $500 reduction in its checking account -- or its cash account -- (in accordance with how its books are set up) and the same $500 increase in the Accounts Receivable account. The bank's books are in balance.
9) In both cases above, Mr. Doe's books will be in balance before and after the transaction . He will have gained an asset (Cash) and gained an offsetting liability (Note Payable).
10) In the transactions, no new money was created.
11) However if the bank did not have enough money in its checking account and, the loan was secured by collateral, the Federal Reserve System would make the bank's check good in accordance with their agreement as long as the lending bank had enough reserves to cover the loan. The requirement of "enough reserves" is probably superfluous -- I can think of no way that the "required reserves" protect any person, company or system -- the reserve system is probably an artifact of the banking system when reserves of gold was necessary to back paper money. But it is foolish to require paper reserves to back paper Money. Banks do not have to and have never had to "back the loan" -- they just have to provide the money in the first place and make sure the collateral is good. From then on it is up to the borrower and our legal system to back the loan and enforce payment.
12) I am not familiar with the Fed's bookkeeping system -- but I assume and deduce that the system is set up whereby a record of a secured loan and an unsecured loan are both rigorously made and maintained. It is advantageous if one automatic system can handle both types of loans and treat them all as a money-creating loan.
13) In any event -- the system will have to have a record whereby all loans are either money creating --- or not.
14) In any event, when the lending banks checks are made good by the Fed -- that loan is doing preciously and ingeniously what it should be doing: "creating money out of thin air". In most cases, that borrowed money will be used to create new wealth by supporting and implementing a new idea or business.
15) In those cases -- when the loan is paid back -- all the account entries are essentially reversed and the newly created money is extinguished --
16) If that statement in #15 is true -- a loan made with newly created money DOES NOT give rise to a threat of inflation -- because the new money will ultimately be extinguished -- leaving behind whatever wealth (probably a new product or machine) was created with that borrowed money. That new wealth usually works for the benefit of us all. It is axiomatic that new wealth has to be shared through normal commerce and trade if it is to benefit the original owner.
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