Google poll #1 to #10

This is: http://www.primeronmoney.com/googlepoll1to10.html

This is # 1 of the Google Poll

From: http://www.yesmagazine.org/issues/the-new-economy/how-banks-make-money

1. How Banks Make Money :: Creating Money Out of Thin Air :: See How ... Creating money out of thin air, a YES! infographic.

Look at the graphic at the above link.

Once you see the graphic at the above link -- go to the next link -- 12 lines down from here and see how it really works.

Analysis -- This is a professional magazine article. It presents a completely erroneous description of “How Banks Make Money” suggesting that banks can lend out 90% of the deposits they have on hand. In fact, as we explain in this book, each bank can lend out 10 times the total amount of money they have in deposits and the stockholder’s capital investment. This magazine is presenting a common error, first generated by the Fed., and still being spread as of this writing in July 2009 by wikipedia. It is a wrongheaded view of (a) the law and (b) what banking is all about. See our analysis of #10 below which goes into the error being made by #1. The analysis there goes through Wikipedia.org to a publication by The Federal Reserve System. How sad. How dumb. (mrc)

Here is how we contend lending works --
<<http://www.primeronmoney.com/how-banks-make-money.html>> (mrc)

Before we are finished we will pay special attention to this error which may be the most common error regarding banking. We will show that it not only is wrong -- but is also impossible. Even Wright Patman makes this error. And he literally “wrote the book”. The error seems to have started with the Fed. In their case, it probably can’t logicaly be called an error, At first it was almost inconceivable to me that they do not know how the system works -- but as I get further into it -- I am not sure whether they are being driven by mendacity or ignorance. (mrc)

How Banks Make Money
Creating Money Out of Thin Air

Yes, the government prints our paper money. But that’s only a small fraction of the money in use. Most of the money in national economies is created when banks write it into their customers’ accounts out of thin air as bank loans.

1) You earn $100 and put it in the bank. And then...
2) The bank keeps $10 in its Federal Reserve account ...
3) This is the “reserve,” which the bank uses when customers withdraw funds. As a rule, depositors don’t take out more than 10% of the money they have on deposit on any given day.
4) Then, the bank loans Susie $90, at interest.
5) Susie deposits the $90 in her bank.
6) That bank keeps 10% ($9) in reserve and loans Joe $81, at interest.
7) See how it all adds up—for the banks.
8) You now have $100 in your account. Susie has $90 in hers. Joe has $81.
9) There’s now $271 total in accounts that you and Susie and Joe can spend, and it all came from your $100 deposit. The banks have created an additional $171 by loaning it into existence.
10) Imagine this money trick over and over.
11) If you do this operation 50 times, that $100 turns into $995.25—$885.25 in loans, and your original $100.
12) Mad math: If those loans are for one year at 10% interest, the banks will make $88.53. If they’d only been able to loan your $100, they’d make $10.

The following is by Marty Carbone

1) I hate to rain on your nice little parade of money -- but I think you have forgotten a few things
2) You left your $100 with your bank -- so they owe you $100. No money was created in this transaction -- you just transfered your money to your bank on a bailment.
3) When the bank lent $90 to Susie -- she signed a note. So she has the $90 -- but she also owes the bank $90 -- and she has to pay interest. There was no money created here. The fact that she deposited the money in the bank did not pay off the loan.
4) Same thing with Joe and his $81 -- he has the money -- but he has a new $81 debt. No money was
created there.
5) Why would a bank lend only 90% of what it started with -- when it has the right to lend 10 times the amount it started with according to the lawful Reserve Requirements which run from Zero % of their loans to borrowers to 10% of their loans to borrowers?
6) You forgot to tell everyone that the money is created when the Fed makes the check by the bank to the borrower “good”. I am not surprised that you did not know this -- the Fed does not like to tell the truth -- even when they are doing what is perfectly legal. My guess is that they are too ashamed to admit they make it possible for each bank to lend out ten times as much money (capital and deposits) as that bank has on hand. (mrc)

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This magazine is presenting a common error, first generated by the Fed., and still being spread as of this writing in July 2009 by Wikipedia. It is a wrongheaded view of (a) the law and (b) what banking is all about. The error was even made by Wright Patman -- and he literally “wrote the book”. (mrc)

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This is # 2 of the Google Poll
from << http://taxesandbudget-blog.ncpa.org/creating-money-out-of-thin-air/>>
Bob McTeer’s Blog / Creating Money Out of Thin Air!!!

Ye’gast!

During the 1980s when I ran the Baltimore Branch of the Richmond Fed, I also taught a Money and Banking course in the graduate evening program of The Johns Hopkins University. As in all such courses, I showed the students how banks create money when they make new loans and how the Fed influences that process with the tools of monetary policy, especially open market operations. I went into the multiple expansion process, showed how the impact of fiscal policy depends largely on how deficits are financed-with newly created money or existing money-and so forth. It was standard stuff using standard textbooks.

In the context of a classroom and textbooks, students readily accepted the fact that central banks can create money out of thin air and they accepted that the exercise of that process can be helpful in promoting economic stability or can be disastrous if abused.

I find that outside the classroom, however, when TV viewers first learn about money creation -- these days usually misleadingly called printing money -- in the context of Fed support of illiquid markets or in its role as lender of last resort, the reaction to central bank money creation is quite different. It is often regarded as sinister.

Alchemy! People don’t worry so much that the process will be abused with negative consequences; they regard the process itself as abuse. They don’t worry about the possibility of inflation; they worry about the certainty of inflation. I’ve even heard some (very influential people from the Austrian School --mrc--) define inflation as money creation.

For such people who are open to clarification or context-and I realize that’s probably not a majority-I have two points to make that should be reassuring.

1. Money creation doesn’t cause inflation until it is spent. Too much spending relative to the economy’s capacity to produce real goods and services will cause inflation. If the velocity of money slows, resulting in slower spending, as it has in recent months, more money is needed just to sustain spending levels, much less drive them to excess. Lately, extraordinary money creation has been necessary to avoid deflation, or falling prices on average. As velocity expands in the future, along with confidence, less money creation will be needed. Our central bankers know this very well. They are watching carefully. They are on the case. Hyperinflation is not a likely outcome of recent policies.

2. As for the alchemy or voodoo involved in creating money out of thin air, be comforted in the fact that new wealth is not being created in the process. New assets in the hands of the public are not being created. Just new money in exchange for assets that are not defined as money.

When the Fed buys government securities in the open market -- traditional open market operations -- some sellers of these securities give up assets in the form of government securities for bank deposits that are included in the definition of money. It’s an exchange of assets held by the public, from assets not included in the definition of money to assets that are.

If a counterfeiter prints new $100 notes, new (illegitimate) money is created; and so is new (paper) wealth since the counterfeiter can spend the new notes for other things. Not so with open market operations. For money, people have to exchange something of value that they earned, ultimately by production. I hope this makes some of you feel better. Central bankers aren’t alchemists.

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This is # 3 of the Google Poll

3. Fed Will Inject $1 Trillion More Into the Economy / NYTimes.com
Mar 19, 2009 ... Having already reduced the key interest rate it controls nearly to zero, the central bank has increasingly turned to alternatives like ... http://www.nytimes.com/2009/03/19/business/economy/19fed.html

Analysis -- Written by Edmund L. Andrews a fine writer for the NY Times which probably has the most accurate infomation on Money and Banking. This article makes a number of assumptions that may or may not be correct and should be scrutinized. We will analyze the article more fully on our website and put the link here. (mrc)

The NY Times article is reproduced below ...

March 19, 2009
Fed Plans to Inject Another $1 Trillion to Aid the Economy
By EDMUND L. ANDREWS

WASHINGTON — The Federal Reserve sharply stepped up its efforts to bolster the economy on Wednesday, announcing that it would pump an extra $1 trillion into the financial system by purchasing Treasury bonds and mortgage securities.

Having already reduced the key interest rate it controls nearly to zero, the central bank has increasingly turned to alternatives like buying securities as a way of getting more dollars into the economy, a tactic that amounts to creating vast new sums of money out of thin air. But the moves on Wednesday were its biggest yet, almost doubling all of the Fed’s measures in the last year.

The action makes the Fed a buyer of long-term government bonds rather than the short-term debt that it typically buys and sells to help control the money supply.

The idea was to encourage more economic activity by lowering interest rates, including those on home loans, and to help the financial system as it struggles under the crushing weight of bad loans and poor investments.

Investors responded with surprise and enthusiasm. The Dow Jones industrial average, which had been down about 50 points just before the announcement, jumped immediately and ended the day up almost 91 points at 7,486.58. Yields on long-term Treasury bonds dropped markedly, and analysts predicted that interest rates on fixed-rate mortgages would soon drop below 5 percent.

But there were also clear indications that the Fed was taking risks that could dilute the value of the dollar and set the stage for future inflation. Gold prices rose $26.60 an ounce, hitting $942, a sign of declining confidence in the dollar. The dollar, which had been losing value in recent weeks to the euro and the yen, dropped sharply again on Wednesday.

In its announcement, the central bank said that the United States remained in a severe recession and listed its continuing woes, from job losses and lost housing wealth to falling exports as a result of the worldwide economic slowdown.

“In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability,” the central bank said.

As expected, policy makers decided to keep the Fed’s benchmark interest rate on overnight loans in a range between zero and 0.25 percent.

But to the surprise of investors and analysts, the committee said it had decided to purchase an additional $750 billion worth of government-guaranteed mortgage-backed securities on top of the $500 billion that the Fed is already in the process of buying.

In addition, the Fed said it would buy up to $300 billion worth of longer-term Treasury securities over the next six months. That would tend to push down longer-term interest rates on all types of loans.

All these measures would come in addition to what has already been an unprecedented expansion of lending by the Fed. The central bank also said it would probably expand the scope of a new program to finance consumer and business lending, which gets under way this week.

In effect, the central bank has been lending money to a wider and wider array of borrowers, and it has financed that lending by using its authority to create new money at will.

Since last September, the Fed’s lending programs have roughly doubled the size of its balance sheet, to about $1.8 trillion, from $900 billion. The actions announced on Wednesday are likely to expand that to well over $3 trillion over the next year.

Despite a trickle of encouraging data in the last few weeks, Fed officials were clearly still worried and in no mood to cut back on their emergency efforts.

Fed policy makers sharply reduced their economic forecasts in January, predicting that the economy would continue to experience steep contractions for the first half of 2009, that unemployment could approach 9 percent by the end of the year and that there was at least a small risk of a drop in consumer prices like those that Japan experienced for nearly a decade.

The Fed rarely buys long-term government bonds. The last occasion was nearly 50 years ago under different economic circumstances when it tried to reduce long-term interest rates while allowing short term rates to rise.

Ben S. Bernanke, the Fed chairman, has been extremely cautious in recent weeks about predicting an end to the recession, saying that he hoped to see the start of a recovery later this year but warning that unemployment, a lagging indicator, would probably keep climbing until some time in 2010.

In contrast to several recent Fed decisions, with the presidents of some regional Fed banks dissenting, the decision at Wednesday’s meeting of the 10 members of the Federal Open Market Committee, the central bank’s policy making group, was unanimous.

Jan Hatzius, chief economist at Goldman Sachs, said the Fed had adopted a “kitchen sink” strategy of throwing everything it had to jolt the economy out of its downward spiral.

But while Mr. Hatzius applauded the decision, he cautioned that the central bank could not solve the economy’s problems by expanding cheap money.

“Even if the Fed could make interest rates negative, that wouldn’t necessarily help,” Mr. Hatzius said. “We’re in a deep recession mainly because the private sector, for a variety of reasons, has decided to save a lot more. You can have a zero interest rate, but if you just offer more money on top of the money that is already available, it doesn’t do that much.”

Fed officials have been wrestling for months with the fact that lenders remain unwilling to lend and borrowers are unwilling or unable to borrow. Even though the Fed has been creating money at the fastest rate in its history, much of that money has remained dormant.

The Fed’s action is an expansion of its effort to bypass the private banking system and act as a lender in its own right.

The Fed and the Treasury are starting a joint venture this week called the Consumer and Business Lending Initiative in their latest effort to thaw the still-frozen credit markets. The program will start out with $200 billion in financing for consumer loans, small-business loans and some corporate purposes.

Fed officials have said they hope to expand the program next month, possibly to include the huge market for commercial mortgages, and both the Fed and Treasury hope the program will eventually provide up to $1 trillion in total financing.

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This is # 4 and # 5 of the Google Poll (inadvertantly duplicated)

From: http://suzieqq.wordpress.com/2009/03/08/the-central-bank-of-england-is-creating-money-out-of-thin-air/

This article appeared at #4 and #5 on our Google poll
4. Creating Money Out Of Thin Air |
Is money creation by the central bank sinister? ... As for the alchemy or voodoo involved in creating money out of thin air, be comforted in the fact that ...

The Central Bank of England is creating money out of thin air!

March 8, 2009 by wordgeezer / American Free Press / March 6. 2009

The Bank of England’s extraordinary decision to create £75 billion to fight the credit crisis has won praise among the press as a bold, if risky move. / 75 billion = 675 billion available for lending and then portions get deposited etc.....

Risky indeed folks. After repeatedly slashing the prime lending rate to a near zero now they are going to be buying more government bonds so they can increase the money supply by increasing debt. This is much like the the US government is doing, except that the UK is admitting that they are printing the money. How can we believe that Helicopter Ben is not doing the same?

Analysis by mrc - This is a rather mild complaint abut the Fed and the system of having banks create money out of thin air. The writer at least shows that he knows something about the multiple created by the system when he tells that “75 billion = 675 billion available for lending ...” which means the commercial banks wind up lending nine times more money than the Fed created. (mrc)

The following text and a photo of Josiah Stamp was on the page with the above article

“Banking was conceived in iniquity and was born in sin. The bankers own the earth. Take it away from them, but leave them the power to create money, and with the flick of the pen they will create enough deposits to buy it back again. However, take it away from them, and all the great fortunes like mine will disappear and they ought to disappear, for this would be a happier and better world to live in. But, if you wish to remain the slaves of bankers and pay the cost of your own slavery, let them continue to create money.”

By Sir Josiah Stamp, Director of the Bank of England (appointed 1928). Reputed to be the 2nd wealthiest man in England at that time.

This is # 6 of the Google Poll

Produced and published by The Socialist Party of Great Britain, 52 Clapham High Street, London SW4 7UN

Socialist Standard January 2009 Page 12 / Published since 1904 - Journal of The Socialist Party of Great Britain - Companion party of The World Socialist Movement /

An urban myth is circulating on the internet that banks have been creating money out of thin air. Banks, money and thin air ...
http://www.worldsocialism.org/spgb/jan09/page12.html

Analysis -- This article is quite long and is almost correct (in the sense that 2 + 2 is almost 5). Because fact is mixed with fiction it is very hard to respond-to completely. We suggest you read the article and reserve judgment until you read the rest of our book, where we hope to clear things up. The article is reproduced below. The article essentially promises to lead you out of a wilderness of misinformation -- and it does -- but you quickly wind up in a swamp of fantasy. (mrc)

Those who have seen the cult film Zeitgeist and its sequel Zeitgeist Addendum, popular amongst conspiracy theorists and others suspicious of governments and banks, will have heard recounted the argument that banks can somehow create money out of thin air by the stroke of a pen or, these days, by the touch of a computer keyboard.

In Zeitgeist Addendum this argument is based on what is stated in an educational booklet published by the Federal Reserve Bank of Chicago. Entitled Modern Money Mechanics it first came out in 1975 and has gone through several editions.

Zeitgeist Addendum begins by describing how it thinks the Federal Reserve Bank (the “Fed”) creates money. If, it says, the government wants more money then, through the Treasury, it creates Treasury bonds which it exchanges with the Fed for currency notes of the same face value; as the government has to pay interest on the bonds this adds to the National Debt and so is “debt money”. Both the Treasury bonds and the currency notes have been created out of thin air.

This is one way of putting it but it is misleading. It is rather the other way round in that the initiative to create more currency comes from the Federal Reserve Bank. Once it has decided that more notes are needed it asks the Treasury to print them (for which the Treasury charges). The normal way these get into circulation is by the commercial banks converting into currency some of the reserves they are obliged to lodge with the Fed. Modern Money Mechanics explains:

“Currency held in bank vaults may be counted as legal reserves as well as deposits (reserve balances) in the Federal Reserve Banks. Both are equally acceptable in satisfaction of reserve requirements. A bank can always obtain reserve balances by sending currency to its Reserve Bank and can obtain currency by drawing on its reserve balance” (p. 4).

In any event, both the Treasury and the Federal Reserve are part of government so we are talking about internal state accounting arrangements. It is, however, true that the new currency has been created out of nothing. Since it is not backed by gold and convertible on demand into a pre-fixed amount of gold, it is what in the US is called “fiat money”, that is, money created by a mere act of State.

Modern Money Mechanics does not in fact have much to say about currency creation but concentrates on what it calls “money creation”. It draws a distinction between “currency” and “money”. This is explained clearly enough on the first page of the booklet where money is defined as currency plus bank accounts with a cheque or debit card; which is M1 in the jargon (“In the remainder of this booklet, ‘money’ means M1”).

Congressman Ron Paul, from Texas, a critic of “fractional reserve banking” and advocate of a return to a gold-backed currency, has an even wider definition of “money”:

““M3 is the best description of how quickly the Fed is creating new money and credit. Common sense tells us that a government central bank creating new money out of thin air depreciates the value of each dollar in circulation.” (27 April 2006, see http://www.lewrockwell.com/paul/paul319.html).

M3 includes other types of bank deposits and liabilities not included in M1. In claiming that all new money created by the Fed depreciates the dollar he is overstating his case. All the US currency (but, as we shall see, not bank deposits) is created “out of thin air” but an increase won’t lead to a depreciation of the dollar as long as it corresponds to an increase in the amount required by the economy for its various transactions (paying for goods and services, settling debts, paying taxes, etc). It is only currency issued in excess of this that will cause a decline in its value and so a rise in the general price level.

Everybody accepts that cash (currency, notes and coin) is money. Some might be prepared to include cash deposited in banks as well. But Modern Money Mechanics definition of bank deposits is wider than this. It doesn’t mean just deposits by people of the money they already possess but any account for which the holder has a cheque or debit card, i.e. including credit lines granted to those who banks have lent money to (so enabling Zeitgeist to go on talking about “debt money”):

“Checkable liabilities of banks are money. These liabilities are customers’ accounts. They increase when customers deposit currency and checks and when the proceeds of loans made by banks are credited to borrowers’ accounts” (p. 3, emphasis added).

So, when it talks about “money creation” it is not talking about currency creation but mainly about “bank deposit” (in the above sense) creation.

The Federal Reserve booklet goes on to explain what “fractional reserve banking” involves and how it can lead to the creation of more “money” in the sense of more bank deposits. Banks, it explains, have learned that when cash has been deposited with them they only need to keep a part (a “fraction”) of it as cash as a “reserve” to deal with likely cash withdrawals; the rest they can lend out. What this fraction is depends on the circumstances, but historically it has been around 10 percent.

On the booklet’s definition, in making a loan a bank is “creating money” as their loans will take the form of creating a new bank deposit as a credit line which the borrower can draw on as if they had made a deposit of their own money (except they will be paying interest on it). The booklet then asks “What Limits the Amount of Money Banks Can Create” and answers that this depends on the cash reserves it has decided to hold or is required by law to keep.

It is here that Modern Money Mechanics, by suddenly shifting from what an individual bank can do to what all banks together (“the banking system”) can, opens the way to the misinterpretation of people like Ron Paul and the makers of the Zeitgeist films that banks too can create “money” out of thin air. The booklet explains that US banks are required by law to keep a “fraction” of deposits as “reserves” in its vaults and/or a balance with the Fed, and says:

“For example, if reserves of 20 percent were required, deposits could expand only until they were five times as large as reserves. Reserves of $10 million could support deposits of $50 million” (p. 4).

This is a very misleading way of putting as it could suggest that if banks receive total new deposits of $10 million they can immediately proceed to make loans of four times this. This is not so, and not really what the booklet meant to suggest. What it means is that the banks can immediately lend out only four-fifths of $10 million, or $8 million, and that this circulates throughout the banking system leading in theory to new loans totalling in the end $40 million, bringing total “bank deposits” up to $50 million.

Confusingly, the numerical examples the booklet goes on to give to illustrate this are based not on a 20 percent reserve fraction but on a 10 percent one (which is more or less what the law in the US requires for the kind of bank deposits in question). So, to take its example, if $10,000 is deposited in the banking system, initially say in one bank, that bank can make loans (create credit line bank deposits) of $9000. When it is spent this $9000 will be re-deposited in other banks which can then lend out 90 percent of this, or $8100; which in turn will be re-deposited in banks, allowing a further $7290 to be lent out, and so on, until in the end and over the period, a total of $90,000 new loans will have been made.

This shows how the Fed can practise “fractional reserve banking” to control the amount of “money” (currency plus bank deposits) in the economy. This is done via “open market operations” as explained in a section headed “Bank Deposits – How They Expand or Contract”:

“Let us assume that expansion in the money stock is desired by the Federal Reserve to achieve its policy objectives . . . [T]he Federal Reserve System, through its trading desk at the Federal Reserve Bank of New York, buys $10,000 of Treasury bills from a dealer in US government securities. In today’s world of computerized financial transactions, the Federal Reserve Bank pays for the securities with an ‘electronic’ check drawn on itself . . . The Federal Reserve System has added $10,000 of securities to its assets, which it has paid for, in effect, by creating a liability on itself in the form of bank reserve balances” (p. 6).

The bank from which the Treasury bills were purchased now has reserves above the 10 percent limit and so can turn the $10,000 into loans, which starts the process described above rolling, leading to an extra $90,000 bank lending.

In theory the Fed could contract bank lending in the same way, but this has never happened. So M1 has gone up and up each year. But what about the currency in all this? It too has gone up but passively and almost automatically. With increased banking activity more currency notes are required, which banks get by converting their reserves into this and which, if it hasn’t enough notes, the Fed just asks the Treasury to print more. But this has consequences -– the depreciation of the dollar and the rise in the general price level Congressman Paul doesn’t like.

But has the banking system really created more “money”? Only if you regard “bank deposits” as money. If you don’t, all that has been shown is that currency has circulated in that the whole process depends on the initial deposit or injection of cash being recycled as further deposits by depositors (as opposed to by banks creating a credit line). So, neither an individual bank nor the whole banking system can lend more than has been deposited with it. By the end of the process, in the example given, the first loan (out of the first deposit of $10,000) of $9000 has been used and used again for genuine deposits totalling $90,000. But all this assumes an expanding economy, since where is the money to repay the loans and the interest on them to come from without being assured of which the banks would not lend the money in the first place?

So the banking system does not create money to lend out of thin air but can only lend out money deposited with it and then only when economic conditions permit it.

Today, bank deposits are not the only source of what the banks lend. They also borrow on the money market (as has been highlighted by the present banking crisis). This means that their reserves are an even smaller percentage of their total loans, only about 3 percent in fact. This figure is mentioned in Zeitgeist Addendum as if this was now the “fractional reserve” and that therefore banks, or the banking system, can “create” loans of up to 33 times an initial deposit. Another silly mistake.

If currency cranks such as the makers of the Zeitgeist films have got the wrong end of the stick about “fractional reserve banking” and imagine that it means banks, whether singly or all together, can create money or credit out of thin air this is partly the fault of the way that booklets like the one produced by the Federal Reserve Bank of Chicago try to explain it. Of course the Fed does not believe the “thin air” claim, but to refute the currency cranks it would have not only to re-iterate that no single bank receiving an additional deposit of $10,000 can forthwith loan out $90,000, but also spell out that the expansion of credit line bank deposits still depends on people making real deposits of their own, unborrowed money (whether in cash or by cheque or by bank transfer). Which would restore a sense of reality and explode the myth that banks can create loans out of thin air.

But it is not a myth. They really do make money out of thin air -- where does Mr. Buick think money comes from? It does not grow on trees and there literally is nobody except the Fed who has the right under the Constitution (subcontracted to the Fed by Congress in 1913) to "create money" (mrc)

ADAM BUICK

# 7 and #8 of the Google Poll were not on point -- so they were eliminated
This is # 9a of the Google Poll

http://www.livescience.com/culture/081023-making-money.html
Out of Thin Air: How Money is Really Made

By Jeremy Hsu, LiveScience Staff Writer / posted: 23 October 2008 07:26 am ET
Making money in 2008 looks like a grim proposition, but not because U.S. government printing presses can’t create enough dollar bills.

The U.S. Bureau of Engraving and Printing (whose web site name perhaps says it all: moneyfactory.gov) churns out about 38 million bills of varying denominations daily, all worth $750 million in face value. Facilities in Fort Worth, Texas and Washington D.C. use 18 tons of ink per day to keep up.

Yet 95 percent of fresh notes simply replace those already in circulation. Common $1 bills last about 21 months, while a $100 bill can go for roughly 7.4 years before requiring replacement. Taken all together, these physical bills represent just a drop in the bucket of global money.

The real trick to funding the $700 billion bailout of the financial industry: Make more money. However, most of that money never actually gets printed at all. Rather, it’s infused into the economy by the ultimate ATM: the federal government. And it grows and grows by a rather mystical process that works only when everyone plays the lending game.

Virtual cash

Most money lives not in our wallets but in something like a banking Matrix – a virtual world of electronic numbers running between bank accounts. People typically look at their money as a figure in a bank statement, and trust that number is real. The economy runs on that faith as workers deposit their checks in banks.

Banks then get down to the business of creating money by lending it out. Assume that you put $100 in your bank account. The government requires banks to hold a certain amount in reserve, say 10 percent, so the bank may just take $90 and lend it out to someone else. That person can then buy something with the $90. The store deposits the $90 in another bank, and the lending process continues to inflate the original $100.

“The original $100 that came in gets blown up by the banking system into something much bigger – essentially $1,000 [assuming a 10 percent reserve],” said Menzie Chinn, an economist and public policy expert at the University of Wisconsin in Madison.

This system may sound a bit magical, yet it works as long as banks and other lenders believe that debtors will pay them back. And if the loans go toward spending or investments that make even more money, everyone gets paid and the money-creation cycle continues.

The problem

People typically deposit their money with commercial banks such as Citibank or Wells Fargo. Corporations and large groups deposit their money with bigger investment banks such as Lehman Brothers and Morgan Stanley.

However, this lending-as-creating process imploded this year after seemingly everyone had bet their borrowed money on the idea that housing prices would keep going up. When housing prices began to fall, many debtors lost that gamble and ended up failing to pay back their loans. Investment banks also found themselves in serious trouble after they had bet on the housing market, and either filed for bankruptcy, ended up on the auction block, or needed a federal hand.

Remaining banks have become scared of lending out money when there is no guarantee they will get any of it back. That reluctance to lend out money “short circuits the money expansion process,” Chinn told LiveScience.

This is a problem because the global economy depends heavily on borrowing and loans. Individuals and corporations may need to borrow heavily during bad times, and the lack of available loans can further plunge the economy into a downward spiral of recession.

The collapse of confidence in the lending system also destroyed any grand illusions of greater wealth created by the long chain of loans and ever-rising housing prices that weren’t supposed to come down. The money-creation cycle screeched to a halt.

“But at the bottom of it, there was some reality of greater wealth,” Chinn said. “Just not as much as we thought.”

Solutions

The U.S. government’s central bank, the Federal Reserve, normally has several tactics to tweak the money-creation process. The Fed can change the amount of money that banks are required to hold in reserve, which either frees up more for loans or reduces the amount available for loans. It can also deal with banks to buy or sell Treasury securities, again to increase or decrease the amount of money available for loans.

That’s how it normally works. But as Chinn and other economists point out, these are strange times. The government is now taking “extraordinary means” to try and unlock the freeze on loans, and may even consider more extreme measures such as guaranteeing all bank deposits in case a bank fails.

“They’re trying to make it so banks and other financial institutions trust each other,” Chinn noted.

The $700 billion bailout bill for Wall Street is another attempt to save faltering banks and financial institutions, but the government has to get all that money somehow.

One option involves issuing more U.S. Treasury bonds so that U.S. and foreign investors or governments can buy them up – basically borrowing more money from the rest of the world. That would tend to drive the interest rate up, so that the U.S. government would ultimately have to pay back more money to its lenders.

The Fed could also buy up some of the Treasury bonds itself and reduce the interest rate on its bonds. That action essentially represents “printing money,” Chinn said. Creating money out of thin air may help in the short term, but in the long run reduces the value of U.S. dollars.

“Or the U.S. government can raise taxes,” Chinn added.

This is # 9b on our Google pool / http://www.livescience.com/culture/081023-making-money.html

9. Out of Thin Air: How Money is Really Made | LiveScience
Oct 23, 2008 ... Remaining banks have become scared of lending out money when there is no ... Creating money out of thin air may help in the short term, ...

Analysis -- this longish article covers more than creating money. In the part about creating money, it precisely repeats the error we tell about, in #1 above. That error was started by the Fed and is being continually spread, to our horror, by Wikipedia. (mrc)

Check this link.http://en.wikipedia.org/wiki/Fractional_reserve_banking

In the section of the article under consideration, titled “Virtual cash”, it presents “Banks then get down to the business of creating money by lending it out. Assume that you put $100 in your bank account. The government requires banks to hold a certain amount in reserve, say 10 percent, so the bank may just take $90 and lend it out to someone else. That person can then buy something with the $90. The store deposits the $90 in another bank, and the lending process continues to inflate the original $100.” (mrc)

That scenario seems more ridiculous every time we read it. Try it with your friends -- lend one of them $100 with the proviso that they have to lend $90 to another friend -- continue this with a chain of 10 friends and see if you wind up with more than the original $100. If this works the way wikipedia says it does -- you and your 10 friends should jointly wind up with considerably more than $100. Some very serious people believe the nonsense. (mrc)

By the way -- Wikipedia will not take this information down from their website -- probably because they got (or think they got ...) the information from a Federal Reserve Publication. They refer to “Page 57 of ‘The FED today’, a publication on an educational site affiliated with the Federal Reserve Bank of Kansas City) designed to educate people on the history and purpose of the United States Federal Reserve system.<< http://www.federalreserveeducation.org/fed101/fedtoday/FedTodayAll.pdf >>. Also see the folowing at Wikipedia (Note the quotation marks) “... An explanation of how it works from the New York Regional Reserve Bank of the US Federal Reserve system. Scroll down to the “Reserve Requirements and Money Creation” section. (mrc)

Here is what it says: “Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81. As the process continues, the banking system can expand the initial deposit of $100 into a maximum of $1,000 of money ($100+$90+81+$72.90+...=$1,000). In contrast, with a 20% reserve requirement, the banking system would be able to expand the initial $100 deposit into a maximum of $500 ($100+$80+$64+$51.20+...=$500). Thus, higher reserve requirements should result in reduced money creation and, in turn, in reduced economic activity.” The link to this page is: http://www.newyorkfed.org/aboutthefed/fedpoint/fed45.html (that link appears to be dead (mrc)

There is no #10