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How Money is Created

[This is from: http://www.kamron.com/economics/money.htm / The [bracketed type] are our comments]

BEWARE! THIS SHOWS WHAT WE ARE UP AGAINST -- ANYONE CAN PUT ANYTHING ON THE INTERNET

[The owner of this website believes that this report is basically nonsense. Beware of any writing that follows this line of thinking.]

[See "Creating Money Out Of Thin Air" for our version of how money is created.]

All funds** in the system we currently have originated from a loan of some sort that bears interest or usury.

[** What is meant by ‘funds’ - coins, paper money gold, notes?]

This interest is the Achilles heal of the system and eventually will bring it and the American people to their knees.

Creation of Cash by Securities

The cash in circulation starts out by the creation of a loan or the sale of a debt instrument.**

[** “a loan and the sale of a debt instrument” -- are essentially the same thing]

The FED begins the process by creating “Raw Money” ** and exchanging it for a Treasury security on the open market.

[** What is raw money?]

Let's look at the process.

The government takes good paper and ink and prints up a certificate with designed borders on it and calls it a bond or a Treasury note. It is a fancy IOU that promises to pay a specific amount at a specific date with a specific amount of interest. Lets say for the exercise it is a 100 million dollar certificate with a 5% interest rate.

The Federal Reserve classifies this paper (on its books) as a Securities Asset because the American People will guarantee it and pay it back with taxes they volunteer**.

[** Note the word "volunteer". When it is written that taxes are "volunteered", that usually signifies that the writer thinks taxes are not required to be paid by any law. There is a fringe group of people who believe this. To describe them as "cranks" would not be far off the mark.]

The FED then takes another piece of paper, a check, and writes out the amount of $100,000,000.00 on it. The paper check (IOU) is then exchanged for the paper certificate IOU. Now keep in mind that neither piece of paper has anything but the American Taxpayer backing it. There is no money in the FED checking account to cover this check. The accounting books are balanced by the two worthless entries so everything looks OK.

The government endorses the check and deposits it in a FED bank where the bank's account** is credited for the $100 million dollars. This is the initial funds that are written out as checks out of the bank and go to pay for salaries, equipment and other items. These checks are all deposited into other banks.

[** Which specific type of an account -- asset, liability, income, expense ? Note they are probably not talking about double entry bookeeping. Unless you know if they are talking about double entry bookeeping, or some other specialized system -- you can't understand the desription that will follow.]

Fractional Reserve Lending

The deposits are all considered assets in the banks where they are deposited.**

[** that answers the previous question. ]

Now through the magic** of fractional reserves the money is re-loaned out into the public.

[** The word "magic" is evidently being used sarcastically]

These banks are allowed to loan 90% of their deposits** so the bank loans 90 million out at interest lets say 10%.

[** This is incorrect, the bank can actualy lend 10 times the amount of the deposit if the fractional reserve rate is 10. This multiplying is explained elsewhere on this website.]

These loans are executed and checks or deposit slips are issued. When this 90 million is deposited it is considered an asset and can be used to loan 81 million and so on.

The original 100 million fabricated on paper is generating 5% interest payable to the FED and it has grown through fractional reserves to more than 900 million generating 10% per year. This is really a total of 1 billion dollars all created out of thin air with paper and ink. It all generates interest. A few dollars of paper and ink in this case generates 100 million every year. **

[** It can actually generate a lot more than that.]

The effect is cumulative and eventually catastrophic to this system.**

[** It is not the least bit catastrophic if the system is managed properly. The bald statement --- “is ... catastrophic” is ridiculous if there is no explaining how it is catastophic.]

[What they fail to mention is that every loan is probably secured by good collateral or the proven ability of every borrower to pay the money back out of their present bank accounts or proven income. If the banks are prudent, the system generates wealth -- because many of the borrowers will use the money they borrow to start businesses, grow businesses, build houses, raise crops and other worthwhile endeavours. How do they have the audacity explain a system that “creates” money to out of thin air” as somehow being catastrophic? One would think they would describe such a system "wonderful".]

Loans to Banks

Banks borrow funds from the Federal Reserve when their cash supply runs low or they have loaned more money out than their reserves dictate or when the FED increases the reserves percentage. These loans carry interest attached at a low rate called the discount rate.

Mini Economy **

[** What follows is a very shallow and substantialy incorrect explanation. I assume it is written here to later cast negative aspersions on the process -- but even if absolutely true -- it does not seem like there is anything to criticize adversely.]

So here we have a mini economy.

It has a 100 million in cash supplied by the FED costing 10%. We have through the miracle of Fractional Reserves created loans of an additional 900 million dollars. Lets evenly spread it over 9 banks to make it simple.

Now lets work this little economic system to the end of the cycle.

We have for this example 100 companies out there who borrowed the fractionally provided 900 million dollars created from the “raw" Money the FED traded for the Treasury Notes.

Our mini Economy has a total of 1 Billion in it.

The companies used their loaned* [*should be "borrowed"] cash it to expand their companies and paid it all out into the economy as purchases of materials equipment and salaries. They now sell their products to obtain funds. These funds are used to pay bills, payroll and some pays the interest on the loans and some may be used to reduce the principle of the original loans.

Our government did the same thing. It used the 100 million to do all kinds of wonderful things.

Now the entire economy here only has a total of 100 million in real cash** to cover the circulation of up to a billion in checks.

[** According to their argument, The whole process started with "paper and ink". Do they accept the resulting certificate as "real money"?]

Some of the people in the economy have a little cash in their pockets also so this puts pressure on the local banks. Some of these banks need to go to the FED money store in order to keep enough cash, lets say they get an additional 90 million between them at 5%.

OK lets see how we do through a few years.

Year one goes by and the government pays out its 10 million in interest to the FED and the banks that borrowed cash because their customers wanted a little walk about money paid 5% on their 90 million or 4.5 million.

These interest payments to the FED are out of the real cash so after year one there is now only 85.5 million in “Raw Money” in the system. The interest paid to the banks is recycled into the system so we can ignore that for now. None of the principle was paid down so the full billion is still owed . The companies all did well and they produced a lot of goods that are on the market now so the general public needs a little extra money to buy these goods. They are writing more checks or carrying more money at the same time that the banks and the government have paid some of the raw cash back. Cash tightens up and the companies decide to not pay back any principle this year and maybe the banks need to borrow a little more money from the FED, but lets not go there as it will cause a quicker crash.

Year two goes by and lets say our government managed its finances well and doesn’t need to borrow any more money and the member banks customers don’t come in for more cash and let their deposits just sit in the bank. This helps our economy hold on. The banks pay another 4.5 million and the government pays another 10 million in interest so our little economy is down to 71 million in “Raw Money”

The banks deposits have decreased as the money supply has been reduced so the banks reserves are low and they need to borrow additional money from the FED in order for their reserves to stay at 10%. The borrow an additional 90 million.

Year three goes by and our government didn’t borrow any more and the companies didn’t borrow any more but the interest paid this year is now 28 million so the “Raw Money is down to 43 million dollars.

If nothing changes the system is totally bankrupt in just a few years.

This system can be supported only by additional borrowings which only make the problem worse. The borrowings must increase as the “Raw Money” is removed from the system as interest.

Here it is in plain simple terms for all to see.** The mystery of the system is removed and the scam plain for all to see.

[** It is not at all plain the see -- they described a theoretical (or hypothetical) system based on a thought experiment that is ridiculous and not at all like the real system. Then they mentally crashed the theoretical system. They did not take into consideration the wealth generated within the system - most of it made possible by the existence of money. Remember -- if the loans are made to reliable lenders with good collateral and good earning capacity, there is no way the system can go bankrupt. Run the same thought experiment with the loans being paid back and you will come to a completely different conclusion. Their argument, by the way, is typical of most negative criticism of the money system. see all the material by Patman on this site to see an accurate portrayal of how the system really works.]

We must change our system NOW. **

[** We can agree that the system must be changed -- but not for the reasons they offer. They are on the right track -- but have boarded the wrong train.]