This writing (from 2008) is outdated. Ben Bernanke's recent (April, 2010) announcement that Fractional Reserve Banking is being eliminated put the nail in the "reserves" coffin and essentially acknowledged that we are now on a Sovereign Money Banking System (the coffin was built and buried in 1913 -- but the death of "monetary reserves" was not announced until now).

This information is primarily presented in an attempt to explain money and the money supply to the American public. After a significant, periodic study over 50 years on "money", It is my opinion that "A Primer on Money" (#3 below) and the two related reports (#4 and #5 below) offer the best available explanations of money and the money supply. Without this information, in my opinion, it is practically impossible to understand the money system. (Martin R. Carbone)

Common Sense Economics -- Commonomics

References: ( Much of what is written in this report is derived from these references)

1. This is a link to the actual current Federal Laws that now ( early 2008) govern banking -- FDIC and FRB law
2. The March, 2008 Financial and Money System Problem. What happened? What should be done? / By Martin R. Carbone
3. "A Primer on Money" -- By Congressman Wright Patman / August 5, 1964 / For the House Committee on Banking and Currency / a 141 page .pdf
4. Speech to Congress by Wright Patman, introducing the "Primer on Money" This speech basically covers the same ground as the above-mentioned "Primer ...". It is easier to understand than the "Primer ...". It also has the advantage of being in .html.
5. "Money Facts -- 169 Questions and Answers on Money" -- A Supplement to the "Primer on Money". This 30 page report explains in relatively plain English what the "Primer ... " is about. An average person should be able to understand this report. If you read only one of these reports -- this should be it.
6. "On The Principles Of The Money System" -- By William Gouge, an advisor to President Jackson / 1833 / A 93 page .pdf -- presented here to add historical perspective. This is a very dense and convoluted report -- practically impossible for an average person to understand. Note that it was written less than 50 years after the formation of the U.S.A. and is probably a good example of the less-than-clear understanding of the general understanding of "the principles of the money system" at that time (and perhaps today?).
7. Common Sense Economics -- Commonomics by Martin R. Carbone
8. Progress and Poverty by Henry George -- An important book on a basic aspect of economics. It basically explains why poverty is virtually unknown in primitive societies but widespread wherever there is great wealth. George's logic is extremely powerful. Although everything he says may or may not be precisely accurate, it is difficult to find a flaw in his reasoning. This edition has been re-written in modern English. It is relatively easy to understand. Who was Henry George, who might have been the third most well known man in the United States (behind Thomas Edison and Mark Twain)?
9. An Abbreviated Monetary History of the US: Part 1 / (c) 2002, American Monetary Institute -- A well written presentation that explains the evolution of money at the start of the U.S. The explanation of how paper money worked then is unique, easily understood and logical. Unfortunately that presentation is outdated since paper money is no longer backed by Gold.

Money, it’s not natural 4/3/05 -- Martin R. Carbone / updated 3/08

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.

Money was not created by God. It is an invention of 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 <<http://www.alphabeticalist.com/Money%20Section/moneyfactsupdated.html>>

Here are the answers:
A. Where does money comes from? -- (1) It is printed or minted by machines owned by the U.S. Government to fill the needs of the banking system and (2) it is created when a bank lends money to an individual, corporation, governent 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 reprenting 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? -- 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 1916. This is a link to the current law << FDIC and FRB law >>. Most Central Banks 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 -- the money is not truly created -- it is traded for 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 came 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 goldmith 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 below 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.

E. What is good about the system?
1. It creates real wealth and is the basic foundation for our economic system.

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) convincing 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 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 otherewise 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). Congress gave that power to the Federal Reserve System (in 1916?) which is privately owned and operated. 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. This is not a healthy situation.

Notes:
1. I have been trying to understand how money is created ever since I took an economics class in 1955 at Newark College of Engineering. At that time, I read almost all the classic text books on economics and read most of the literature distributed by the Federal Reserve System. None of that information was the least bit helpful.

2. I was a charter depositor of “The County Bank” of Carpinteria, California.

3. I sold my business in 1969 to Mr. Fred Lennon a businessman from Ohio who started a bank because the banks in his town were not serving him well. At the time, Mr. Lennon was the 100th richest man in the United States according to Forbes magazine. He owned thirty companies in and around Cleveland Ohio.

4. My direct experience with the banks mentioned in 3 and 4 above -- and the following referenced books are the basis for my understanding of the present system. I also sent for and received an application to start a bank in 1970 and read all the related forms which were sent to me by the State of California.

5. The information I have presented above comes primarily from "A Primer on Money", a 141 page .pdf report by Wright Patman a Congressman from Texas and then Chairman of “The House Committee on Banking and Currency”. It was printed by, and was available through, the Government Printing Office. It is no longer in print or available from the government. Also see <<http://www.alphabeticalist.com/Money%20Section/moneyfactsupdated.html>>

6. Another book worth reading is “Progress and Poverty” written by Henry George around the turn of the century. Mr. George, a private citizen, set out to discover why poverty is virtually unknown in primitive societies but widespread wherever there is great wealth. The book became the foundation for Fabian Socialism, which was an important social movement when it was published. Its main ideas were (a) that all wealth comes from the ownership of land and (b) private ownership of land created poverty wherever it was allowed.

The following is from "Progress and Poverty" -- "An inquiry into the cause of industrial depressions and of increase of want with increase of wealth... The Remedy by Henry George / San Francisco, 1879 / Dedicated to those who, seeing the vice and misery that spring from the unequal distribution of wealth and privilege, feel the possibility of a higher social state and would strive for its attainment."

Mr. George came to the conclusion that the private ownership of land would never be changed, so he advocated taxation as being the way for the public to get their share of the natural wealth in the land. It may very well be that Mr George's book resulted in our country putting forth our somewhat progressive income tax laws in the early 1900s.

7. Years ago there was almost no information about this system available from any source. That has changed. There is now lots of information on the internet about this system. Just Google “money supply” or "creation of money” or "fractional reserve system". Be aware that much of the information you will find is wrong and lots of it is written by people (cranks?) who simply think the present banking system is a rip-off of the public.

Martin R. Carbone

This is a link to the actual Federal Laws that govern banking -- FDIC and FRB law

The following reserve requirement ratios are prescribed for all banks. The numbers come from § 204.9 (e) of << http://www.fdic.gov/regulations/laws/rules/7500-500.html#7500204.2 >>, a federal law.

"Net Transaction Accounts" is basically the dollar value of all customer's deposits and accounts receivable on the bank's books. The precise definition of transaction account comes from § "202 Definitions" of the URL immediately above: it is reproduced below

"(e) Transaction account means a deposit or account from which the depositor or account holder is permitted to make transfers or withdrawals by negotiable or transferable instrument, payment order of withdrawal, telephone transfer, or other similar device for the purpose of making payments or transfers to third persons or others or from which the depositor may make third party payments at an automated teller machine (“ATM”) or a remote service unit, or other electronic device, including by debit card ... "

The "Reserve Requirement" is basically the cash the bank has on hand, plus the money it has on deposit at the Federal Reserve.

In other words, if a bank has a total of $50 million of (a) customer's deposits and (b) loans to borrowers on its books, it must have $1,099,000 of its own money as a reserve
[$ 1,038,000 + $61,000 (10% of $6,100,000)].

That $1,038,000 is just under 4% of the $50 million. That means such a bank can lend 25 times as much money as it has in "net accounts".

Note that the bank needs zero reserves if it has up to $9 million dollars in loans out to customers. In other words, if a bank has none of its own money in the bank -- it can still lend out up to $9 million.

§ 204.9 Reserve requirement ratios (in text form)

The following reserve requirement ratios are prescribed for all depository institutions, banking Edge and agreement corporations, and United States branches and agencies of foreign banks:

For a net "Transaction Amount" (TA), the "Reserve Requirement" (RR) is in accordance with the following text.

For a TA of $0 to $9.3 million, the RR is 0% of TA
For a TA of $9.3 to $43.9 million, the RR is 3% of TA
For a TA over $43.9 million, the RR is $1,038,000 + 10% of amount over $43.9 million

More to come --- August 2008

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