Debt-damned economics: either learn monetary reform, or kiss your assets goodbye (4 of 7)

(Before It's News)

The following is my high school teaching assignment for Advanced Placement Macroeconomics students (available as extra credit for other classes) on how money is created. I offer this for non-profit use; divided into seven sections:

• Instructions (1 of 7)
• Contextual orientation: seeing the past as clearly as possible (2 of 7)
• Money and bank credit (3 of 7)
• Fractional reserve banking (4 of 7)
• Debt (public, private) and money supply (5 of 7)
• Historical struggle between government-issued money and private bank-issued credit (6 of 7)
• Cost-benefit analysis for monetary reform in your world of the present (7 of 7)

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3. Fractional reserve banking

“This proposal (debt-free money created by government to directly pay for infrastructure) will of course be opposed by the bankers from whom it takes the lucrative privilege of creating purchasing power. It would however insure the safety of deposits, give large revenues to the government, provide complete social control over monetary matters and prevent abnormal fluctuations in the capital market. At the same time it would permit the allocation of productive resources…to remain primarily in private hands. All in all it seems the most promising program for the reform of our monetary and credit system…”  – Paul Douglas in the Chicago Plan booklet (19). The Great Depression in the US (1929-1941) motivated professional economists to comprehensively and creatively address its causes. Upon consideration of previous US economic depressions in 1837, 1873, and 1893, prominent economists led by Henry Simons at the University of Chicago proposed monetary reform as the nation’s most effective and practical policy response, known as the Chicago Plan (20) (and here [21]). This proposal was endorsed by Simons’ colleague, Paul Douglas, Frank Graham and Charles Whittlesley of Princeton, Irving Fisher of Yale, Earl Hamilton of Duke, Willford King of NYU, and sent to a thousand academic economists for their input. Three hundred twenty responded to the mailed proposal and survey (an impressively high number for a cold-call proposal and survey) from 157 universities, with 73% in full agreement with the proposal, 12.5% in approval with various considerations in its implementation, and only 14% in disagreement.

“The bankers will favor a course of special legislation to increase their power…They will never cease to ask for more, …so long as there is more that can be wrung from the toiling masses of the American People…The struggle with this money power has been going on from the beginning of the history of this country.” – Peter Cooper, famous American inventor in his letter to President Hayes, June 1, 1877 (22).

“Fractional reserve banking” is how banks and the banking industry create credit. An individual bank creates credit and “so-called lends” it to the public as a fraction of the deposits the public puts in the bank. Because the money so-called lent ends up in another bank that then so-called lends the money again, the effect in the overall economy is a multiplier effect rather than an individual bank phenomenon of a fraction. It works like this: the definition of “fractional reserve banking” is that banks keep a regulated “fraction” of their total deposits “on reserve,” called their reserve ratio (RR) that they cannot “lend,” and can create new credit out of thin air up to the total of all their customers’ deposits minus their RR.

Among AP Econ teachers, our teaching experience agrees with John Kenneth Galbraith’s quote above that this is difficult to grasp. But stick with it; these mechanics are as understandable as the mechanics of simple items on your desk: seeing how a stapler works, the geometry how facial tissues are put into the box, and far simpler than your phone!

So: once a bank is established, they must hold a percentage (ratio) of their total deposits “on reserve” that is not leant to customers. This rate is set by the Federal Reserve (Fed), 10% for established banks and less for smaller ones (however, banks get around these limits (23) and will always make credit on terms profitable to the bank).

This means that if you deposit money into your bank, they can then create credit up to their limit in new “loans.” If you deposit $100, the bank can create new/thin-air credit of $90 to anyone asking for a loan. That’s the micro picture.

The macro picture is that the new credit then circulates to other banks and is “re-leant” at 90% and so on. Let’s say that someone borrows the $90 from your bank, purchases something, and then the $90 ends up deposited in another bank. The receiving bank can create credit, let’s say 90% of up to $81 in new credit. The injection of increasing the money supply comes from the Federal Reserve. They create money out of nothing and then use it to buy government securities or non-voting shares of banks, etc. If they buy a government bond for $1,000 from money they create out of nothing, this new money increases the money by the formula 1/RR. Assuming a simplified textbook understanding of a RR of 10% of deposits that banks cannot create credit from, in this case of the Fed creating $1,000, the new credit/money multiplied from the banking system is $1000 x 1/10%, or $1000 x 10 = $10,000. This is the macro effect if all receiving banks create credit up to their reserve requirement and all “lend” out the new credit.

Because the Federal Reserve is owned by the banking industry, this causes a classic conflict of interest: the banking industry’s profit comes from expanding the money supply and then creating credit to “lend” to us at interest. Expanding the money supply is in conflict with the public’s interest to limit the supply of money to guard its value from inflation.

Some people are confused by the Fed’s ownership. What’s openly stated by the Fed’s attorneys (24) is that the Fed is owned by their member banks. They pay dividends to its shareholders (25). Court cases have found in each instance that the Federal Reserve is not a government agency (26). You cannot find them in a government agency organizational chart in any branch of government. Back when people used to use phone books, the Federal Reserve would not exist in the government section, but be listed in the business section shortly after Federal Express.

Endnotes:

¹⁹ more info here: Herman, C. Top 10 Americans for monetary reform: #10: 86% of Economics professors during Great Depression. Oct. 5, 2009: https://web.archive.org/web/20140707095228/http://www.examiner.com/article/top-10-americans-for-monetary-reform-10-86-of-economics-professors-during-great-depression

²⁰ Zarlenga, S. The 1930s Chicago Plan and the American Monetary Act. AMI Monetary Reform Conference, Oct. 2005: http://www.monetary.org/the-1930s-chicago-plan-vs-the-american-monetary-act/2009/08

²¹ Asia Times. Ashari, H; Krichene, N. Dust off the Chicago Plan. Sept. 17, 2008: http://www.atimes.com/atimes/Global_Economy/JI17Dj03.html

²² Herman, C. President Andrew Jackson, Peter Cooper on monetary reform. March 8, 2012: http://www.washingtonsblog.com/2012/03/president-andrew-jackson-peter-cooper-on-monetary-reform.html

²³ Web of Debt Blog. Brown, E. Why do banks want our deposits? Hint: it’s not to make loans. Oct. 26, 2014: http://ellenbrown.com/2014/10/26/why-do-banks-want-our-deposits-hint-its-not-to-make-loans/

²⁴ Washington’s Blog. Federal Reserve attorneys: Fed banks are “not agencies” but “independent corporations” with “private boards of directors.” July 26, 2011: http://www.washingtonsblog.com/2011/07/federal-reserve-attorneys-fed-banks-are-not-agencies-but-independent-corporations-with-private-boards-of-directors.html

²⁵ Global Research. Brown, E. Who owns the Federal Reserve? Oct. 8, 2008: http://www.globalresearch.ca/who-owns-the-federal-reserve/10489

²⁶ Washington’s Blog. Everyone knows that the Federal Reserve banks are PRIVATE… except the American people. July 13, 2013: http://www.washingtonsblog.com/2013/07/everyone-knows-that-the-federal-reserve-banks-are-private-except-the-american-people.html

Debt-damned economics: either learn monetary reform, or kiss your assets goodbye (4 of 7) was originally published on Washington's Blog

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