#3 How Is money created?

(Editors note:  I became curious about the amount of money in the US economy. According to the St.Louis Fed, the M2* money supply on Nov. 1980 was 1,591 Billion dollars.  On Dec. 2014 the figure was 11,643 Billion.  So I had to ask myself: "Where does all this money come from?")

http://www.themoneymasters.com/faqs/

 How does the Fed “create” money out of nothing?

Answer: It is a four-step process. But first a word on bonds. Bonds are simply promises to pay — or government IOUs. People buy bonds to get a secure rate of interest. (Editor’s note: whoever “buys” a bond is, in reality, lending the government money.) At the end of the term of the bond, the government repays the principal, plus interest (if not paid periodically), and the bond is destroyed. There are trillions of dollars worth of these bonds at present. Now here is the Fed moneymaking process:

Step 1. The Fed Open Market Committee approves the purchase of U.S. Bonds on the open market.

Step 2. The bonds are purchased by the New York Fed Bank from whomever is offering them for sale on the open market. (You sell $100,000,000 worth of bonds you bought from the government to the New York Fed Bank. “You” could be a pension fund, Bank of America, China or a Warren Buffet type).

Step 3. The Fed pays for the bonds with electronic credits (created by strokes on a computer keyboard!) to the “your” bank, which in turn credits the “your” bank account. ($100,000,000 worth of electronic credits appear on “your” bank account.  These credits are now real US dollars). These credits are based on nothing tangible. The Fed just creates them.

Step 4. The banks use these deposits (your $100,000,000) as reserves. Most banks may loan out ten times (10x) the amount of their reserves to new borrowers, all at interest.

In this way, a Fed purchase of, say a billion dollars worth of bonds, gets turned into over 10 billion dollars in bank deposits.  The Fed, in effect, creates 10% of this totally new money and the banks create the other 90%. (Out of thin air).

This also explains why the Fed consistently holds about 10% of the total US Treasury bonds. It had to buy those (with accounts or Fed notes the Fed simply created) from the public in order to provide the base for the rest of the money the private banks then get to create, most of which eventually winds up being used to purchase Treasury bonds, thus supplying Congress with the borrowed money to pay for its expenditures.

Due to a number of important exceptions to the 10% reserve ratio, some loans require less than 10% reserves, and many no (0%) reserves, making it possible for banks to create many times more than ten times the money they have in “reserve”. Due to these exceptions from the 10% reserve requirement, the Fed creates only a little under 2% of the total US money supply, while private banks create the other 98%.

To reduce the amount of money in the economy, the process is just reversed — the Fed sells bonds to the public, and money flows out of the purchaser’s local bank. Loans must be reduced by ten times the amount of the sale. So a Fed sale of a million dollars in bonds, results in 10 million dollars less money in the economy.

Question: If private banks create over 90% of the US money supply,  then are they not a  greater threat to our democracy than the Fed itself?

Answer: Of course. The Fed was simply a smoke-screen designed to hide the stark reality that behind the Federal Reserve Act of 1913, signed by an unwitting President Wilson (who later deeply regretted that act) was a monumental power grab by the largest bankers who designed the Act at their secret meeting at Jekyll Island, Georgia. 

Having a Federal Reserve or similar national Central Bank, in itself, is not a bad thing (it can be a good thing) – but allowing private banks to practice fractional reserve banking (pursuant to the Federal Reserve Act of 1913 or any other such law) is the real problem, which is impoverishing all Americans and now all peoples worldwide, except the bankers. For clarity, it should be renamed the Fractional Reserve Banking Act. The exponential concentration of wealth, in the US and abroad, is due almost exclusively to fractional reserve banking by privately owned banks such as Bank of America, Wells Fargo, Citigroup, J.P. Morgan Chase, etc. The Fed is simply part of the mechanism screening this grave injustice from public knowledge and scrutiny.

*M2 includes a broader set of financial assets held principally by households. M2 consists of M1 plus: (1) savings deposits (which include money market deposit accounts, or MMDAs); (2)           small-denomination time deposits (time deposits in amounts of less than $100,000); and (3) balances in retail money market mutual funds(MMMFs).