What is our current money system?

Private bankers create our money as debt-credit

Today, the private banking system creates about 98 percent of our national money, which we use as bank account entries or cash bills. Private banks create most new money when someone takes out a loan by entering that loan amount in the borrower’s account. It’s really that simple. 

Yes, the banks like JP Morgan Chase & Co., Citibank, Wells Fargo, Bank of America, all the smaller banks, and the central bank that serves them create about 98 percent of the new money when they make loans – or in the case of the central Fed, when they buy government debt in the marketplace. This is called the Federal Reserve System.

Chase bank front

signing loan agreement

Commercial bank money creation

Most bank loans create new money that is added to the supply. For example, if you borrow $1,000 from your bank, the bank takes your IOU and counts it as an asset. Then the bank, with a simple accounting entry, puts $1,000 into your account, and counts that $1,000 as a liability. They promise to produce $1,000 for you on your demand. The money supply now has an additional $1,000. You can convert the account entry to cash, or spend it via checks, debit card, or electronic payment. Our commercial banks are part of a network of banks in the Federal Reserve System, and our money – whether it is a cash bill or an accounting entry – is an IOU from the whole banking system. All banks will honor other banks’ promises to produce this value on demand because we have made the banking system’s IOUs our legal tender.

A bank may also make loans using existing money that it gets from customers specifically to be reinvested (such as in a fixed term savings account or with the money they exchange for a certificate of deposit). When this last happens, the bank is serving as a go-between for savers-investors, using money that already exists, and carrying a contract specifying the bank’s use of these funds, the risk, and the return to the saver-investor. This is how most people think bank lending works, but in fact, in our current system, banks create most money that they lend via keystroke.

This private bank-money, created by banks when they make a loan, serves to make any kind of payment in our economy. It is bank-money and debt-credit money. When you pay off your loan, the money supply shrinks by that amount. In good times, the private banks turn right around and create more money by lending to someone else. According to the Fed’s financial reports, over the past 100 years the private banks have increased the money supply by an average of about 8 percent net each year.

Money circulates in our economy and can be used many times by many people. This is called the velocity of money, and it is the beauty of money. Money acts as a transaction lubricant for our commerce, like blood in the body.

Central bank money creation

In addition to the creation of money by the commercial banks, our privately owned and authorized-by-government central bank (the Fed) can create new money to buy US government debt in the open market. (The law prohibits the Fed from creating money by loaning it directly to the government). This money creation process is called monetizing the government debt and is sometimes referred to as quantitative easing (or QE). This central Fed money creation privilege is intended to give the central bank a way to influence the total money supply, and it plays a role in what is called fractional reserve money creation – for which our system is named. The Fed has established an arcane system of definitions and accounting around reserves, assets, and liabilities that obscures the fundamental process of money creation.

When the Fed buys government debt it adds new money to the supply. When it sells government debt, it takes money out of the supply. In 2018 the central bank had nearly $4 trillion of government debt on its books, so it likely created less than 25 percent of the total current money supply of $15 trillion. However, historically, this is an extraordinarily high ratio. When the Federal Reserve, NY branch, creates new money by buying – or extinguishes existing money by reselling – government debt, it trades only through a few privileged government bond brokers who represent banking interests. It does not deal directly with the public or with the government. When the Fed buys Treasuries, the newly-created Fed money goes first to the institutions, commercial banks, and individuals who could afford to buy them in the first place with existing money. 

Commercial bank money enters circulation

Once created, roughly 9 percent of commercial bank digital entries are exchanged for cash, leaving only 90 percent of our money as a digital accounting entry, and the remainder in cash and coin. When we spend it, we instruct the bank to move money from our account to someone else’s, and this takes place with accounting entries. Nothing tangible changes hands.

Cash bills, about 9 percent of the money supply, are printed by our government, but they are turned into money at face value by the private banking system when existing account entry bank money is exchanged for them. All account entry bank money is created by the private bankers. Today, coins are the only money created by our government and they are less than two percent of our money supply.

stack of coins

Some people and business entities make loans of existing money to each other, and that increases debt without increasing the money supply. This also happens when banks sell off loans to the secondary market where they are often bundled and resold as investment instruments. These are two reasons why today there is over three times as much debt as there is money in the supply – creating unnecessary scarcity to pay back all the debt. Also, when new money is created by issuing debt-credit, interest is charged, accrues, and is continuously paid on the money supply – in perpetuity. This constrains the economy because interest payments must come out of the existing money supply which is created with someone else’s borrowing.

The more money paid for interest, the less that is available for non-financial (real) goods and services. This creates unnecessary scarcity; there is never enough money to pay off the debt and its accumulating, compounding interest. This is the fundamental, systemic burden that we and the rest of nature pay for by our continuing consent to it. When enough of us withdraw our consent and demand that we upgrade our system, we will get out from underneath this extractive burden.

While new money is created by debt in our current system, not all debt creates new money.

When there is not enough money to pay loans back except to borrow more, our debts get so high we cannot pay them and defaults start resulting in a severe financial crisis. This is one of the factors that triggered the Great Recession of 2008. During crises wealth transfers from the many to the already wealthy few.

A bank money system serves bankers’ interests

Private banks are mostly for-profit institutions. By law, a for-profit corporation is required to make profit-making for shareholders its highest value.1 This means that the creation of our money supply is not made with the best interests of our society as the top priority. Bank profit expectations and loan qualifications determine the supply.

Our Federal Reserve System was established by law in 1913. The Bank of England, established in 1694, was first of its kind. Our Fed is a consortium of private banks, given by law the power and privilege of creating our money supply. It is neither a federal agency nor a reserve of money. It is not designed to be easily understood, perhaps intentionally. This is a very simplified explanation of how our current system works. To understand this opaque system better we have included a list of references at the end.

stock market tracking overlays big city in background


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