I’m assuming that most of us learned about fractional reserves in Jr. High or high school. I think that Jr. High is now called Middle School and Libraries are now called Learning Resource Centers but I digress. Anyway, most of us learned about one way banks create money out of thin air called fractional reserves and if you were like me, I was taught this was a good thing.

To refresh our memories, I thought I’d explore how this works yet again but this time I’d add the front end of this equation where a large part of this money creation occurs.

So here’s what happens:

The US Government calls up the Federal Reserve (which is not Federal and has no Reserves) and says we want to sell $10 billion in T Bonds. The Fed says okay you have a deal. The US Government sends the Fed some pretty paper that has the number $10 billion printed on it and then the Fed issues $10 billion in Federal Reserve notes and trades this for the bonds. The money the Fed created didn’t exist an instant before this transaction and was created out of thin air. And in fact they don’t even bother to print these Federal Reserve notes, they just make a few entries on their computer and presto $10 billion dollars shows up in a US Government bank account. So you can see that money was created out of debt and in fact money is debt and debt is money.

When the Government bank receives the $10 billion, the bank can now loan out 90% of the $10 billion (or $ 9 billion) that was deposited to other customers and charge interest. The 10% of the $10B must stay in the bank because of fractional reserve requirements.

Now let’s say that the bank loans out the $9 billion to a customer and this customer takes this money and deposits it into yet another bank. Using the same formula, this bank can loan out 90% of the 9B or $8.1B…$7.29B… and so it goes theoretically forever. The practical limit in the real world however is about 9X the original amount or $90B has been created from the first $10B borrowed by Uncle Sam.

Now notice that all this money is created from debt so money in our current monetary system is debt.

If you look historically at the Money supply and debt, the curves are the same. Every single dollar in your wallet is owed by someone to someone. Debt is money and money is debt. But there is a problem here and that problem is the interest that banks charge. There’s never enough money supply to pay the interest since debt = money. What this means is that some one has to go bankrupt and the banks take ownership of their real assets. It’s like playing musical chairs except when the music stops someone goes bankrupt.

Last time the national debt was paid off was in 1835 when Andrew Jackson shut down the central bank that preceded the Federal Reserve.

So what gives all this new money value? It steals its value from the money that already exists. In fact our money has been devalued this way by 96% from 1913 – 2007.

Federal Reserve Modern Money Mechanics

Fractional reserve banking system

http://www.rayservers.com/images/ModernMoneyMechanics.pdf