This post is meant to be educational so that everybody knows how our monetary system works. Knowing how the system works is the first step to identifying the problems and considering solutions.
How modern Fractional Banking works:
line 1 Bank Starting Capital………………….1,200
line 2 Reserve for Bank working capital……………………………………. ..200
line 3 Private Loans……….1000…….1000……..1000…….. ..1000
line 4 Int + Prin……………..2000……..2000……2000… ….2000
Total Principal + Interest on Line 4= $8,000
Line 1 Starting capital is only $1,200
Line 2 The bank keeps only 200 in reserve.
Line 3 The bank has lent out $4,000 on $1,000 and expects to get paid back $8,000. The bank has lent the same $1,000 out to four people at the same time. They can do this because the money never really leaves the banking system. It is just being transferred around from one account to another.
The money to be payed back, the total of Interest + principal on line 4 ($8,000), does not exist because on line 1 they only started out with $1,200.
More money must be created (printed) to pay back the Int + Prin… or the borrowers will default. The system depends on more borrowers coming in after and create more money through debt borrowing. Factional Banking is a legalized Ponzi scheme, but there is nothing better that would scale to a growing economy that has been thought of yet.
The system is designed so that all new money must be borrowed into existence. More money must be constantly created or else the borrowers will default because at any given time there is not enough money in existence for ALL borrowers to pay back their debt. The Church understood this and tried to ban the practice of Fractional Banking. Andrew Jackson, the 7th US president, knew this too and fought hard to destroy the Second Federal Bank of the United States. The charter of the First Federal Bank was allowed to expire. The point is that there are costs and benefits to this system that have been known for a long time.
The system is good because it allows for the money supply to scale to a growing economy. The system requires that all borrowings are backed by collateral. So if allowed to work properly, it is a very good system with a built in control on inflation. The money created at the local level IS backed by something. It is backed by real assets which have an intrinsic value much greater then gold. Gold is not good for much except art. The down side of debt based currency is a situation when there are not enough new loans coming in. When there are not enough new borrowers coming in to borrow more money (create new money), some people will default (recession). This is the built in control on inflation. The Federal Reserve has traditionally used interest rate adjustments as the throttle control on this debt based money creation system. With lower the interest rates there is more borrowing, hence more money creation. If there is too much money creation the Fed raises interest rates to slow the rate of new borrowing, which slows the creation of new money.
If this system is confusing let me put it another way. If you want to borrow money from a bank to buy a house, the rules allow the bank to create electronic money out of thin air as long as the house is used as collateral. No money is ever really exchanged today in large transactions. Neither the buyer, nor the seller of the property ever see hard cash. The money is moved electronically from one account to another. Since all US bank are chartered by the Federal Reserve, all the banks that seem independent really function as one giant bank. It will also surprise people that in all likely hood they have never held real money in their hands there entire lives. If you look at a one dollar bill you will see the words “Federal Reserve Note”. A Note is a Payable. Those words say that the Federal Reserve OWES you a one dollar. So what you think is money in your hands is really just an IOU from the Fed to you.
The system can work. I can’t think of a better system that would satisfy the needs of a modern economy. The problem with this system is the Government. The government has given itself the ability to borrow as much money as it wants without putting up real assets as collateral. The Treasury just prints up paper bonds and sells them to the Fed Reserve for new cash. The govt basically gives itself an IOU for new money. This is proof that anything that government touches… turns to shit.
It is false to say that our money is not backed by anything, it is infact backed by real assets that borrowers use as collateral. The only problem in this system is the Government borrowing which is not backed by anything of value other then its “power” to tax and confiscate property almost at will.
As the government borrows more and more, its debt becomes a bigger percentage of ALL the Outstanding debt. As that Government percentage goes higher, it means that a greater percentage of our money is NOT backed by real assets.
There is only one possible solution to this problem at this point. The national debt can never be paid back, since in this system the money to pay it all back never exists at any point in time. The amount not actually owed to anyone can be written off. That should be balanced by proportionally decreasing the private debt and the money supply. The effect of this is “Deflation”. The problem of this is only psychological as people will have to get use to the idea of taking a pay cut every year. That however would be offset by lowered living expenses. People with savings would benefit from an appreciation as the value of the dollar increases.
(Note: Permission to reprint and link with credit to Bill Tsafa is hereby granted)