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Money Myths and Magic R.W. Zimmerer - COMER \|\| May 29, 2006 Related - The Number 1 Reason YOU became a Slave For one thing, money is a contract — the freest, most gorgeous contract of them all. Money is somebody else’s promise to pay, to give me what I want, when I want it. What a magnificent conception! The fully alienable contract for anything, anytime, anywhere. If you are at all aware of the history of contract law, you will realize what an immense historical achievement modern paper money represents. Whatever else history may ultimately record of the Western bourgeoisie, this honor most certainly must be accorded them: They perfected modern money which is a contract with parties unknown for the future delivery of pleasures undecided upon (David T. Bazelon, The Paper Economy, 1963). Adapted from the six-part series "Money Magic" by R. W. Zimmerer printed in the Main Street Free Press, Longmont. Money Myths Part One After years spending hundreds of billions of $US on Operation Iraq Liberation (OIL) and no end in sight, we now must pay for Hurricane Katrina recovery. Where will all the new money come from? Have we a spare $200 billion to get started reconstructing the Gulf Coast? The US is financing a trade deficit of some $700 billion this year to buy foreign oil, Japanese automobiles, and Chinese merchandise. We do it by selling US Treasury Bonds and Bills effectively trading US Treasury Bonds for imported products. A good deal for US consumers as long as foreigners will go along with it. Can we pay for Hurricane Katrina on such good terms? The journey of a new $US begins when the US Treasury sells a US government Bond, Bill, or Note receiving a check on a bank account which it deposits into the Treasury’s Federal Reserve bank account. US banks and foreign governments are big buyers of these securities. When the Federal Reserve buys back that US Treasury security it makes a deposit of $US into the seller’s bank account. The creditor has his money back (plus interest) and the Federal Reserve now owns the US Treasury bond. As the Treasury writes checks on its Federal Reserve bank account spending that bond money, it puts brand new $US into circulation. The US government can pay for Hurricane Katrina. First the US Treasury would sell $200 billion of new Bonds. The Federal Reserve would then buy back those $200 billion of Treasury Bonds through its Open Market Operation where it buys and sells many billions of dollars of Treasury securities every day. Creditors have now been repaid and the Fed owns $200 billion worth of US Treasury securities upon which the Federal government now pays interest to itself! The Treasury has $200 billion more in its Federal Reserve account to spend on Hurricane Katrina recovery. It seems a round-about way to handle government spending, not at all like a household budget operation, but the United States of America is not a household economy. There is plenty of money waiting to be born and pay for Hurricane Katrina recovery. It would not be for a lack of money but for a lack of skilled workers and materials which could limit reconstruction. To get started recovering from the destruction of Hurricane Katrina, Congress need only set up the proper agencies to receive and spend the first $200 billion. One might compare this to the Marshall Plan which rebuilt European nations destroyed in WWII. The $US of the Marshall Plan were loaned on the condition that they were spent in the US providing jobs for returning GIs. When US dollars pour out to foreign manufacturers who are selling us what we no longer manufacture and we have little to sell in foreign countries to reclaim those dollars, the US has a big and growing problem. After WWII the $US became the world currency, in demand everywhere as good as gold! Trade is based on exchanging real things but the US has been trading US Treasury securities, paper, for real things. This returns dollars to the US but leaves a claim against the US for future delivery of something real, not just paper money. This is a growing threat to international finance not just the US economy because the dollar is used as the world’s currency/money. It is much different for the US to be heavily in debt to foreign creditors than for Argentina. US Treasury Securities have been the safest place to store dollars. That can change. Euros could replace US dollars as world currency. Our dollars would lose value, foreign imports would cost more and more, and the US would have to rebuild its factories and once again manufacture what we need. Can this future be avoided? Part Two Thus outlined in broad strokes is the basic process by which new money is continuously being created through the collaboration of the US Treasury which prints and mints money, 12 Federal Reserve Banks, and many private commercial banks. Legal tender, cash, enters the economy by selling and buying back Treasury securities which all pay interest to their holders. Private banks create a multiple of this new money by making loans on which they are paid interest. Where does the money come from to pay this interest? Why, from more money creation! This is debt based money, either "backed" by US National Debt or "backed" by a bank debt. Almost all bank deposits are somebody else’s bank loan. Pay off all bank loans and nearly all bank deposits would vanish. Interest rates are variable and inconsistent depending on demand for new money and guesses by individual private banks and Fed governors who set interest rates. Congress said the purpose of its 1913 Act creating the Federal Reserve System is: "...to provide for the establishment of Federal reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the US, and for other purposes.... (The Federal Reserve System — Purposes & Functions, page 2 of 1994 edition, available upon request from the Federal Reserve Board of Governors). There is no doubt that the Fed and banks are key players controlling US economic activity — the daily business of buying and selling. This power was tragically unused in the Great Depression of the 1930s when many banks collapsed wiping out depositors’ accounts and bank owners. The quantity of money in circulation decreased sharply and surviving banks were reluctant or unable to create the money (make loans) so desperately needed to revive the US economy. The Fed refused to act as Bank of Last Resort as it was empowered to do. The Depression lasted 10 years until WWII ended it. There was no shortage of new money when the US needed to manufacture great quantities of war materials! US factories returned to full production and new factories were built to win the war. Women replaced drafted men on the assembly line. After WWII Congress, very concerned that the US economy would collapse again into depression with the end of war production, passed the Employment Act of 1946 which said that a goal of the Federal government would be a peacetime economy at full employment. Why could not a peacetime economy be as productive of things as a war economy? This set the stage for peacetime government intervention in the market place of buying and selling. The GI Bill of Rights offered returning war veterans money to go to college, buy a house, start a business, and other choices all of which generated economic growth and created new jobs. New money continued to flow into the US economy for a while. Ex GIs bought homes in new suburbs, went to college, started businesses, and there was full employment. By 1950 this economic boom was over and signs of depression reappeared. But then the Korean "police action" began and the economy revived as the US sent men and material to Korea. President Eisenhower was elected on a program to end the Korean War which he did and soon the US experienced what economists called the Eisenhower Doldrums and his administration called a "rolling readjustment." Treasury Secretary Humphrey tried fruitlessly to balance the Federal Budget. It was an economic recession caused by the end of war production: no more new money was needed. Since then there have been many Economic Doldrums alternating with economic recoveries after new money entered circulation. The only recovery not based on war production was the Space Race to beat the Russians to the Moon supported by an enthusiastic US public. The evidence seems irrefutable that our economy must have a continuing infusion of new money to be successful. It also seems that war production is not the only "excuse" to keep creating new money. The question is how to maintain a steady increase of new money into the economy. "Collect $200 when passing GO" instructs players of the popular Depression era board game Monopoly! Part Three As reviewed in part 2, the history of economic booms and busts reveals that a growing economy requires a continuous injection of new money. With banks creating interest-bearing business loans, more new money must be created just to pay that interest. It is a common misunderstanding that banks only loan the money deposited in them. How banks came to loan money into existence is explained in Modern Money Mechanics — A Workbook on Bank Reserves and Deposit Expansion printed by the Federal Reserve Bank of Chicago. In it we read: "It started with goldsmiths. As early bankers, they initially provided safekeeping services, making a profit from vault storage fees for gold and coins deposited with them. People would redeem their ‘deposit receipts’ whenever they needed gold or coins to purchase something, and physically take the gold or coins to the seller who, in turn, would deposit them for safekeeping, often with the same banker. Everyone soon found that it was a lot easier simply to use the deposit receipts directly as a means of payment. These receipts, which became known as notes, were acceptable as money since whoever held them could go to the banker and exchange them for metallic money. "Then, bankers discovered that they could make loans merely by giving their promises to pay, or bank notes, to borrowers. In this way, banks began to create money. More notes could be issued than the gold and coin on hand because only a portion of the notes outstanding would be presented for payment at any one time. Enough metallic money had to be kept on hand, of course, to redeem whatever volume of notes was presented for payment. "Transaction deposits are the modern counterpart of bank notes. It was a small step from printing notes to making book entries crediting deposits of borrowers, which the borrowers in turn could ‘spend’ by writing checks, thereby ‘printing’ their own money. Article Posted at www.KnowledgeDrivenRevolution.com "If deposit money can be created so easily, what is to prevent banks from making too much — more than sufficient to keep the nation’s productive resources fully employed without price inflation? Like its predecessor, the modern bank must keep available, to make payment on demand, a considerable amount of currency and funds on deposit with the central bank. The bank must be prepared to convert deposit money into currency for those depositors who request currency. It must make remittance on checks written by depositors and presented for payment by other banks (settle adverse clearings). Finally, it must maintain legally required reserves, in the form of vault cash and/or balances at its Federal Reserve Bank, equal to a prescribed percentage of its deposits." This is how banks create money subject to limits and supervision by the Federal Reserve, the US central bank. Gold is replaced by paper money printed only by the US Treasury. Printed on every $US is: "Federal Reserve Note. This note is legal tender for all debts public and private." Legal tender, cash, enters circulation when Treasury debt is purchased by the Fed from its private owners. Federal Reserve Notes can be used to purchase gold on the open market but they no longer carry a fixed exchange rate of gold ounces per dollar. President Nixon took the US dollar off the gold standard. An interesting question arises. Why does not the Fed buy Treasury debt directly from the US Treasury so that all our National Debt is owned by the Fed, the people, not by private investors? Would that solve the National Debt problem? Here are further excerpts from Modern Money Mechanics — A Workbook on Bank Reserves and Deposit Expansion by the Federal Reserve Bank of Chicago. It is out of print but available on the Internet from www.worldnewsstand.net/money/mmm2.html and on several other sites in both pdf and html. "The actual process of money creation takes place primarily in banks. As noted earlier, checkable liabilities of banks are money. These liabilities are customers’ accounts. They increase when customers deposit currency and checks and when the proceeds of loans made by the banks are credited to borrowers’ accounts. "In the absence of legal reserve requirements, banks can build up deposits by increasing loans and investments so long as they keep enough currency on hand to redeem whatever amounts the holders of deposits want to convert into currency. This unique attribute of the banking business was discovered many centuries ago." It is called Fractional Reserve Banking. Part Four Summarizing 1. Modern US dollars are no longer "backed" by anything more tangible than the "Full Faith and Credit of the USA." 2. Most US money in circulation is in the form of bank checks and credit/debit card transactions. 3. Only paper dollars and metal coins manufactured by the US Treasury are legal tender, cash. 4. A growing US market economy is sustained by a continuous infusion of new legal tender from Federal Reserve purchases of Treasury debt greatly multiplied by private bank loans. No physical investment nor purchase is made before money is available to pay for it. Yet, a power plant sells the power it generates after the money has been spent to construct it. A dam delivers water to farmers who grow crops for sale after the money is spent to build it. People are educated before they can become productive citizens. The money for all this is created by bank loans and Federal Government spending. Big dams, river levees, conservation programs, national parks and forests, space exploration, the military, are funded by government spending while sprawling subdivisions, shopping centers, office towers, corporation mergers & acquisitions, and consumer spending, depend on private bank loans. Banks become business partners with their customers, often as members of a borrower’s board of directors. Banks can influence the design of a new subdivision more than a city planning department. Bank loan officers exert great control over business decisions and economic activity. Bankers are not elected and until the recent repeal of the Glass-Steagall Banking Act of 1933, banks could not finance their own non-bank business ventures. Return to the roaring 20s! As previously explained, US legal tender arises out of government spending. The funds appropriated by Congress are raised from taxes, tariffs, fees, sale of Treasury bonds and direct cash from Treasury. When the Fed buys back a Treasury bond with legal tender it gets from the US Treasury, it increases the money base upon which banks can further increase the money supply. The National Debt is what backs US dollars. The only way to reduce it is to return the legal tender it created. This curious bookkeeping could be simplified by either selling all Treasury bonds directly to the Fed or just spending the Congressional appropriation directly from the US Treasury. Bankers who wrote the Jekyll Island Accords which became the Federal Reserve Act of 1913 wanted to have secure US Treasury bonds available to them. They provide the highest security for idle money and buying and selling them is a profitable business. If the Treasury paid for all future government spending directly there would be no further increase in the National Debt. Thomas Edison, in an interview with the New York Times in December 1921, praised and explained Henry Ford’s plan to pay the $30 million to build Muscle Shoals Dam directly from the US Treasury — no bonds required. This debt-free new money would pay the workmen etc. and would be "backed" by the wealth the big dam would produce. The Fed today could be authorized to buy State and local government bonds as the Bank of Canada can buy Provincial debt. New money would flow into the economy and solve a major problem of State financing. Corporations have floated the idea of the Fed buying their commercial paper/debt as well as US Treasury bonds! The Fed could buy public school bonds, hospital bonds, and debt of any productive infrastructure investment approved by elected public representatives. The Federal Government already makes an array of grants to lesser government entities — outright gifts of money. Indeed, once it is fully understood how new money is created and why it must be continuously created, citizens can consider far more effective ways to manage a national economy for full employment, universal health care, public education, and sustainable use of natural resources. Part Five Injecting new legal tender, cash, into commerce is a responsibility of the Federal Reserve Board of Governors. Banks also inject new money as they extend credit — make new loans. By Fractional Reserve Banking these loans can multiply the Fed’s new legal tender some 10-fold! As the US economy of buying and selling grows, so must this debt grow. It is estimated that consumer spending today, mainly financed by credit card debt, accounts for some 60% of our Gross Domestic Product. Federal Government spending, dependent on Congressional appropriations, provides the primary economic stimulus. Very little new commercial activity is undertaken without bank loans or government spending. Congressional appropriations for the US Army, Navy, and Air Force account for much government spending. While great debate attends appropriations for civic purposes, military spending is often increased over a President’s request. There is little interest in reducing military spending. Witness the disappearance of the expected "Peace Dividend" upon the end of the Cold War in 1990. By careful design, military spending graces every Congressional District. Only US Post Office construction is as popular! "Pork Barrel" spending ("earmarking" in the dead of night) is both standard practice and hypocritically deplored, but it helps support the Economy. NASA was a spectacular exception in Congressional spending. Created in 1957 out of NACA to meet the challenge of the USSR satellite Sputnik, President Kennedy aroused enthusiastic public support to land on the Moon within ten years. Not since Rail Road construction has such a massive peacetime spending program costing billions and billions of dollars been sustained. After reaching the moon support waned as NASA continued with routine shuttle missions for undramatic scientific goals. President Eisenhower cautioned in his Farewell Address as only a military hero could, that a vast Military-Industrial complex can arise and threaten our Democracy. What Eisenhower feared is coming to pass. Upon the collapse of the USSR there were a few years of military base closings and aerospace contract terminations, but a new Military-Industrial-Congressional complex arose. Private banks range in size from "friendly" local banks which loan to car dealers and "mom & pop" stores to gigantic national banks loaning billions of dollars for mega-mergers of multinational corporations. It has been noted that these banks can be too big to fail. Banks get into trouble when they have too many loans which can’t pay interest. A small bank is simply closed while the Continental Illinois Bank (1984) gets saved with new money from the Fed. It was not always so. The Fed refused to save banks in 1929, a main cause of The Great Depression which was ended only by WWII war production. When Long Term Capital Management hedge fund failed in 1998 the Fed acted quickly to avoid an international financial collapse because the $US is the reserve currency of world trade. The Savings & Loan Association crisis in 1982 was temporarily averted by relaxing S&L rules leading to an ultimate collapse in 1989 (announced after the Presidential election) which cost several hundred billions of dollars. In such threatening financial crises the Fed now acts quickly as the Bank of Last Resort to provide immediate money from the US Treasury Vault. A new money crisis is building from the vast amount of personal credit card debt. The Controller of the Currency, responsible for bank monitoring, is looking the other way as banks thrill to charge 20 and 30% or more on credit card balances. The Bank Act of 2005 was passed to protect banks from their customers who can’t pay interest. This developing crisis was explored in a recent PBS Frontline documentary. The Federal Government is The Great Underwriter of the US Economy. It builds our infrastructure of many dimensions, passes out legal tender as needed for commerce, and saves corporations whose failure would threaten the "game." Federal government spending is the vital component of our Economy. Our real concern should be for what it is spent! Part Six Money serves two principal purposes in commerce. It is a convenient generic medium of exchange and an independent store of value. As a medium of exchange it extends the time between selling and buying during which time it stores value. The value of money is temporary, comparable in some ways to the value of fresh vegetables or fish. Money is valued for what it can be exchanged for paper money is more easily handled, particularly in large amounts, than metal coins. Today a check or credit card is even easier to use. Money in hand can be compared to a contract or promissory note which confers certain benefits on its holder. Because the value of money can change there is much interest in places to put it where its future value is well protected. Buying something which can be sold in the distant future to recover the purchasing power of the original money is one method — if one can find such items. During the German hyperinflation of the 1920s wealthy people bought pianos. Works of art, rare coins, gem stones, real estate, and gold are physical objects commonly used. Intangible objects are stocks, bonds, and patents. All these are also bought by speculators whose interest is in short term financial profit — not long-term safety. The terms investment and expenditure distinguish between buying something which can return future value from paying present expenses. Investment is usually made with idle money not needed for expenses. Many people work their way through college spending money today as an investment in their future. On a larger scale, a society can plan for future health care by spending money today to educate medical personnel, undertake research, and construct hospitals. This is investing money in people and infrastructure to obtain desired future benefits, an investment today which preserves the future value of money. Bibliography The Internet today is a powerful source of information. Identified in this essay are two official publications of the Federal Reserve. A very readable source of comment and publications is the Committee on Monetary and Economic Reform which publishes a monthly journal ER, Economic Reform. It has a web site, www.comer.org, where most articles in ER since 2002 can be read and its many publications can be ordered. I particularly recommend It’s Your Money by Wm. F. Hixson which explains the debt origin of today’s money and Towards a Non-Autistic Economy — A Place at the Table for Society by Wm. Krehm the editor of ER. His book connects the mechanics of money creation to its economic impact. A fascinating examination of the impact of neoliberal economy and money management on a modern nation is Bruce Jesson’s Only Their Purpose is Mad: The Money Men Take Over NZ. In 1984 New Zealand was cut lose from the Commonwealth to find its own way in the new world economy of Globalization and Privatization. It was an experiment in government producing tragic consequences for a nation of some 3.6 million people. A classic analysis of The Great Depression financial collapse is Thurman Arnold’s Folklore of Capitalism with a prescient Preface by Arnold to the 1962 edition. Arnold led an official Federal investigation of its many causes and reports here to a lay audience in a readable style. John Maynard Keynes had strong opinions about gold, money and private enterprise which he expressed colorfully as in this excerpt from General Theory of Employment, Interest & Money, p. 129. In the 1930s when nations struggled with a global financial collapse and argued over gold standards and unemployment, Keynes made these observations on the folly of bankers. While the details today are different, the struggle for personal power and our guiding money myths remain largely the same. "If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coal mines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note bearing territory), there need be no more unemployment and the real income of the community would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing. "The analogy between this expedient and the gold mines of the real world is complete. At periods when gold is available at suitable depths experience shows that the real wealth of the world increases rapidly; and when but little of it is available our wealth suffers stagnation or decline. Just as wars have been the only form of large scale loan expenditure which statesmen have thought justifiable, so gold mining is the only pretext for digging holes in the ground which has recommended itself to bankers as sound finance. "Ancient Egypt was doubly fortunate, and doubtless owed to this its fabled wealth, in that it possessed two activities, namely pyramid building as well as the search for precious metals, the fruits of which, since they could not serve the needs of man by being consumed, did not stale with abundance. "The Middle Ages built cathedrals and sang dirges. Two masses for the dead are twice as good as one; but not so two railways from London to York. Thus we are so sensible, having schooled ourselves to so close a semblance of prudent financiers, taking careful thought before we add to the ‘financial’ burdens of posterity by building them houses to live in, that we have no such easy escape from the sufferings of unemployment. We have to accept them as an inevitable result of applying to the conduct of the State the maxims which are best calculated to ‘enrich’ an individual by enabling him to pile up claims to enjoyment which he does not intend to exercise at any definite time." The complexity of money manipulation by banks and the Federal Reserve is explained in The Economics of Money, Banking, and Financial Markets by Frederic S. Mishkin. Prof. Mishkin writes with clarity on a bewildering subject. The 3rd edition (1992) has many examples of bank failures and rescues by the Fed. Masters of Illusion: The World Bank and the Poverty of Nations by Catherine Caufield relates the sad story of how the World Bank’s good intentions went awry and brought poverty not prosperity to Third World Nations. Together with the International Monetary Fund they did the bidding of the USA building the neoliberal "Washington Consensus." Collision and Collusion — The Strange Case of Western Aid to Eastern Europe 1989-1998 by Janine R. Wedel relates another sad story of misguided money management led by the Harvard Institute for International Development using $US supplied by the US Treasury Dept. Employing "Shock Therapy" advocated by Prof. Jeffrey Sachs to rebuild the Russian economy after the collapse of the USSR, it brought about the destruction and theft of the economy instead. About KDR \| \| Home \| \| Weekly Features Archive	Weekly Weekly Features Archive
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Money Myths and Magic

R.W. Zimmerer - COMER || May 29, 2006

Related - The Number 1 Reason YOU became a Slave

For one thing, money is a contract — the freest, most gorgeous contract of them all. Money is somebody else’s promise to pay, to give me what I want, when I want it. What a magnificent conception! The fully alienable contract for anything, anytime, anywhere. If you are at all aware of the history of contract law, you will realize what an immense historical achievement modern paper money represents. Whatever else history may ultimately record of the Western bourgeoisie, this honor most certainly must be accorded them: They perfected modern money which is a contract with parties unknown for the future delivery of pleasures undecided upon (David T. Bazelon, The Paper Economy, 1963).

Adapted from the six-part series "Money Magic" by R. W. Zimmerer printed in the Main Street Free Press, Longmont.

Money Myths

Part One

After years spending hundreds of billions of $US on Operation Iraq Liberation (OIL) and no end in sight, we now must pay for Hurricane Katrina recovery. Where will all the new money come from? Have we a spare $200 billion to get started reconstructing the Gulf Coast?

The US is financing a trade deficit of some $700 billion this year to buy foreign oil, Japanese automobiles, and Chinese merchandise. We do it by selling US Treasury Bonds and Bills effectively trading US Treasury Bonds for imported products. A good deal for US consumers as long as foreigners will go along with it. Can we pay for Hurricane Katrina on such good terms?

The journey of a new $US begins when the US Treasury sells a US government Bond, Bill, or Note receiving a check on a bank account which it deposits into the Treasury’s Federal Reserve bank account. US banks and foreign governments are big buyers of these securities. When the Federal Reserve buys back that US Treasury security it makes a deposit of $US into the seller’s bank account. The creditor has his money back (plus interest) and the Federal Reserve now owns the US Treasury bond. As the Treasury writes checks on its Federal Reserve bank account spending that bond money, it puts brand new $US into circulation.

The US government can pay for Hurricane Katrina. First the US Treasury would sell $200 billion of new Bonds. The Federal Reserve would then buy back those $200 billion of Treasury Bonds through its Open Market Operation where it buys and sells many billions of dollars of Treasury securities every day. Creditors have now been repaid and the Fed owns $200 billion worth of US Treasury securities upon which the Federal government now pays interest to itself! The Treasury has $200 billion more in its Federal Reserve account to spend on Hurricane Katrina recovery.

It seems a round-about way to handle government spending, not at all like a household budget operation, but the United States of America is not a household economy. There is plenty of money waiting to be born and pay for Hurricane Katrina recovery. It would not be for a lack of money but for a lack of skilled workers and materials which could limit reconstruction.

To get started recovering from the destruction of Hurricane Katrina, Congress need only set up the proper agencies to receive and spend the first $200 billion. One might compare this to the Marshall Plan which rebuilt European nations destroyed in WWII. The $US of the Marshall Plan were loaned on the condition that they were spent in the US providing jobs for returning GIs.

When US dollars pour out to foreign manufacturers who are selling us what we no longer manufacture and we have little to sell in foreign countries to reclaim those dollars, the US has a big and growing problem. After WWII the $US became the world currency, in demand everywhere as good as gold!

Trade is based on exchanging real things but the US has been trading US Treasury securities, paper, for real things. This returns dollars to the US but leaves a claim against the US for future delivery of something real, not just paper money.

This is a growing threat to international finance not just the US economy because the dollar is used as the world’s currency/money. It is much different for the US to be heavily in debt to foreign creditors than for Argentina.

US Treasury Securities have been the safest place to store dollars. That can change. Euros could replace US dollars as world currency. Our dollars would lose value, foreign imports would cost more and more, and the US would have to rebuild its factories and once again manufacture what we need. Can this future be avoided?

Part Two

Thus outlined in broad strokes is the basic process by which new money is continuously being created through the collaboration of the US Treasury which prints and mints money, 12 Federal Reserve Banks, and many private commercial banks. Legal tender, cash, enters the economy by selling and buying back Treasury securities which all pay interest to their holders. Private banks create a multiple of this new money by making loans on which they are paid interest. Where does the money come from to pay this interest? Why, from more money creation!

This is debt based money, either "backed" by US National Debt or "backed" by a bank debt. Almost all bank deposits are somebody else’s bank loan. Pay off all bank loans and nearly all bank deposits would vanish. Interest rates are variable and inconsistent depending on demand for new money and guesses by individual private banks and Fed governors who set interest rates.

Congress said the purpose of its 1913 Act creating the Federal Reserve System is: "...to provide for the establishment of Federal reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the US, and for other purposes.... (The Federal Reserve System — Purposes & Functions, page 2 of 1994 edition, available upon request from the Federal Reserve Board of Governors).

There is no doubt that the Fed and banks are key players controlling US economic activity — the daily business of buying and selling. This power was tragically unused in the Great Depression of the 1930s when many banks collapsed wiping out depositors’ accounts and bank owners. The quantity of money in circulation decreased sharply and surviving banks were reluctant or unable to create the money (make loans) so desperately needed to revive the US economy. The Fed refused to act as Bank of Last Resort as it was empowered to do. The Depression lasted 10 years until WWII ended it. There was no shortage of new money when the US needed to manufacture great quantities of war materials! US factories returned to full production and new factories were built to win the war. Women replaced drafted men on the assembly line.

After WWII Congress, very concerned that the US economy would collapse again into depression with the end of war production, passed the Employment Act of 1946 which said that a goal of the Federal government would be a peacetime economy at full employment. Why could not a peacetime economy be as productive of things as a war economy? This set the stage for peacetime government intervention in the market place of buying and selling. The GI Bill of Rights offered returning war veterans money to go to college, buy a house, start a business, and other choices all of which generated economic growth and created new jobs. New money continued to flow into the US economy for a while. Ex GIs bought homes in new suburbs, went to college, started businesses, and there was full employment.

By 1950 this economic boom was over and signs of depression reappeared. But then the Korean "police action" began and the economy revived as the US sent men and material to Korea. President Eisenhower was elected on a program to end the Korean War which he did and soon the US experienced what economists called the Eisenhower Doldrums and his administration called a "rolling readjustment." Treasury Secretary Humphrey tried fruitlessly to balance the Federal Budget. It was an economic recession caused by the end of war production: no more new money was needed.

Since then there have been many Economic Doldrums alternating with economic recoveries after new money entered circulation. The only recovery not based on war production was the Space Race to beat the Russians to the Moon supported by an enthusiastic US public.

The evidence seems irrefutable that our economy must have a continuing infusion of new money to be successful. It also seems that war production is not the only "excuse" to keep creating new money. The question is how to maintain a steady increase of new money into the economy. "Collect $200 when passing GO" instructs players of the popular Depression era board game Monopoly!

Part Three

As reviewed in part 2, the history of economic booms and busts reveals that a growing economy requires a continuous injection of new money. With banks creating interest-bearing business loans, more new money must be created just to pay that interest. It is a common misunderstanding that banks only loan the money deposited in them. How banks came to loan money into existence is explained in Modern Money Mechanics — A Workbook on Bank Reserves and Deposit Expansion printed by the Federal Reserve Bank of Chicago. In it we read:

"It started with goldsmiths. As early bankers, they initially provided safekeeping services, making a profit from vault storage fees for gold and coins deposited with them. People would redeem their ‘deposit receipts’ whenever they needed gold or coins to purchase something, and physically take the gold or coins to the seller who, in turn, would deposit them for safekeeping, often with the same banker. Everyone soon found that it was a lot easier simply to use the deposit receipts directly as a means of payment. These receipts, which became known as notes, were acceptable as money since whoever held them could go to the banker and exchange them for metallic money.

"Then, bankers discovered that they could make loans merely by giving their promises to pay, or bank notes, to borrowers. In this way, banks began to create money. More notes could be issued than the gold and coin on hand because only a portion of the notes outstanding would be presented for payment at any one time. Enough metallic money had to be kept on hand, of course, to redeem whatever volume of notes was presented for payment.

"Transaction deposits are the modern counterpart of bank notes. It was a small step from printing notes to making book entries crediting deposits of borrowers, which the borrowers in turn could ‘spend’ by writing checks, thereby ‘printing’ their own money.

Article Posted at www.KnowledgeDrivenRevolution.com

"If deposit money can be created so easily, what is to prevent banks from making too much — more than sufficient to keep the nation’s productive resources fully employed without price inflation? Like its predecessor, the modern bank must keep available, to make payment on demand, a considerable amount of currency and funds on deposit with the central bank. The bank must be prepared to convert deposit money into currency for those depositors who request currency. It must make remittance on checks written by depositors and presented for payment by other banks (settle adverse clearings). Finally, it must maintain legally required reserves, in the form of vault cash and/or balances at its Federal Reserve Bank, equal to a prescribed percentage of its deposits."

This is how banks create money subject to limits and supervision by the Federal Reserve, the US central bank. Gold is replaced by paper money printed only by the US Treasury. Printed on every $US is: "Federal Reserve Note. This note is legal tender for all debts public and private."

Legal tender, cash, enters circulation when Treasury debt is purchased by the Fed from its private owners. Federal Reserve Notes can be used to purchase gold on the open market but they no longer carry a fixed exchange rate of gold ounces per dollar. President Nixon took the US dollar off the gold standard.

An interesting question arises. Why does not the Fed buy Treasury debt directly from the US Treasury so that all our National Debt is owned by the Fed, the people, not by private investors? Would that solve the National Debt problem?

Here are further excerpts from Modern Money Mechanics — A Workbook on Bank Reserves and Deposit Expansion by the Federal Reserve Bank of Chicago. It is out of print but available on the Internet from www.worldnewsstand.net/money/mmm2.html and on several other sites in both pdf and html.

"The actual process of money creation takes place primarily in banks. As noted earlier, checkable liabilities of banks are money. These liabilities are customers’ accounts. They increase when customers deposit currency and checks and when the proceeds of loans made by the banks are credited to borrowers’ accounts.

"In the absence of legal reserve requirements, banks can build up deposits by increasing loans and investments so long as they keep enough currency on hand to redeem whatever amounts the holders of deposits want to convert into currency. This unique attribute of the banking business was discovered many centuries ago."

It is called Fractional Reserve Banking.

Part Four

Summarizing

1. Modern US dollars are no longer "backed" by anything more tangible than the "Full Faith and Credit of the USA."

2. Most US money in circulation is in the form of bank checks and credit/debit card transactions.

3. Only paper dollars and metal coins manufactured by the US Treasury are legal tender, cash.

4. A growing US market economy is sustained by a continuous infusion of new legal tender from Federal Reserve purchases of Treasury debt greatly multiplied by private bank loans.

No physical investment nor purchase is made before money is available to pay for it. Yet, a power plant sells the power it generates after the money has been spent to construct it. A dam delivers water to farmers who grow crops for sale after the money is spent to build it. People are educated before they can become productive citizens.

The money for all this is created by bank loans and Federal Government spending. Big dams, river levees, conservation programs, national parks and forests, space exploration, the military, are funded by government spending while sprawling subdivisions, shopping centers, office towers, corporation mergers & acquisitions, and consumer spending, depend on private bank loans.

Banks become business partners with their customers, often as members of a borrower’s board of directors. Banks can influence the design of a new subdivision more than a city planning department. Bank loan officers exert great control over business decisions and economic activity. Bankers are not elected and until the recent repeal of the Glass-Steagall Banking Act of 1933, banks could not finance their own non-bank business ventures. Return to the roaring 20s!

As previously explained, US legal tender arises out of government spending. The funds appropriated by Congress are raised from taxes, tariffs, fees, sale of Treasury bonds and direct cash from Treasury. When the Fed buys back a Treasury bond with legal tender it gets from the US Treasury, it increases the money base upon which banks can further increase the money supply. The National Debt is what backs US dollars. The only way to reduce it is to return the legal tender it created. This curious bookkeeping could be simplified by either selling all Treasury bonds directly to the Fed or just spending the Congressional appropriation directly from the US Treasury.

Bankers who wrote the Jekyll Island Accords which became the Federal Reserve Act of 1913 wanted to have secure US Treasury bonds available to them. They provide the highest security for idle money and buying and selling them is a profitable business.

If the Treasury paid for all future government spending directly there would be no further increase in the National Debt. Thomas Edison, in an interview with the New York Times in December 1921, praised and explained Henry Ford’s plan to pay the $30 million to build Muscle Shoals Dam directly from the US Treasury — no bonds required. This debt-free new money would pay the workmen etc. and would be "backed" by the wealth the big dam would produce.

The Fed today could be authorized to buy State and local government bonds as the Bank of Canada can buy Provincial debt. New money would flow into the economy and solve a major problem of State financing. Corporations have floated the idea of the Fed buying their commercial paper/debt as well as US Treasury bonds! The Fed could buy public school bonds, hospital bonds, and debt of any productive infrastructure investment approved by elected public representatives.

The Federal Government already makes an array of grants to lesser government entities — outright gifts of money. Indeed, once it is fully understood how new money is created and why it must be continuously created, citizens can consider far more effective ways to manage a national economy for full employment, universal health care, public education, and sustainable use of natural resources.

Part Five

Injecting new legal tender, cash, into commerce is a responsibility of the Federal Reserve Board of Governors. Banks also inject new money as they extend credit — make new loans. By Fractional Reserve Banking these loans can multiply the Fed’s new legal tender some 10-fold! As the US economy of buying and selling grows, so must this debt grow. It is estimated that consumer spending today, mainly financed by credit card debt, accounts for some 60% of our Gross Domestic Product. Federal Government spending, dependent on Congressional appropriations, provides the primary economic stimulus.

Very little new commercial activity is undertaken without bank loans or government spending. Congressional appropriations for the US Army, Navy, and Air Force account for much government spending. While great debate attends appropriations for civic purposes, military spending is often increased over a President’s request. There is little interest in reducing military spending. Witness the disappearance of the expected "Peace Dividend" upon the end of the Cold War in 1990. By careful design, military spending graces every Congressional District. Only US Post Office construction is as popular! "Pork Barrel" spending ("earmarking" in the dead of night) is both standard practice and hypocritically deplored, but it helps support the Economy.

NASA was a spectacular exception in Congressional spending. Created in 1957 out of NACA to meet the challenge of the USSR satellite Sputnik, President Kennedy aroused enthusiastic public support to land on the Moon within ten years. Not since Rail Road construction has such a massive peacetime spending program costing billions and billions of dollars been sustained. After reaching the moon support waned as NASA continued with routine shuttle missions for undramatic scientific goals.

President Eisenhower cautioned in his Farewell Address as only a military hero could, that a vast Military-Industrial complex can arise and threaten our Democracy. What Eisenhower feared is coming to pass. Upon the collapse of the USSR there were a few years of military base closings and aerospace contract terminations, but a new Military-Industrial-Congressional complex arose.

Private banks range in size from "friendly" local banks which loan to car dealers and "mom & pop" stores to gigantic national banks loaning billions of dollars for mega-mergers of multinational corporations. It has been noted that these banks can be too big to fail. Banks get into trouble when they have too many loans which can’t pay interest. A small bank is simply closed while the Continental Illinois Bank (1984) gets saved with new money from the Fed.

It was not always so. The Fed refused to save banks in 1929, a main cause of The Great Depression which was ended only by WWII war production. When Long Term Capital Management hedge fund failed in 1998 the Fed acted quickly to avoid an international financial collapse because the $US is the reserve currency of world trade. The Savings & Loan Association crisis in 1982 was temporarily averted by relaxing S&L rules leading to an ultimate collapse in 1989 (announced after the Presidential election) which cost several hundred billions of dollars.

In such threatening financial crises the Fed now acts quickly as the Bank of Last Resort to provide immediate money from the US Treasury Vault. A new money crisis is building from the vast amount of personal credit card debt. The Controller of the Currency, responsible for bank monitoring, is looking the other way as banks thrill to charge 20 and 30% or more on credit card balances. The Bank Act of 2005 was passed to protect banks from their customers who can’t pay interest. This developing crisis was explored in a recent PBS Frontline documentary.

The Federal Government is The Great Underwriter of the US Economy. It builds our infrastructure of many dimensions, passes out legal tender as needed for commerce, and saves corporations whose failure would threaten the "game." Federal government spending is the vital component of our Economy. Our real concern should be for what it is spent!

Part Six

Money serves two principal purposes in commerce. It is a convenient generic medium of exchange and an independent store of value. As a medium of exchange it extends the time between selling and buying during which time it stores value.

The value of money is temporary, comparable in some ways to the value of fresh vegetables or fish. Money is valued for what it can be exchanged for paper money is more easily handled, particularly in large amounts, than metal coins. Today a check or credit card is even easier to use. Money in hand can be compared to a contract or promissory note which confers certain benefits on its holder.

Because the value of money can change there is much interest in places to put it where its future value is well protected. Buying something which can be sold in the distant future to recover the purchasing power of the original money is one method — if one can find such items. During the German hyperinflation of the 1920s wealthy people bought pianos. Works of art, rare coins, gem stones, real estate, and gold are physical objects commonly used. Intangible objects are stocks, bonds, and patents. All these are also bought by speculators whose interest is in short term financial profit — not long-term safety.

The terms investment and expenditure distinguish between buying something which can return future value from paying present expenses. Investment is usually made with idle money not needed for expenses. Many people work their way through college spending money today as an investment in their future.

On a larger scale, a society can plan for future health care by spending money today to educate medical personnel, undertake research, and construct hospitals. This is investing money in people and infrastructure to obtain desired future benefits, an investment today which preserves the future value of money.

Bibliography

The Internet today is a powerful source of information. Identified in this essay are two official publications of the Federal Reserve.

A very readable source of comment and publications is the Committee on Monetary and Economic Reform which publishes a monthly journal ER, Economic Reform. It has a web site, www.comer.org, where most articles in ER since 2002 can be read and its many publications can be ordered. I particularly recommend It’s Your Money by Wm. F. Hixson which explains the debt origin of today’s money and Towards a Non-Autistic Economy — A Place at the Table for Society by Wm. Krehm the editor of ER. His book connects the mechanics of money creation to its economic impact.

A fascinating examination of the impact of neoliberal economy and money management on a modern nation is Bruce Jesson’s Only Their Purpose is Mad: The Money Men Take Over NZ. In 1984 New Zealand was cut lose from the Commonwealth to find its own way in the new world economy of Globalization and Privatization. It was an experiment in government producing tragic consequences for a nation of some 3.6 million people.

A classic analysis of The Great Depression financial collapse is Thurman Arnold’s Folklore of Capitalism with a prescient Preface by Arnold to the 1962 edition. Arnold led an official Federal investigation of its many causes and reports here to a lay audience in a readable style.

John Maynard Keynes had strong opinions about gold, money and private enterprise which he expressed colorfully as in this excerpt from General Theory of Employment, Interest & Money, p. 129. In the 1930s when nations struggled with a global financial collapse and argued over gold standards and unemployment, Keynes made these observations on the folly of bankers. While the details today are different, the struggle for personal power and our guiding money myths remain largely the same.

"If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coal mines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note bearing territory), there need be no more unemployment and the real income of the community would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.

"The analogy between this expedient and the gold mines of the real world is complete. At periods when gold is available at suitable depths experience shows that the real wealth of the world increases rapidly; and when but little of it is available our wealth suffers stagnation or decline. Just as wars have been the only form of large scale loan expenditure which statesmen have thought justifiable, so gold mining is the only pretext for digging holes in the ground which has recommended itself to bankers as sound finance.

"Ancient Egypt was doubly fortunate, and doubtless owed to this its fabled wealth, in that it possessed two activities, namely pyramid building as well as the search for precious metals, the fruits of which, since they could not serve the needs of man by being consumed, did not stale with abundance.

"The Middle Ages built cathedrals and sang dirges. Two masses for the dead are twice as good as one; but not so two railways from London to York. Thus we are so sensible, having schooled ourselves to so close a semblance of prudent financiers, taking careful thought before we add to the ‘financial’ burdens of posterity by building them houses to live in, that we have no such easy escape from the sufferings of unemployment. We have to accept them as an inevitable result of applying to the conduct of the State the maxims which are best calculated to ‘enrich’ an individual by enabling him to pile up claims to enjoyment which he does not intend to exercise at any definite time."

The complexity of money manipulation by banks and the Federal Reserve is explained in The Economics of Money, Banking, and Financial Markets by Frederic S. Mishkin. Prof. Mishkin writes with clarity on a bewildering subject. The 3rd edition (1992) has many examples of bank failures and rescues by the Fed.

Masters of Illusion: The World Bank and the Poverty of Nations by Catherine Caufield relates the sad story of how the World Bank’s good intentions went awry and brought poverty not prosperity to Third World Nations. Together with the International Monetary Fund they did the bidding of the USA building the neoliberal "Washington Consensus."

Collision and Collusion — The Strange Case of Western Aid to Eastern Europe 1989-1998 by Janine R. Wedel relates another sad story of misguided money management led by the Harvard Institute for International Development using $US supplied by the US Treasury Dept. Employing "Shock Therapy" advocated by Prof. Jeffrey Sachs to rebuild the Russian economy after the collapse of the USSR, it brought about the destruction and theft of the economy instead.