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In passing today at the office, the discussion came up regarding Barack Obama’s stimulus package and how it may (but won’t) help our struggling economy.  During this conversation, I mentioned that you can not simply solve a economic problem by creating more money out of thin air (one of the root problems in the first place).  This seemed to create some confusion amongst my co-workers, and it struck me just how little people understand about our banking and monetary system, especially the Federal Reserve.  One guy actually told me that the money was backed by gold still.  Oh boy…  We’re in trouble.

Getting into this is a little off the normal path of where I was going with this blog, but what the hell.  This issue has bothered me enough that I feel really compelled to write about this and try and make some progress with this subject among my friends at the very least and at best maybe someone will pass by this and decide to do some of their own homework.

First of all, people have to understand that our “money” has no value outside the fact that our government has ordered that it must be an acceptable means to pay debt.  That’s what is called a “Fiat Currency“.  It’s backed by nothing accept the word of our government that it’s worth something and the belief of us that it is.  That’s a little scary in itself, but it’s pretty much the standard in monetary practice today.  However, now we’re going to combine this with our banking system being a “Fractional-reserve” banking system and things really start to look messed up.

This was explored exceptionally well in Zeitgeist: Addendum.  Some of the transcription is here:

A number of years ago, the central bank of the United States, the Federal Reserve, produced a document entitled “Modern Money Mechanics”.  This publication detailed the institutionalized practice of money creation, as utilized by the Federal Reserve and the web of global commercial banks it supports. On the opening page, the document states its objective: “The Purpose of this booklet is to describe the basic process of money creation in a fractional-reserve banking system”. It then proceeds to describe this ‘fractional-reserve process’ through various banking terminology. A translation of which goes something like this:

The United States Government decides it needs some money, so it calls up the Federal Reserve, and requests, say, 10 billion dollars. The fed replies, saying ” sure… we’ll buy 10 billion in government bonds from you.”

So, the government then takes some pieces of paper, paints some official looking designs on them, and calls them ‘Treasury Bonds’. Then, it puts a value on these Bonds to the sum of 10 billion dollars, and sends them over to the Fed. In turn, the people at the Fed draw up a bunch of impressive pieces of paper themselves, only this time calling them ‘Federal Reserve Notes’…also designating a value of 10 billion dollars to the set.

The Fed then takes these notes and trades them for the Bonds. Once this exchange is complete, the government then takes the 10 billion in Federal Reserve Notes and deposits it into a bank account…and upon this deposit, the paper notes officially become ‘legal tender’ money, adding 10 billion to the US money supply. And there it is… 10 billion in new money has been created. Of course, this example is a generalization, for, in reality, this transaction would occur electronically, with no paper used at all. In fact only 3% of the US money supply exists in physical currency. The other 97% essentially exists in computers alone.

Now, Government bonds are, by design, instruments of Debt and when the Fed purchases these bonds, with money it created essentially out of thin air, the government is actually promising to pay back that money to the Fed.

In other words… The money was created out of debt. This mind numbing paradox of how money, or value, can be created out of debt, or a liability, will become more clear as we further this exercise.

So, the exchange has been made and now 10 billion dollars sits in a commercial bank account. Here is where it gets really interesting, for as based on the Fractional Reserve practice, that 10 billion dollar deposit instantly becomes part of the bank’s Reserves, just as all deposits do. And regarding reserve requirements, as stated in Modern money mechanics:

“A bank must maintain legally required reserves, equal to a prescribed percentage of its deposits. It then quantifies this by stating: under current regulations, the reserve requirement against most transaction accounts is 10%.”

This means that with a ten billion dollar deposit, 10% or 1 billion is held as the required reserve, while the other 9 billion is considered an excessive reserve and can be used as the basis for new loans.

Now, it is logical to assume that this 9 billion is literally coming out of the existing 10 billion dollars deposit. However, this is actually not the case. What really happens is that the 9 billion is simply created out of thin air, on top of the existing 10 billion dollar deposit. This is how the money supply is expanded. As stated in Modern Money Mechanics: “…of course, they (the banks) do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes (loan contracts) in exchange for credits (money) to the borrower’s transaction accounts.”

In other words, the 9 billion can be created out of nothing, simply because there is a demand for such a loan, and there is a 10 billion dollars deposit to satisfy the reserve requirements.

Now, let’s assume that somebody walks into this bank and borrows the available 9 billion dollars. They will then most likely take that money and deposit it into their own bank account.

The process then repeats, for that deposit becomes part of the banks reserves, 10% is isolated and in turn 90% of the 9 billion or 8.1 billion is now available as newly created money for more loans. And, of course, that 8.1 can be loaned out and redeposited creating an additional 7.2 billion…to 6.5 billion.. to 5.9 billion etc.

This deposit-money creation-loan cycle can technically go on to infinity… the average mathematical result is that about 90 billion dollars can be created on top of the original 10 billion. In other words, for every deposit that ever occurs in the banking system, about 9 times that amount can be created out of thin air.

So that we understand how money is created by this fractional reserve banking system, a logical, yet elusive question might come to mind:

What is actually giving this newly created money value?

The answer: The money that already exists.

The new money essentially steals value from the existing money supply… for the total pool of money is being increased, irrespective to demand for goods and services, and, as supply and demand finds equilibrium – prices rise, diminishing the purchasing power of each individual dollar. This is generally referred to as ‘inflation’ and inflation is essentially a hidden tax on the public.

The problems of our economy is the system itself.  Now bankers and very large corporations have a lot to gain from this system so it’s never really brought to light by many of our politicians.  The very few that do are shunned or simply ignored like Ron Paul.

If you think any of these economic problems will be solved by bailing out banks, auto companies  or giving out stimulus packages, I suggest you do some real homework on the Federal Reserve and how it operates.  I would also suggest doing some research on the Amero and North American Union.  Stop relying what you see on CNN and Fox News for god sake.