Tag Archives: money creation

Web of Debt, by Ellen H. Brown, is a fascinating treatment of the monetary history of the U.S. and a revelation of how money is created in modern monetary systems. She writes in an engaging and highly readable style about one of the most critical issues that runs through all of American history from Colonial times through today with the financial crisis and Great Recession. There are no equations that I recall, a handful of charts, but mainly a lot of well-researched history and interesting anecdotes.

You can listen to an audio of the book’s Introduction here: http://www.webofdebt.com/media/WebofDebtintro.mp3.

There have been continuing struggles in the U.S. over the type of money, private or public, and gold, silver or paper, throughout the past 250 plus years. She focuses particularly on the time from the Civil War until present day. Who creates the money is just as important, if not more so, than what type of money we have.

Most money, including that in your checking or savings account (CD) resides as digits inside computers and not as stacks of bank notes, which represent only a few percent of the total. Money is created almost entirely by private commercial banks, not by the Treasury department, and not by the Federal Reserve (although the Fed does create monetary reserves or base money)[1]. But money in general, the money we know and love and use in the real economy, is created out of thin air by banks as a direct result of the process of making loans to individuals and companies. The banks create most of the money supply and the Fed creates the underlying bankers’ money.

Thus money is debt and debt is money. If loans outstanding expand, so does the money supply; if loans contract, the money supply contracts. With all the discussion currently around the “fiscal cliff” recently it is critical to understand that if the US government debt were to be paid off quickly, the money supply would shrink to a fraction of its present value, completely undermining the economy and causing not only a very severe depression but untold suffering.

The Fed has worked in recent years to try to increase the money supply in order to avoid deflation and depression and ameliorate unemployment. But they have been having a hard time of it, because it’s the banks and the players in the economy that have the real control. As banks foreclose on mortgages or write down loans the money supply decreases. As they tighten lending standards and as consumers and corporations cut back on borrowing and sit on cash, the money supply stops expanding or falls, and the velocity, or rate of turnover contracts.

Now this money created as debt is leveraged through the “magic” (or fraud) of fractional reserve banking. Banks are allowed to create 10 times or more money in loans than they have as reserves at the Fed. This is the “secret” of fractional reserve banking.

The book begins with, and almost revolves around, the story of the Wizard of Oz, written by Frank Baum. This is not just a child’s story, or a great American fairy tale, but actually was written purposefully as an allegory about the monetary battles in the U.S. at the end of the 19th century. For example, in the Wizard of Oz the yellow brick road represents the gold standard. When Dorothy throws water on the Wicked Witch of the East (the New York banking interests led by J.P. Morgan) it represents liquidity (greater money supply) which melts the witch.

Prior to the Civil War the US was on a bimetallic standard, that is, both gold and silver coin were minted. Paper money was issued by state-chartered banks. During the Civil War the US was on a national fiat money standard with the issuance of paper money (Greenbacks). But in 1873 the US reverted to a gold (only) standard.

As a result, in the post Civil War period, the bankers were able to keep credit tight and farmers were heavily in debt and often facing foreclosures by the banks. There were repeated booms and busts and the economy was generally deflationary, due to an insufficient money supply. A fight emerged between the Eastern banking establishment’s support of the gold standard, and their desire to keep the money supply restricted, and alternatively, the demand for greater coinage of silver or issuance of Greenback US Treasury notes as alternatives advocated by farmers and laborers for greater liquidity (and better prices for agricultural products).

There was no Federal Reserve during this time, that didn’t come until 1913, approaching the eve of World War 1. Coinage was created by the Treasury (US Mint) but was insufficient, there were Greenbacks in circulation, and there were Gold certificates (back by gold coin), Silver certificates (backed by silver coin) and Treasury notes (back by government bonds).

Gold and silver coins, and our modern coins represent debt-free money. In addition Greenback US Treasury notes were also issued as debt-free money. So either paper money or coin money can be debt-free.

In contrast, today’s Federal Reserve notes are backed by US Treasury bonds or agency bonds held by the Fed and are thus debt-laden money. US coinage, amounting to less than 1% of the money supply and issued by the Mint, is debt-free.

Ellen Brown’s fine book helps you understand these issues, and how the private banks struggled to grab control of the monetary system away from the US government. They won the battle in 1913 with the creation of the Federal Reserve system[2], and further consolidated their control with the elimination of the gold standard in 1971 by President Nixon. The value of the dollar has fallen by over 23 times (what was a dollar has shrunk to 4 cents) since the Fed was established because the bankers get to touch the money supply first, and continually earn interest on it, and thus it is in their direct interest for it to expand continuously, even faster than necessary to support population and productivity growth.

Federal Reserve Notes, legal tender for all debts public and private, note Green seal on right front side (and they retain the green back of Lincoln’s debt-free US Treasury notes).

In fact, in a debt-based money system, there is no real alternative, since loan principal must be paid back with interest added on top. When loans are created the principal is created, but not the interest! If the majority of people are going to be able to pay interest and principal fully on their mortgages and car loans and credit cards, then the money supply must continually expand. The Fed has indirect influence over the supply of money through direct market operations and the influence over interest rates, especially short-term rates, but not the ultimate control. (Thus the expression “pushing on a string” especially when short-term interest rates are near zero.)

Web of Debt is a great place to start to understand these issues, or for those who have a good understanding already, to get another perspective. The explanation of the tie-in to the Wizard of Oz[3] allegory is very interesting. Towards the end of the book she explores alternatives to our current system, such as the elimination of fractional reserve lending, and bringing the Federal Reserve system within the Treasury department, thus enabling a return to Treasury issued debt-free money. The government debt could be retired over a period of some years by paying the interest and principal as they came due with debt-free US Treasury issued Notes. This is not a radical idea, below is the image of a US  Note issued as recently as 1963, and which I remember in circulation when I was much younger (note the distinguishing red seal and red numbers and United States Note at the top). In reality, such US Treasury Notes would be primarily in the form of digits inside computers, just as Federal Reserve Note-based money is today.

The book is available through the author’s web site, Amazon and elsewhere in physical or e-book format.

Sections in Web of Debt:

1. The Yellow Brick Road: From Gold to Federal Reserve notes
2. The Bankers Capture the Money Machine
3. Enslaved by Debt: The Bankers’ Web Spreads over the Globe
4. The Debt Spider Captures America
5. The Magic Slippers: Taking Back the Money Power
6. Vanquishing the Debt Spider: A Banking System that Serves the People

Footnotes:

[1] These monetary reserves are used exclusively between banks and the Federal Reserve. Individuals and non-banking corporations cannot have accounts at the Federal Reserve, only banks in the system can. Monetary reserves theoretically provide some limit on how much money banks can create through reserve requirements, but in practice have little effect since banks can and do lend reserves to one another. This monetary base can be said to support the much larger stock of money used in the economy and around the world.

[2] Is the Fed public or private? It’s a hybrid. Some call it the fourth branch of government, but in many ways it stands outside of the government, although in practice it coordinates with the Treasury. There are 12 regional Federal Reserve banks in the system; they are fully owned by the member banks, not by the government. The member banks, not the government, own the shares and receive dividends. The NY Fed is first among equals, it engages in the monetary operations in concert with the commercial banks centered in New York. The system has oversight by the Chairman and the Board of Governors whose members (generally bankers or academic economists) are appointed by the President, and who report to Congress regularly. Profits of the Federal Reserve system are returned to the US Treasury. But the Fed guards most of its operations in secrecy and is not fully audited.

[3] What is Oz? Simply, Oz = oz. = ounce, as in ounce of silver, or ounce of gold.