Wednesday, April 1, 2009

Money Ex Nihilo

Since our little economic crisis took center stage, I have been trying, vainly, to understand it, along the way trying to understand money and a little concept called “debt-based currency.” Recently, I think I’ve got it—not thoroughly, to be sure, but enough to be able to perceive a monstrous scam when I see one, thanks to an amazing little article I suggest everyone read: “Dollar Deception: How Banks Secretly Create Money,” by Ellen Brown, J.D. on It doesn’t have to do with AIG or with credit default swaps or securitized mortgages. It has to do with the basic idea of money creation, who creates it, and how.

Begin with some common misconceptions. 1) The Federal Reserve is the nation’s bank, a public, government entity. Wrong. The Federal Reserve is actually a consortium of private banks, which creates money and lends it to the government, to us, at a nice rate of interest. 2) The Federal Reserve, by creating its Federal Reserve notes, i.e. printing all that money we all lust after, makes most of the money supply. Also wrong. Forget paper money: most of the money that’s created is actually created by plain old banks when they make loans. 3) The money that banks create is actually backed by something substantial, like gold or silver. Wrong. The United States went off the gold standard in 1933, when Franklin Delano Roosevelt made this move to keep what money was left in the United States from fleeing to foreign banks. Since then, the legendary stash of gold in Fort Knox supposedly backing our paper dollars no longer exists. Your dollars are backed by literally nothing except the U.S. government’s pledge to honor them in some way that is not clear. It’s a bit of a magic trick, kept afloat by the faith of people and businesses (and countries like China and Saudi Arabia which hold so much U.S. debt that if they ever decided to call it in, we’d all be in the sewer).

But let’s get back to basics. Banks create money out of thin air. Ellen Brown cites an astonishing lawsuit that illustrates this in an amazing way. In 1969, a man named Daly was about to lose his home to a bank that held a $14,000 mortgage on it. Daly, a lawyer, decided to sue the bank for not having “consideration,” or something of value, backing its loan to him. In court, the bank’s president admitted this was true, saying that the bank routinely created money “out of thin air” for its loans, which he said was standard practice in the industry. The judge, a Justice of the Peace named Mahoney, reiterated what he had heard: “Plaintiff admitted that it, in combination with the Federal Reserve Bank of Minneapolis…did create the entire $14,000 in money and credit upon its own books by bookkeeping entry. That this was the consideration used to support the note…[and that] the money and credit first came into existence when they created it. Mr. Morgan [the bank president] admitted that no United States Law or Statute existed which gave him the right to do this…” Given these facts—that the bank was actually extending credit without backing its loans with anything it actually had in its vaults—the court ruled against the bank’s foreclosure claim, and Daly kept his house.

Now elementary banking theory seems to partially admit this. It grants that since at least the 17th century, in a practice started by goldsmiths, bankers have engaged in what is known as “fractional reserve banking.” That is, when people deposited their gold with goldsmiths, and received paper notes testifying to the amount and allowing them to redeem the gold when they needed it, the goldsmiths holding the gold noticed something. People never came all at once to redeem their gold. In fact, at any one time, only about 10 or 20% of the gold was needed to redeem the notes people presented. This meant that the goldsmith could actually lend from 5 to 10 times as much money (in notes) as they had backed with gold. This became the basis for “fractional reserve banking” and most currency: except in situations like the Depression, where everyone suddenly wants to redeem paper bank notes for gold or silver in what is known as a “run” on banks, banks could lend out—literally create—far more money than they actually had in reserves. Ellen Brown quotes some notable bankers on this.
Sir Josiah Stamp, president of the Bank of England in the 1920s:
“The modern banking system manufactures money out of nothing. The process is perhaps the most astounding piece of sleight of hand that was ever invented.”

Or Graham Towers, Governor of the Bank of Canada from 1935 to 1955:
“Banks create money. That is what they are for. . . The manufacturing process to make money consists of making an entry in a book. That is all. . . .Each and every time a Bank makes a loan . . . new Bank credit is created -- brand new money.”

Or Robert B. Anderson, Treasury Secretary under President Eisenhower:
“[W]hen a bank makes a loan, it simply adds to the borrower's deposit account in the bank by the amount of the loan. The money is not taken from anyone else's deposit; it was not previously paid in to the bank by anyone. It's new money, created by the bank for the use of the borrower.”

To get some idea of the amount of money that gets created this way, and its inflationary effect (creating money means more dollars (demand) chasing the same amount of goods (supply), hence prices tend to rise) Brown cites the Fed’s own money supply (M3) statistics. First of all, new money has to be created all the time, i.e. borrowed, “just to pay the interest owed to bankers. A dollar lent at 5 percent interest becomes 2 dollars in 14 years. That means the money supply has to double every 14 years just to cover the interest owed on the money existing at the beginning of this 14-year cycle. The Federal Reserve’s own figures confirm that M3 has doubled or more every 14 years since 1959. That means that every 14 years, banks siphon off as much money in interest as there was in the entire economy 14 years earlier. This tribute is paid for lending something the banks never actually had to lend, making it perhaps the greatest scam ever perpetrated…”

Now think about it. Bankers, and especially those in the big banks like Citibank and Morgan and Chase and Wells Fargo and Bank of America, have been getting rich on this “greatest scam ever perpetrated” for years, a scam that at one time was called usury. But not content with making billions on interest, especially from the difference between the rate they pay to borrow the money from the Federal Reserve and the outrageous rate they have been allowed, since 1981, to charge their credit card customers (one of my bank credit cards just informed me that my interest rate was being raised about 4%, the difference between the essentially 1% they get it for and the 13% they now charge me being their profit, not to mention the profit they make from poorer folks whom they charge 25 and 30% for the same credit), they had to get into “subprime” mortgages and complicated securitized debt instruments as well, so they could make even more obscene profits. All of which came a cropper when the housing bubble burst and all that debt going bad (I gather that that debt or money owed them is what banks tend to use as “consideration”) threatened to take the whole financial system down with them. And which they then had the nerve to beg the Federal Government via taxpayers to rescue them from. And which the government, using taxpayer dollars, urged the sucker public to agree to because otherwise we’d all be doomed.

Now, with a new president to hopefully instill some root sense into the whole system, we find that his top advisers, the Summers and Geithners and Emanuels and Goolsbees, are not only “centrist” and rooted in the financial system themselves, as are all our so-called representatives who derive the bulk of their contributions from this same financial sector, but in practice determined to revive and maintain the same bankers and the same system that brought us all to the brink of financial Armageddon in the first place.

So consider. Bankers create money out of nothing. And then charge us and the government (also us) interest on it. Not a bad way to make a living, one you’d think would be enough for these charlatans (who, by the way, pay their working-class tellers about $11 an hour to start). But no. Greed, by definition, knows no moderation, never says ‘this is enough.’ No, greed is infinite. Until, that is, the people finally wake up and get fed up and cry “foul.” Some of that has been happening already regarding the bonuses to the AIG scoundrels. Now what one hopes is that the outrage will continue until all banks and bankers and their whole system are truly brought to heel, along with insurance companies and the rest of the Wall Street bunco artists. How this might happen is not something I’m competent to predict (Ellen Brown suggests establishing a true government bank that prints its own money but doesn’t charge itself interest; think of the savings!) But perhaps we can all find out before it’s too late. Meantime, next time you see your banker, you might let him know that you know: Money ex nihilo might sound godlike, but it’s more like what Freud said it symbolized—the doings of the other end.

Lawrence DiStasi

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