Punchinello’s Chronicles

April 12, 2009

Fractional Reserve Banking and Money from Nuthin’

Well, I decided I’d better continue my discovery of economics and how money works. Of course we don’t learn any of this in school anymore. We don’t learn civics and how the political system in the country works. Nor are we taught even the most basic concepts of economics and money. I learned a lot of it from my father, but then, as I got older I began reading more about money on my own. One of the benefits of reading is that we get educated.

In today’s world, where everyone seems to be talking about money, I thought it’d be a good idea to have some specifics in my head. Specifically, how the Federal Reserve works. That’s the Central Bank of America, for anyone who imagines that we don’t have a central bank, like they do in Europe.

Holy Crap! We are SO screwed, it’s beyond comprehension! In fact, given the manipulations by world bankers over the past 100 years, we’ve reached a point of a borderless economy. Money moves around the world so fast (with computers) that we have a term, “stateless capital.” That means money from outside the nation’s borders. People invest it, then if there’s a problem, they pull it out.

Since stateless capital is under no bank’s control (forget political control, there isn’t any), it’s basically chaos.

Even the sophisticated bankers, financiers, super-wealthy investors, Wall Street tycoons, and central economic planners have no idea what’s going to happen with the US dollar collapsing.

Suppose you and I decide we’re going to create our own bank. We’ll call it the VRFM Bank of Punchinelloland. That’s the Virtual Reality Funny Money bank. All we need is a charter from the state and we’re in business. The first question is whether or not there are any laws or regulations we have to abide by. Nope. None. Of course I’m over-simplifying, but only to make a point.

So we get our first depositor, Peter, who puts $100 in the bank. We’re in business! We’ve got $100. But unfortunately, that won’t make us any money. It gets us capital of a sort, but we need to do something with that money. We need to make it work for us.

There’s only one way a bank makes money, basically, and that’s by charging interest. When someone uses money (a loan), they have to pay for that use. The money they pay is interest.

Alright, so we want to lend out money. How much can we lend before someone yells at us? If we lend out the entire $100, what happens if Peter wants to take out $20 from the Automatic Teller Machine (ATM)? No, we have to keep some money in reserve.

Here’s the thing: You’d think that we’d have to keep at least a large portion of Peter’s money in the bank, right? Nope, wrong. That’s because in addition to Peter, we have lots of other “customers” who deposit money in our bank. At any given moment, we trust in luck (not God) that most people will leave their money alone.

According to the rules set by the Federal Reserve, we really only need to keep 10% of our deposits in the bank. So we need only $10 of Peter’s money. Then we can loan out $90 (90%).

Two things are interesting about this. First, the Federal Reserve is a private bank. It’s illegal and unconstitutional, but Congress authorized the creation of the Federal Reserve bank, back in 1913. President Woodrow Wilson signed it into reality, despite there being a clear statement in the Constitution that ONLY Congress can print money. Oddly enough, the Federal Reserve is allowed and authorized to print money. And set banking regulations.

The second interesting thing (literally), is that the Federal Reserve can set interest rates as well as how much money has to be held in reserve by any bank. We already know that we have to keep $10 in reserve, but that’s only for short-term money, what Peter might pull out of the ATM. In fact, ATM money is called “vault cash,” and we really only need to keep 3%, or $3.

For long-term money, like certificates of deposit, savings accounts, and money that will be in the bank a particular length of time, we can keep zero in reserve. That’s 0%. Zip, zero, nada. How cool is THAT!

But for the moment, we get to lend out $90 and we can charge interest on that money. So we get, say, $2/year coming in on our (Peter’s) ninety bucks. And we don’t have to have anything in the bank. After all, who’s going to come running to the bank and demand their money back? The economy’s great, don’t’cha know.

Well, okay, but just suppose people come to the bank and want money? The Federal Reserve stands ready to lend us money. They’ll lend money to the VRFM bank because we’re a bank. And they charge us interest! You and me! The bank! By golly, if we borrow money from the Fed, as it’s called, then we have to pay them interest.

Ah…so where does the Fed get the money to lend you and me?

The Federal Reserve has the right to create money. They “say it’s money because they say so.” That’s called fiat money, backed by nothing at all other than say-so. We’re told that this fiat money is backed by the goods and services of the US economy, but that’s just for public relations. In fact, it’s backed by nothing. It’s just paper.

So the Fed lends us $80 to cover an odd moment when a few of our customers happen to want money. That’s fine, and we lend out that $80 too. Nobody wants cash, really, they want a loan. Or a credit card.

We’re now lending out $90 of Peter’s money, and getting interest on that. We’ve also borrowed $80 of nothing from the Fed, and we can lend that out to Paul. And Paul pays us interest. But we’re paying the Fed interest.

What’s even cooler is that we now can claim, on the accounting books, that we actually have $180! In fact, since we expect interest on the money we lent out…let’s say $5…we really have $185. Hah!

Since we have $185, we can lend out everything except about $18. And of course that puts us at risk in case some other ignorant bank customer wants their money. So we go back to the Fed and ask for another $100. Just in case. And they print up some more paper, loan it to us, and we have to pay interest to them.

Almost all the money that comes into yours and my hands is from the Federal Reserve. You can look at a dollar and see right there that it’s a Federal Reserve Note. The government tells us we have to accept it. The good news is they have to accept it when we pay taxes.

Only the Federal Reserve has the authority to create money for the United States. They tell the Treasury to actually run the printing press, but the Fed creates the money.

Would you like to see higher taxes to pay for all the programs and wars? Nope, neither would I. So to get around that, the politicians simply borrow money from the Fed, and Social Security and other countries. How did we pay for the war in Iraq? We borrowed money from the Federal Reserve. Who pays it back? You and me.

Is there any limit to how much money the Fed can print? None whatsoever. They used to try and keep 10% of whatever toilet-paper they’d printed, just to look good. But now they don’t bother.

Wanna know how come it costs ten times as much to buy today what you used to buy yesterday? Because of inflation. There’s more money in the economy than the value of goods. Therefore, the price goes up. The only drawback is that you and I don’t own a bank. Nor can we print our own money.

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