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crisis has an exit By Ellen
Countries everywhere are facing debt
crises today, precipitated by the credit collapse
of 2008. Public services are being slashed and
public assets are being sold off, in a futile
attempt to balance budgets that can't be balanced
because the money supply itself has shrunk.
Governments usually get the blame for excessive
spending, but governments did not initiate the
crisis. The collapse was in the banking system,
and in the credit that it is responsible for
creating and sustaining.
popular belief, most of our money today is not
created by governments. It is created by private
banks as loans. The private system of money
creation has grown so powerful over the centuries
that it has come to dominate governments globally.
The system, however, contains the seeds of its own
source of its power is also a
fatal design flaw.
The flaw is that banks
advance "bank credit" that must be paid back with
interest, continually requiring more money to be
repaid than was created as loans; the only way to
get additional money from the private banking
system is to take out yet more loans, at interest.
The system is, in effect, a pyramid scheme. When
the banks run out of borrowers to support the
pyramid, it must collapse; and we are nearing that
There are more sustainable
ways to run a banking and credit system, as will
How banks create
money The process by which banks create
money was explained by the Chicago Federal Reserve
in a booklet called Modern Money Mechanics.
"The actual process of money creation takes
place primarily in banks." [p3]
"[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
in exchange for credits to the borrowers'
transaction accounts. Loans (assets) and deposits
(liabilities) both rise [by the same amount]."
"With a uniform 10 percent reserve
requirement, a $1 increase in reserves would
support $10 of additional transaction accounts."
A $100 deposit supports a $90 loan, which
becomes a $90 deposit in another bank, which
supports an $81 loan, etc.
conventional model, but banks actually create the
loans first. They find the deposits to meet
the reserve requirement later. Banks create money
as loans, which become checks, which go into other
banks. Then, if needed to clear the checks, they
borrow the money back from the other banks. In
effect, they borrow back the money they just
created, pocketing the spread between the interest
rates as their profit. The rate at which banks can
borrow from each other in the United States today
- the Fed funds rate - is an extremely low 0.2%.
How the system evolved The
current system of privately issued money is traced
in Modern Money Mechanics to the 17th
century goldsmiths. People who left gold with the
goldsmiths for safekeeping would be issued paper
receipts for it called "banknotes". Other people
who wanted to borrow money were also happy to
accept paper banknotes in place of gold, since the
notes were safer and more convenient to carry
The sleight of hand came in when
the goldsmiths discovered that people would come
for their gold only about 10% of the time. That
meant that up to 10 times as many notes could be
printed and lent as the goldsmiths had gold.
Ninety percent of the notes were basically
This system is called
"fractional reserve" banking and was
institutionalized when the Bank of England was
founded in 1694. The bank was allowed to lend its
own banknotes to the government, forming the
national money supply. Only the interest on the
loans had to be paid. The debt was rolled over
That is still true today.
The US federal debt is never paid off but just
continues to grow, forming the basis of the US
money supply. The public banking
alternative There are other ways to create
a banking system, ways that would eliminate its
Ponzi-scheme elements and make the system
sustainable. One solution is to make the loans
interest-free; but for Western economies today,
that transition could be difficult.
Another alternative is for banks to be
publicly owned. If the people collectively own the
bank, the interest and profits go back to the
government and the people, who benefit from
decreased taxes, increased public services, and
cheaper public infrastructure. Cutting out
interest has been shown to reduce the cost of
public projects by 30-50%.
In the United
States, this system of publicly owned banks goes
back to the American colonists. The best of the
colonial models was in Benjamin Franklin's colony
of Pennsylvania, where the government operated a
"land bank". Money was printed and lent into the
community. It recycled back to the government and
could be lent and relent.
The system was
mathematically sound because the interest and
profits returned to the government, which then
spent the money back into the economy in place of
taxes. Private banks, by contrast, generally lend
their profits back into the economy, or invest in
private money-making ventures in which more is
always expected back than was originally invested.
During the period that the Pennsylvania
system was in place, the colonists paid no taxes
except excise taxes, prices did not inflate, and
there was no government debt.
private banknotes became the national US
currency The Pennsylvania credit system was
sustainable, but some early American colonial
governments just printed and spent, inflating the
money supply and devaluing the currency. The
British merchants complained, prompting King
George II to forbid the colonists to issue their
Taxes had to be paid to England
in gold. That meant going into debt to the English
bankers. The result was a massive depression. The
colonists finally rebelled and went back to
issuing their own money, precipitating the
In an international
first, the colonists funded a war against a major
power with mere paper receipts, and won. But the
British counterattacked by waging a currency war.
They massively counterfeited the colonists' paper
money at a time when this was easy to do. By the
end of the war, the paper scrip was virtually
worthless. After it lost its value, the colonists
were so disillusioned with paper money that they
left the power to issue it out of the US
Hamilton, the first US Treasury Secretary, was
faced with huge war debts, and he had no money to
pay them. He therefore resorted to the ruse used
in England known as fractional reserve banking. In
1791, Hamilton set up the First US Bank, a largely
private bank that would print banknotes "backed"
by gold and lend them to the government.
The ruse worked: the paper banknotes
expanded the money supply, the debts were paid,
and the economy thrived. But it was the beginning
of a system of government funded by debt to
private bankers, who lent banknotes only nominally
backed by gold.
During the American Civil
War (1861–1865), president Abraham Lincoln avoided
a crippling war debt by returning to the system of
government-issued money of the American colonists.
He issued US Notes from the Treasury called
"Greenbacks" rather than borrowing at usurious
interest rates. But Lincoln was assassinated, and
Greenback issuance was halted.
the privately owned Federal Reserve was authorized
to issue its own Federal Reserve Notes as the
national currency. These notes were then lent to
the government, eliminating the government's own
power to issue money (except for coins). The
Federal Reserve was set up to prevent bank runs,
but 20 years later we had the Great Depression,
the greatest bank run in history. Robert H
Hemphill, credit manager of the Federal Reserve
Bank of Atlanta, wrote in 1934:
We are completely dependent on the
commercial Banks. Someone has to borrow every
dollar we have in circulation, cash or credit.
If the Banks create ample synthetic money we are
prosperous; if not, we starve.