Trying to understand money

Trying to understand money
June 23, 2012 Idea Guy

I took some time here to wrap my head around the way money works and I thought I try to shed some understanding since it can be a little complicated with all the finance jargon and specialized knowledge…

Debt = Money, Money = Debt

Where does money come from?  You would think that question would be simple, but it’s not the case.  Consequently, a vast majority of Americans have no clue about the US monetary system.  We all use money every day but most of us never stop to think about how it comes into existence.  The truth is that through the federal reserve banking system, currency is created out of thin air.  There is no backing to the green bills you carry, only by full faith and credit to the United States Government.  Although a commi (hehe, what I call a person versed in commerce) will remind you that the US has never defaulted on a loan and that this is about as much confidence as it gets.  I’ll let you decide as you read if you think this practice is as sound as all those commis assert.

In our financial system, the U.S. government cannot print money and no individual citizens are allowed to create money.  Rather, it is the bankers who enter into financial relationships with other bankers to create large sums of credit. Most of the time, any money that is created comes into existence as debt.  Either the U.S. government accrues more debt when it sells Treasury securities for Reserve Notes, banks go into more debt by taking on loans, or individual Americans go into more debt when they take out loans from any bank (mortgage, car loans, student loans, etc).

First, let’s examine how money is created.

(^ this chart may be a bit confusing, but it is just supposed to show the recycling of currency and where it ultimately ends up)

Under our current system, the United States government has a legal relationship with the central bank in order to conduct the financial affairs of the country.  The particulars of this relationship are defined by law or in other wards, a bank is granted a legal right to exist by the government supposedly in the interest of citizens, business, USA, etc.  What I’m getting at is if the U.S. government needs more currency (more money to pay it’s bills) it sells bonds in the form of Treasury securities.  A US  Treasury security is a government debt issued by the US Department of the Treasury through the Bureau of Public Debt.  They are the debt financing instruments of the US federal government to fund its operations.  When the “government” determines that there needs to be more currency in circulation, by government I mean the Federal Reserve Board of Governors and the FOMC (Federal Open Mark Committee), the Federal Reserve has 3 tools to respond.  The Fed is not to be confused with the Department of Treasury which manages government revenue and debt instruments.  The Federal reserve is the central bank intentionally seperate from the US Government.  The Treasury issues securities but doesn’t print money.  The Treasury “prints” currency via the Fed to reduce the potential for corruption, at least that was the idea I read somewhere.  Thus, the Treasury raises capital through the sale of treasury securities, the Fed being a large buyer.

The Federal Reserve central bank, a non-governmental organization, controls the supply of currency in the US economy, but more importantly affects where most of that supply ends up.  The Fed  has three tools in its belt to manipulate the money supply: 1. it can buy & sell treasury securities 2. alter the discount window rate  3. change the reserve requirement for banks.  I already went over treasury securities…Discount window lending is between any bank that is a a part of the Federal Reserve system.  The rate is on the loans between the banks that is facilitated through the Federal reserve who controls the rate at which these banks can lend to each other.  Which banks can do this? Pretty much every bank you’ve heard of is a part of 1 of the 12 reserve banks that comprise the whole US central bank. These bank are eligible to use the discount window, borrowing large sums of credit with varying interest rates, but recently zero. The last tool, the reserve requirement is how much of a bank’s deposits it is required to keep on hand.  So how much of the money that its customers deposit into savings accounts must be kept by the bank.  The rate currently is 10%.  So where does the other 90% of the money go? I’ll get to that soon…

While the fed can change the discount rate and the reserve requirement, it tends to use Treasury securities more often.  The last time the discount rate changed was on March 16, 2008.  And the most current reserve requirement was in effect by December 29, 2011.  Most of the time, the fed buys Treasury securities in order to increase capital in the market.  One important thing to note is that most of this currency is never printed or represented in cash.  Only 3% is printed on bills, the rest stored and traded via computers. Can you believe the dollar used to be backed by gold!?

Back to the discount window – the Federal Reserve determines the federal funds rate which is the interest at which banks loan to other banks.  These banks must have an account held at the federal reserve in order to be eligible for discount window lending.  There are 12 banking corporations corresponding to the 12 Federal Reserve Districts, created by the Federal Reserve Act of 1913.  These districts come with names like the Federal Reserve bank of New York, Richmond, Chicago, etc…  Through this exchange the Fed influences the supply of money at a Federal and district level.

Alright so the reserve requirement – the Federal Reserve sets the bank reserve requirement which essentially is how much cash a bank must keep in its vault.  The rate is approximately 10% (although lower than 11.5 million in deposits has no requirement, and between 11.5 and 71 million has a 3% requirement).  This means that when money is deposited into a bank through savings deposits or loans or any other means, the bank is only required to keep 10% of the total amount.  It is free to loan out the other 90%.  Say the Federal Reserve purchases a treasure security from a bank.  The fed credits the bank $100 million and the process of money creation begins.  The bank keeps $10 million on reserve and loans out the other $90 million to another bank.  The new bank takes the deposit, keeps $9 million and loans out $81 million.  This process continues and results in the banking system expanding the initial $100 million to a little less than $1 trillion ($100M + $90M + 81M + $72.90M + …=$1T). Start with $100 million and end up with $1 trillion…what a deal?! And this profit potential derives from tediously drafted financial legislation…

Money creation occurs using all three of these tools.  When the Federal Reserve buys treasury securities from the government, US currency is credited to the Treasury.  But where does this credit come from?  Well technically it comes for the legal rights granted to banks by the exclusive relationship between the Federal Reserve and US government.  But really credit comes into existence just because they say it does, created value from nothing.  In the same way the Federal Reserve purchases treasury securities from banks, crediting the their accounts with made up value.  I say it is ‘made up because the money that it deposits into the account is just a number on a computer.  Think about it like this – money is used for exchange, the exchange of things that have real value to those involved.  Currency simplifies commerce by providing a unit of standardization, allowing for anything to be traded.  The things traded have real value, whether food for sustenance, services, etc. However, when currency enters the market ‘top down’ issued by the Fed, it affects the real value of the goods and services that we experience in our every day life.  An important side note is that most of the currency coming from the Fed is not even printed into cash, but only ever exists as a number on a computer. Now it may be difficult to understand why this matters, but just remember that the Fed adds money to the economy that never gets printed.  The currency goes to banks which then are free to loan out 90% and the cycle begins.  See?  All that made up value in the form of additional currency to the economy goes straight to the banks who make a 90% profit basically right of the gun.

Now this is just explaining the foundation. As you may have noticed there are quite a few places for things to go awry.  A system which creates a flow of currency which by the very nature of the flow profits banks hugely.  This is just step 1 to understanding the increasing concentration of wealth and the the almost financial collapse in 2008.

More on the Fed

You may still be wondering what exactly the federal reserve is? Well I couldn’t even find a complete list of which banks comprise the 12 federal reserve banks.  Interestingly obscure…

The Federal Reserve  is not part of the U.S. government by design supposedly to prevent the centralization of governing power & money.

“Ostensibly, the Federal Reserve Banks are 12 private banking corporations; they are independent in their day-to-day operations, but legislatively accountable to Congress through the auspices of Federal Reserve Board of Governors. The Board of Governors is an independent governmental agency consisting of seven officials and their support staff of over 1800 employees headquartered in Washington, D.C. It is independent in the sense that the Board currently operates without official obligation to accept the requests or advice of any elected official with regard to actions on the money supply, and its methods of funding also preserve independence. The Governors are nominated by the President of the United States, and nominations must be confirmed by the U.S. Senate. The presidents of the Federal Reserve Banks are nominated by each bank’s respective Board of Directors, but must also be approved by the Board of Governors of the Federal Reserve. The Chairman of the Federal Reserve Board is generally considered to have the most important position, followed by the president of the Federal Reserve Bank of New York. The Federal Reserve System is primarily funded by interest collected on their portfolio of securities from the US Treasury, and the Fed has broad discretion in drafting its own budget,but, historically, nearly all the interest the Federal Reserve collects is rebated to the government each year.” – Wikepedia

So what’s the problem? Well Ron Paul puts it like this –

“The Federal Reserve in collaboration with the giant banks has created the greatest financial crisis the world has ever seen. The foolish notion that unlimited amounts of money and credit created out of thin air can provide sustainable economic growth has delivered this crisis to us. Instead of economic growth and stable prices, (The Fed) has given us a system of government and finance that now threatens the world financial and political institutions. Pursuing the same policy of excessive spending, debt expansion and monetary inflation can only compound the problems that prevent the required corrections. Doubling the money supply didn’t work, quadrupling it won’t work either.”

And now we’ve reached a point where you can hopefully understand generally how the monetary system operates to create money.  Next, to cover the housing marketing collapse, fall of Freddie Mac, the Fed intervention, the recession and all the other sketchy financial activity that went on.  This will elucidate how particular elites used the way the system works to gamble the livelihood of the world for more wealth…


Leave a reply