Posts Tagged ‘Banking’


July 6, 2010


(In case you don’t know, The “Fed” is the US Federal Reserve System.)

Why end the Fed? Most Americans have no idea. I think it’s important that every citizen understand this. If enough people did understand this, Ron Paul would now be the U.S. President.

The Fed is the means by which our government can tax us without limit, so the government can finance wars and other programs which taxpayers would refuse to support. The Fed is picking your pocket with the stealth tax.

Without the stealth tax, we probably would have avoided involvement in all of the wars of the past 100 years. There would be no American Empire.

Inflation caused by the Fed is the cause of the boom and bust business cycle, stock market, commodity, and housing bubbles, the great depression, and all the lesser recessions since then, including the present one. The course the Fed is following will assure that this recession will become a long, hard depression, with increasing unemployment and hardship.

The American Banking system is a cartel, and the Fed controls it. A cartel is a group of companies acting together to gain the advantages of monopoly: the profit advantage that comes from the exclusion of competition.

The banking cartel was created by the law which created the Fed. The system protects the banks from competition and from failure. Thus secure, the banks can invest recklessly. That recklessness was what caused the crash of 2008. Sure enough, the banks threatened with bankruptcy in 2009 were rescued with massive bailouts from the government. The excuse was that they were “too big to fail”.

Who’s to blame for this crazy system? I wish I knew. There is a hint, though in the identity of the people who drafted the law which created the Fed. In a secret meeting on Jekyll Island, Georgia in 1910, representatives of the Morgan banks, the Rockefeller banks, and Kuhn, Loeb & Co drafted the bill to create the Fed. The bill was passed into law by Congress in 1913

It would be interesting to trace the relationship of all the financial beneficiaries of the 2009 bailouts to see how they relate to the people who wrote the law, 100 years ago, that created the Fed.

Now I’m going to try to explain just how the Fed can cause all those problems. Bear with me. It isn’t simple. In fact the Fed is designed to create an illusion, to delude us into believing that our government, our banks, and our dollars are real, honest, and trustworthy. All these things rest on our faith. If we lose that faith, they will all collapse. That might return us to the sort of country, and government, that the Constitution originally spelled out.

The Evolution of the dollar

Our dollar started out as the Spanish silver dollar, a strong and trustworthy currency. Later we went onto a gold standard. The dollar was defined as one twentieth of a troy ounce of gold. Ten dollar and twenty dollar US gold coins circulated along with silver dollars. Paper treasury notes circulated in $1, $2, and $5 denominations. These, and silver coins, were all redeemable on demand in gold.

We were on the gold standard. Independent banks printed their own paper notes but they too were redeemable in gold. Banks did print some paper notes in excess of the gold they held, but prudence kept them from getting reckless, lest they get caught out and go bankrupt. This kept them fairly cautious and “reasonably” honest.

Bank customers deposited cash in checking accounts. Banks lent temporary fictitious money called credit to customers by crediting their checking accounts with dollars. Banks developed clearing systems so that checks written on an account in one bank could be deposited to an account in another bank. Any imbalance in the flow of money by checks from one bank to another was balanced by a transfer of gold between the banks.

These transfers of gold kept the banks honest, or at least “prudent”. They had to keep enough gold or silver cash on hand to redeem banknotes and checks. All the banks produced some banknotes and credit in excess of their cash reserves; call it an overhang. If they all had about the same overhang in proportion to their reserves, the interbank gold transfers would balance and they would all keep enough cash to redeem checks. Charging interest on credit outstanding was profitable and the chief source of income for banks.

Businessmen, investors, and speculators use credit to invest and make a profit. They always complain that there isn’t enough “money” in circulation. What they really mean, however is not money but cheap credit. The British had long since perfected a central banking system (The Bank of England) which provided lots of cheap credit. This provided funding for the many colonial ventures which eventually built the British Empire. Many Americans clamored for a duplicate of the Bank of England. They wanted to get rich quick, using cheap credit.

The Genesis of the Fed

Twice in the 19th century the US government created a central bank and twice the government, under new administrations, closed them down. Finally in 1913, the Fed was created. It has lasted nearly 100 years.

The purpose of a central bank is to form a cartel of the banking system, to coordinate the expansion of lots of credit on top of the gold reserves. By 1971, the number of dollars in circulation was so great And the value of the dollar so reduced, that foreigners were exchanging all their dollars for gold. At that point we simply went off the gold standard. The government confiscated all the gold. We were left with the fiat dollar. The law (fiat) said that the dollar was legal tender, and the legal tender law said that we must accept the dollar “for all debts, public and private”.

The Stealth Tax Alias Government Deficits

Government, more than anybody, likes cheap credit. Obscured by the smoke and mirrors of bookkeeping, (Now you see it, now you don’t!) the Fed “lends” the government whatever amount of money it wants. The loan is never repaid, and the interest the government pays the Fed is returned to the US Treasury. I’d call that loan an outright gift, wouldn’t you?

This is how our government finances its deficit. The Fed creates (counterfeits) new money for the government to spend. Talk about our grandchildren paying the mounting “debt” is a smokescreen. This is why people in government can say, “Deficits don’t matter.” That newly created money is spent as fast as it is created, and becomes a permanent addition to the money in circulation. That’s money inflation.

Something that’s hard to realize is that money, like any commodity, obeys the law of supply and demand. The more dollars available on the market (in circulation), the less each dollar is worth. Not immediately, but in time. The market reacts slowly because the realization spreads slowly that something has changed. Gradually all prices rise. You and I get less real wealth in goods for the money we earn. Uncle Sam has cleverly picked our pockets.

Remember, money is not wealth; it is just a medium of exchange. Putting it in terms of macroeconomics, the market adjusts prices so that the amount of money in circulation matches the amount of goods in production.

It would be tempting to set this down as an equation (It has been tried) but there are two problems with that. First, an equation implies an instantaneous reaction while the response of prices to money supply is a slowly ongoing process which never quite catches up with the latest change in the money supply.

The second problem lies in the definitions of “in circulation” and “in production”. They are both difficult to define and impossible to measure. But that is a fundamental problem with macroeconomics.

The Business Cycle

Perennial government deficits are a one-way street. Government wants money, the Fed supplies it, the government spends it, and goes back for more. The trend is an ever increasing money supply and an ever decreasing value of the dollar.

The business cycle, however, involves a cyclical variation of the money supply which is superimposed on the trend of increasing money supply caused by the government deficits.

The business cycle is caused by the efforts of the Fed to sustain an unsustainable boom. The boom is unsustainable because it is an illusion. The idea that manipulating the supply of money or credit can somehow increase the production of goods is a basic Keynesian fallacy.

The Fed tries to stimulate the economy by reducing interest rates to encourage the expansion of credit. The banks gladly extend credit at low interest, mostly to businesses.

Businessmen invest the new money on capital goods to improve productivity in hopes of profits. Such expansion appears profitable because of the new low interest rates.

The boom that follows does not affect everyone equally. Rather than increase total production, it shifts some productive activity away from production of consumer goods to production of capital goods: the buildings, machinery, and tools needed to improve production. These capital goods will increase productivity, in time. Meanwhile, the supply of consumer goods will be reduced to provide the means (labor and materials) to produce the capital goods.

The Fed operates on the Keynesian fallacy that adding money to the system is all that is needed to expand production and maintain prosperity. However, added production requires added materials and labor. Increasing the production of materials requires even more added labor. Labor is the limiting factor in a boom. More money can’t create more labor. It can only shift workers between jobs and companies and industries.

To persuade workers to move to new jobs requires offers of increased pay. This is the beginning of the price inflation which always follows an increase in the money supply. As workers spend their increased pay, we find an increasing supply of money chasing a reduced supply of consumer goods. Price inflation follows. Wage inflation spreads.

As with the stealth tax, the means to invest in capital goods is taken by stealth from the value of every dollar in circulation. It also reduces the value of my insurance policy and your pension fund.

The action of the Fed has defeated our efforts to provide for the future. The Fed has taken away our free choice as to how much to spend now and how much to provide for the future. We have been forced to do without some consumption goods now, to subsidize industry in the hope of better or cheaper goods in the future.

Businesses calculate the investment in new capital goods to be profitable on the basis of current prices of materials and labor. Increasing prices of materials and labor may be enough to turn the profit to loss. Some of those projects will fail. When this happens, new buildings and machinery will be wasted, abandoned or sold off at a loss.

When the banks feel that the credit they have expanded has become excessive in proportion to their reserves, they will halt the expansion or even reverse it. To do this, they will raise interest rates on their outstanding credit. This will cause more businesses to fail.

When, finally, some businesses default on their interest payments, bankers will panic and call in loans to retreat to a safer reserve ratio. This is the crash phase of the business cycle. Businesses retrench, downsize, and lay off workers.

The money supply has suddenly shrunk and prices and wages have dropped. Unemployment soars. Recession has arrived. The boom was started by creating money out of nothing. Now the money has returned to the nothingness from which it came. The Fed has orchestrated the cycle, guided by the fallacies of John Maynard Keynes.


June 18, 2010


I’m going to try to explain the hat trick by which money in banks appears out of nowhere.

This may seem crazy to non- economists, but this “pulling money out of thin air” is the cause of the business cycle, the boom and bust and depressions which make the supposedly free market fail and cause periodic misery for millions: companies that fail and the unemployment that scares us. Understanding the hat trick points the way to end that misery. And it’s not enough for the economists to understand it; unless we all understand it, we can’t muster enough political power to stop it.

The hat trick is built into the system all businesses use to keep track of their financial condition. It’s called “double entry bookkeeping”. Each money transaction is recorded in two columns, as either an asset or a liability. The columns are supposed to balance at all times.

When the bank lends me $1000, it opens a checking account in my name. It enters $1000 on the liability side of the ledger. The liability is the new checking account. The bank owes me $1000. I can write checks on my new account and the bank is obliged to redeem them right away.

The entry on the asset side of the ledger is my IOU to the bank. I have promised to pay back the $1000 in 1 year (with interest, but let’s ignore that). So now the balance sheets show additions of $1000 debit and $1000 credit. The book balances, right? Not really. The amounts balance, but the reality doesn’t.

$1000 cash in hand is not at all equal a $1000 IOU to be paid in one year. I can spend the $1000 now. The bank can’t spend my IOU. I assure you that my word is as good as gold, but you can’t know that. So nobody but the bank will accept the IOU as money

The bottom line is that the bank has converted my IOU into temporary cash, $1000 for 1 year. At the end of the year I’ll pay my debt. The $1000 will disappear by way of a pair of entries in the bank’s books, and the interest I pay will be added to the bank’s assets.

Bankers are convinced that this is open, honest, and above board. It’s all down in the book, for anyone to see. It just doesn’t mention that the $1000 asset won’t be a real asset until next year. So for the next year, an extra $1000 will be added to the supply of money in circulation.

Honest or not, it’s a time honored tradition of banking. It’s legal. OK, it’s a gamble. If I spend the borrowed money and then die penniless, it’s a dead loss for the bank. That’s partly what the interest is for, to compensate for such risk. If one out of 20 such loans fails, the bank will still be earning 5% interest on all of the money they pulled out of the hat.

Someone has said that double-entry bookkeeping is one of the greatest inventions. I’ve always found it confusing enough to make me suspect smoke and mirrors- a hat trick.

But– what the banks give, the banks can take away. Aside from the banks making money out of their hat trick, they cause the amount of money in circulation to rise and fall, causing the distorting oscillations of the business cycle.

Why get excited about this hat trick? Practiced by many banks, coordinated by the Federal Reserve, and protected by deposit insurance, the practice of fractional reserve banking gives us a sick dollar, with alternate fever and chills, and most painfully, periodic mass unemployment.

The hat trick causes the humps and hollows in the economy, such as the frenzy of the stock market boom and crash of the 1920s, the depression of the 1930s & 1940s, the stagflation of the 1970s and the Housing bubble and plunge into depression of 2008. And each time, we have spells of unemployment. That’s serious business.

100 years ago, very few people had bank accounts. Workers received their pay in cash or checks. They promptly cashed them at a bank or currency exchange. Banks worked for years to gain our trust, so now nearly everyone has a bank account. We trust the banks and the dollar. It’s only because of that trust that we can be so easily fleeced by the banks and government. The banks need our money in their bank accounts as a base for a pyramid of temporary money called credit. For every dollar that we keep in a bank account, banks can maintain $10 of temporary money (credit), earning interest.

This is all legal. Some judge long ago decided that your deposits in a bank are not deposits for safekeeping, but a loan. If the bank gets in trouble and can’t pay you back, that’s just your tough luck.

The rules of honest banking wouldn’t allow this. Every dollar in a deposit account (Payment on demand) should be backed by a dollar of cash in the vault.

Why Banking?

April 2, 2010

Why Banking?

Metal coins are convenient, but there is always the risk of theft. Storing gold and silver safely is a problem. Long ago goldsmiths and silversmiths needed to safely store gold and silver for their production of jewelry, tableware, etc. They found it profitable to store other people’s money as well, for a small fee. They would give the depositor of the money a receipt, a claim check with which he could reclaim his money at any time.

These receipts were soon circulating in the economy in place of coins. In time the receipts evolved into banknotes of fixed value which could be redeemed for, say, a pound of silver or an ounce of gold. Gradually the goldsmiths and silversmiths became bankers.

Banknotes were more convenient to carry than coins. Since then banks have developed other ways to facilitate payments, by check, debit and credit card, and electronic transfer of money. Banks act as go-betweens to lend the deposits of savers to borrowers.  Thus banking added another level of convenience to the use of money. Unfortunately, and perhaps unintentionally, their lending business developed into a form of counterfeiting. I’ve already covered that subject in previous blogs.