Our banking system, established by the Federal Reserve Act of 1913, works essentially like a spring. When the Central Bank, the Federal Reserve, wishes to create new money, it simply does so, but often at the behest of the US government. The government asks for money and we get it with the requisite interest slapped on. But importantly - functionally there are no reserves to our money.
The Fed then spends this money, usually to buy Treasury Bonds from private owners of the bonds (more recently to bailout or help huge banks buyout failing banks), which the sellers had purchased from the Treasury Department. These bonds (and Treasury bills, TIPS and notes) were initially sold to the public to fund government deficits. The money created by the Fed is the spring. The spring gets stretched in the following manner....
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Banks, privately-owned, are permitted to loan out 90% of this new Fed-created money once it is deposited by the sellers of the bonds. That would not be a problem, except for the fact that the borrowers almost always redeposit the money (or the people they pay with their loan proceeds do). Once re-deposited, the banks can lend it out again. This re-loan, redeposit, re-loan, redeposit, invest etc. scheme, authorized by the Federal Reserve Act of 1913, allows banks each time to retain just 10% of the re-deposited loan proceeds as a reserve, ultimately allowing banks to lend out 9 times the original amount deposited, and to charge interest on it as many times as it was loaned. So instead of an interest rate of, for example, 6%, the banks may be collectively receiving a total of 54% interest per year (6% x 9; usually it is somewhat less due to the lack of qualified borrowers). This why banks grow and prosper much more than other businesses, that is, until they have stretched the spring to the maximum.
Once the economy is flooded with this bank-created money 9 times in excess of the money originally created by the Fed, an expansion that increases the money supply, which reduces the purchasing power of already-existing money (including wages and savings), interest rates begin to drop (as there is more money to lend) and prices rise (inflation). The dollar begins to fall relative to the money of other countries not in this same stage of money expansion. Money begins to flow out of US Treasury bonds (due to lower interest rates and the lessening purchasing power of the dollar due to inflation). Thus ends the expansionary or "boom" part of this artificial "business cycle." To combat rising inflation and the falling dollar, the Fed begins raising interest rates.
Then the spring of the economy - the money supply - having been stretched to the maximum, begins its contraction, usually initiated by rising interest rates reaching a point that begins to inhibit borrowing and also inflation. The economic "bust" part of the cycle begins. Loans dwindle as interest rates rise and credit terms tighten. Various segments of the economy, accustomed to easy credit, begin to contract due to higher interest rates; loans become harder to get. Home prices fall, businesses begin to fail, bankruptcy's increase. This "bust" part of the cycle continues, and worsens, until inflation is "tamed," prices stabilize, and the dollar rises relative to other currencies. Eventually, the higher interest rates begin to attract foreign money, and the Treasury then is able to borrow what it needs at lower and lower interest rates. Interest rates fall. The artificial cycle then begins anew.
This boom-bust economic cycle is totally unnecessary and is deeply connected to the instability in the economy. It is due to too-rapid increases in the money supply due to deficit spending and then the multiplier effect of fractional reserve banking and to lenders greedy to take advantage of such a system that rewards lending with more and more interest revenue; followed by a too-rapid contraction of the money supply (such as we are experiencing now), necessary to combat the inflationary effects of the former phase, both the direct result of the Federal Reserve Act of 1913.
We urgently need to reform this system that rewards greed and results in ever-increasing swings from boom-to-bust - destroying ordinary businesses and farms in the process. We need to repeal or fundamentally reform the Federal Reserve Act of 1913, and to replace it with a system that eliminates the ability of private banks to "create" and multiply money as loans.
The major banks of this country - the ones the government is lending our money to, and from which the Bailout Bill (any version really) proposes to buy their bad assets, are busily swallowing up the banks in trouble in this latest bust - one deeper because of more rapid prior monetary expansion and inflation. As after all prior bust cycles, they will emerge larger and more powerful, and fewer. Wealth will be even more concentrated under their control, which they will use in the next bust to further this process, until eventually no one will own anything but the ability to borrow - to go deeper into debt to banks than their neighbors. Not savings, but credit scores will determine the average American's ability to engage in economic activity (such as buying a home or car). No one will dare breathe a word against such power, concentrated in very few hands, and our republic will end with a whimper.
Congress struggles with ignorance of the complex, bank-created system enacted in 1913. It struggles with the money the bank PACs flood into the political system to defeat their critics and elect their shills. It struggles with mass media owned or controlled by the banks, which seek to stir up panic in the populace, to stampede Congress into bank-developed "solutions" that only make the fundamental problems worse and increase their wealth. Based on history, the banks will not fail to see-saw the economy and the markets to match their strategies for fooling the public, and putting pressure on the Congress to do their will. But we must resist. We must hold out for genuine reform - for repeal or fundamental reform of the Federal Reserve Act of 1913.
So what in its place?
how about this reform? Letting the US Government take control of its own money and print it interest free like Lincoln did during the Civil War by printing greenbacks...
This proposed law would require banks to increase their reserves on deposits from the current 10%, to 100%, over a one-year period. This would abolish fractional reserve banking (i.e., money creation by private banks) which depends upon fractional (i.e., partial) reserve lending. To provide the funds for this reserve increase, the US Treasury Department would be authorized to issue new United States Notes (and/or US Note accounts) sufficient in quantity to pay off the entire national debt (and replace all Federal Reserve Notes).
The funds required to pay off the national debt are always closely equivalent to the amount of money the banks have created by engaging in fractional lending because the Fed creates 10% of the money the government needs to finance deficit spending (and uses that newly created money to buy US bonds on the open market), then the banks create the other 90% as loans (as is explained on our FAQ page). Thus the national debt closely tracks the combined total of US Treasury debt held by the Fed (10%) and the amount of money created by private banks (90%).
Because this two-part action (increasing bank reserves to 100% and paying off the entire national debt) adds no net increase to the money supply (the two actions cancel each other in net effect on the money supply), it would cause neither inflation nor deflation, but would result in monetary stability and the end of the boom-bust pattern of US economic activity caused by our current, inherently unstable system.
Thus our entire national debt would be extinguished – thereby dramatically reducing or entirely eliminating the US budget deficit and the need for taxes to pay the $400+ billion interest per year on the national debt - and our economic system would be stabilized, while ending the terrible injustice of private banks being allowed to create over 90% of our money as loans on which they charge us interest. Wealth would cease to be concentrated in fewer and fewer hands as a result of private bank money creation. Thereafter, apart from a regular 3% annual increase (roughly matching population growth), only Congress would have the power to authorize changes in the US money supply - for public use -not private banks increasing only private bankers' wealth.
discus.