From the Radio Free Michigan archives ftp://141.209.3.26/pub/patriot If you have any other files you'd like to contribute, e-mail them to bj496@Cleveland.Freenet.Edu. ------------------------------------------------ MONEY & MYTHS Carmen Pirritano 5/93 First let us define what we mean by "money". Among its other definitions, money is anything that is acceptable both as payment for goods and services anywhere in the country, and to governments and banks as payment for taxes and loans. Only three things fit this description: 1) Federal Reserves Notes (cash) 2) coins 3) checkbook money Everyone is, of course, familiar with the first two; they are also familiar with the last one, although maybe not by that name. Checkbook money is circulated via checks - it is the money that banks create for the following purposes: to pay their expenditures, to make loans, and to make investments. Interestingly enough, checkbook money is not legal tender, only cash and coins are (see 'Your Money - A Review of Money in the US' by the Federal Reserve Bank of Richmond), but checkbook money is so widely acceptable that is serves almost as legal tender (virtually everyone has had at least 1 experience where a vendor would not accept a check - and of course checks must be endorsed whereas cash and coins obviously are not). Gold, silver and other types of wealth are not money; they must first be converted to money in order to be used. The only place that your wealth can be legally used to retire a bank debt is bankruptcy court. How much money is in circulation? Well, according to Federal Reserve statistical data, there was $935 billion in the M1 by 3/31/92. Of that amount, checkbook money represents about 68%, cash is around 30%, and coins represent only 2% of the M1. "When most people think of money, they think of currency. Contrary to this popular impression, however, transaction deposits [checkbook money] are the most significant part of the money stock." (from the Chicago Fed in 'Modern Money Mechanics') Now that we have established the types of money in our economy, let us look at how these moneys are actually created and injected into the money supply. First, Federal Reserve Notes Many myths surround cash. Among them are the following: 1) The government owns Federal Reserve Notes 2) The government prints them to finance itself 3) The government is responsible for the amount in circulation 4) Federal Reserve Notes do not cost the taxpayer anything 5) Cash increases the money supply through multiple deposits and withdrawals 1) Federal Reserve Notes are owned lock, stock, and barrel by the 12 privately owned Federal Reserve Banks. "These notes are produced by the Bureau of Engraving and Printing and turned over to the Federal Reserve Banks" ('How Currency Gets Into Circulation'- NY Fed) "Reserve banks 'buy' new paper money and coins from the Treasury" ('The Federal Reserve Today' - Richmond Fed) "Federal Reserve Banks pay 2.5 cents for each note produced by the Bureau" ('Your Money...) Note that this 2.5 cents is per bill regardless of the denomination - it is the cost of paper, ink and labor. 2) Now if you still believe that the government prints cash to pay its bills, then why do we run a deficit every year? The New York Fed supplies the answer in 'I Bet You Thought', "The Bureau of Engraving and Printing ... is responsible for printing the nation's currency, but, its orders come from the twelve Federal Reserve banks, not the president or Congress. The Reserve banks, not the Treasury, determine how much currency is printed ... Under this arrangement, the government cannot print more Federal Reserve notes to pay its bills or reduce its debt." 3) As far as the supply of cash in circulation, it is determined by the public through their withdrawals, up to a limit. If a bank is short on cash and has excess reserves, they can "arrange to draw currency directly from their reserve accounts at their district Reserve Bank." ('How Currency...) The public can only withdraw as much cash as the banks have, and for any bank in particular, this amount is the bank's reserve total. Banks are required to have reserves equaling only 10% of their transaction deposits. If every person who possesses a checking account were to simultaneously withdraw, say 20% of their money in cash - every bank in the country would close overnight. 4) All cash is a debt that is owed to the 12 Federal Reserve banks. Why? "Before being issued to the public, Federal Reserve notes must be secured by legally authorized collateral, most of which is in the form of U.S. government and federal agency securities held by the Federal Reserve Banks." ('Your Money...) What this means is that for every dollar bill ever put into circulation, the Fed owns a dollar of interest-earning government securities. The sum of money owed to the Fed will always be greater than the amount of Federal Reserve Notes that they distribute due to the interest that the securities pay. Where does the Fed get the money to buy these securities? They create the money to buy them - "...the Fed has no bank deposit of its own. ... when the Federal Reserve buys government securities, it is by the mere stroke of a pen putting new money into the banking system." ('Putting It Simply' - Boston Fed) 5) Federal Reserve notes travel from the Fed to a bank's vault, and then to you. They are not directly injected into the money supply; instead they must be "bought" with an equivalent sum of checkbook money. The Chicago Fed explains with an example, "Suppose a bank customer cashed a $100 check ... Bank deposits decline because the customer pays for the currency with a check on his or her transaction deposit. ... The public now has the same volume of money as before, except that more is in the form of currency and less is in the form of transaction deposits. ... After ... currency returns to the banks ... the banks gain reserves as 100 percent reserve money" ('M.M.M.') What this means is that in order to get cash into circulation, "the public ... converts checkbook dollars into paper currency" ('How Currency...). The Richmond Fed verifies this in 'Money', "When people want more coin or paper money, they cash checks - exchanging one form of money, checkbook money, for another, cash." The cash then assumes the debt status of the checkbook money it represents. In this way cash can not increase the money supply through multiple deposits and withdrawals. Secondly, coins: It would be logical to assume that the rules held concerning Federal Reserve notes apply to coins also. There are exceptions to every rule, and coins are the exception. For some strange reason, the government has decided to stand its ground and demand to be fully reimbursed for the coins they mint. "Reserve Banks pay the Treasury for coin at face value" ('How Currency...') This payment is in the form of an increase to the government's checking account held at the Federal Reserve. At this point the coins are not even in circulation yet. Coins are injected into the economy in the exact same manner as Federal Reserve notes, thus the physical metal in your pockets is actually a placeholder for the checkbook money it represents. The debt-free nature of coins arise from the one-time credit the government receives, therefore multiple deposits and withdrawals of coin money will never increase the amount of debt-free money in circulation. Lastly, checkbook money: There is a popular myth that banks lend money from the pool of their saver's deposits. The Federal Reserve Bank of New York knows better (actually best); "Institutions such as the Federal Reserve and commercial banks create money every day. Do commercial banks create the money that they lend? Yes. One institution --the commercial bank-- creates new money --checkbook money-- when it lends." (From 'The Story Of Money') This is reinforced by the Chicago Fed, "they do not really pay out loans from the money they receive as deposits ... What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers' transaction accounts." ('M.M.M'). This means that a bank is monetizing your collateral and not, in any way whatsoever, lending out some other depositor's money. If they were then every dollar loaned out would be backed by several people's tangible assets. From this we learn that checkbook money is always bank created money, which is created and injected into the money supply in one fell swoop. However, this is only 1/3 of the story of checkbook money; as I stated earlier banks also make investments for themselves with checkbook money. In this way the money supply can increase without the need for people to be granted loans. But is this amount really significant? Well according to the Federal Reserve Statistical Release (H.8) on the assets and liabilities of domestic banks, the ratio of loans to investments is 7 to 3. I would venture to say that is a significant number. Most people have the mistaken, but understandable, belief that a bank would pay for investments out of the profits they make via interest charges. Not so: the San Francisco Fed in 'Monetary Policy in the United States' state that "banks and other depository institutions have the power to create new deposits and either lend them out to customers or use them to purchase investments". New deposits can only be created as checkbook money, and checkbook money gets created through bank reserves. The Chicago Fed explains further: "Reserves ... may be used to increase earning assets - loans and investments". "Suppose that the demand for loans at some ... banks is slack. These banks would then probably purchase securities. If the sellers of the securities were customers, the banks would make payment by crediting the customer's transaction accounts; ...More likely, these banks would purchase the securities through dealers, paying for them with checks on themselves or on their reserve accounts". Do banks wait for a lull in consumer borrowing before making investment purchases? No, "Because excess reserve balances do not earn interest, there is a strong incentive to convert them into earning assets (loans and investments)" (all from 'M.M.M') From this we learn that banks create checkbook money when they wish to make investments, and that a bank's interest earnings play no part in this (exactly why will be explained shortly). At this point, before going on to the relationship between bank expenditures and checkbook money, the concept of 'bank reserves' needs to be addressed. What are reserves? "Currency [cash and coins] held in bank vaults may be counted as legal reserves as well as deposits (reserve balances) at the Federal Reserve Banks. ... Reserve balances and vault cash in banks, however, are not counted as part of the money stock held by the public." (Chicago Fed in 'M.M.M') The maximum amount of reserves in the system, at any point in time, is a constant; it is the above definition plus all the currency in circulation, if it were to be re-deposited into banks. This constant can only be changed by the Fed. The first misconception concerning reserves is this: banks must hold 10% of all their deposits as reserves. This is actually 2 misconceptions rolled up into one. First of all, reserves are not held against the various types of savings accounts held by the public; as the SF Fed knows, "Under the Depository Institutions Deregulation and Monetary Control Act of 1980, the checkable deposits of all depository institutions are subject to reserve requirements set by the Federal Reserve within certain ranges. ... in addition, a 3 percent requirement is placed on so-called 'nonpersonal' time and savings deposits - those not held by individuals." The second misconception is the belief that banks take 10% of their incoming deposits and squirrel them away to satisfy their reserve requirement. This simply is not so. Now how can 10% of a customer's deposit be put away for reserves given the first quote in the above paragraph? This would mean that the money supply would drop 10% upon every single (transaction account) deposit. Also the reserves balances of commercial banks held by the Federal Reserve Banks are currency accounts (actually currency credit accounts, see 'How Currency...). Are we to believe that if you deposited a $1000 paycheck (checkbook money by definition) that the bank would take $100 of this checkbook money and have it credited to their Fed reserve balance account. Impossible! This account is for currency only - not checkbook money. Not to mention the fact that reserve accounts are held at the Fed and banks can not change these accounts. Most importantly, reserves are not a part of a customer's deposit because reserves are created via a separate process that has absolutely nothing to do with the public's deposits. As the SF Fed states, "The Federal Reserve can change the amount of deposits banks issue ... by altering the amount of reserves available ... The principal tool the Fed uses ... is open market operations. ... Open market operations affect nonborrowed reserves - those not provided by the Fed through loans to depository institutions. Nonborrowed reserves typically account for 96 percent or more of total reserves." ('M.P. in the US') The SF Fed is stating that 96% of every dollar of reserves was created by the Federal Reserve and given to the banks; the other 4% were also created by the Fed, but these were loaned to the banks. Reserves can only be created by the Fed, and not by banks for the purposes of loans and investments ("Reserves are unchanged by the loan transactions" 'M.M.M.') As the final nail in the coffin, consider this errant example: a bank has $10 million in transaction deposits and $1 million in reserves. They have no excess reserves. Now you wish to transfer $100 from your saving's account into your checking account. The bank takes $10 and counts it as reserves to balance out the $100 increase in transaction accounts. The bank now has $10,000,010 in reserves; they have created new reserves. They have also just broken the rules, "the Fed writes and issues rules of conduct to implement banking laws." ('The Federal Reserve System in Action' - Richmond Fed) and the Fed states that only they create new reserves. Obviously then "reserves and customer deposits are two distinct entities." (from a personal letter by Dan M. Bechter - Vice-President Federal Reserve Bank of Richmond) The final piece of the checkbook puzzle is it's most misunderstood one. Banks have many expenses that they have to keep up with: supplies, real estate taxes, employee salaries, dividends, interest for savings and CD accounts ... Ask anyone and they will tell you that is why banks charge interest; so that they can pay for these items. It seems to make sense on the surface, but it is another myth. With excess reserves a bank can create the checkbook money needed for the above expenses. How does a bank pay for the above items? Forgetting interest on savings for the moment, a bank will issue a bank check for those expenses. All a bank needs is only 1/10 of the amount available in excess reserves. As the Chicago Fed explains, "For individual banks, reserve accounts also serve as working balances. Banks may ... draw down these balances by writing checks on them or by authorizing a debit to them in payment for currency, customer's checks, or other funds transfers." ('M.M.M.') The Chicago Fed is telling us that whenever a bank writes a "bank check", the funds behind the check are coming from the bank's reserves and not from some bank checking account that holds interest paid to a bank. A bank check "is a direct obligation of the issuing bank ... as long as the issuing bank is sound, the recipient of a cashier's check can be reasonably sure that the check will be paid. ... Cashier's checks are frequently referred to as 'bank checks', a term that applies to treasurer's checks, teller's checks, and bank money orders. ... A 'treasurer's check' is issued by a state-chartered bank, whereas a cashier's check is issued by a national bank. ... a teller's check is drawn by one bank on another bank." ('Check Rights' Boston Fed) The only type of account that a bank has with another bank is a 'correspondent bank' account and this is always a reserve account (see 'How Currency...). As far as saving's interest goes, that is a bank credit to an account which is not affected by reserve requirements. Of course the bank realizes that this money could be withdrawn as cash or transferred to checking, which then would affect their reserve position. What happens if a bank has no excess reserves? Am I telling you that bank employees will not get paid then? No, because banks rarely have reserve crisis's - for two reasons: 1) The Fed is constantly giving new reserves to banks - especially to banks that need excess reserves and 2) "The Fed lends when others won't. The Federal Reserve is the lender of last resort, responsible for forestalling national liquidity crises [see point 1] and financial panics. By lending ... Reserve Banks can help protect the safety and soundness of the nation's financial system." ('The Federal Reserve System In Action' by the Richmond Fed). When the Fed lends, they lend reserves. Again, we see that checkbook money pays the bank's bills and not their interest earnings. Wait a second, just what purpose does interest earnings serve? Aren't bank profits the difference between the interest they earn on loans and investments and the interest they pay to depositors? For that to be true, banks would have to be lending out their depositor's money, and as previously shown, banks create the funds necessary for all of their expenditures. They can not spend interest earnings because every single dollar paid to a bank reduces the money supply! There is no interest around to use. The New York Fed explains away this misconception in 'Money: master or servant?' , "Do banks extinguish the money paid to them when borrowers repay their debts? Yes. The money paid to commercial banks goes out of existence and is extinguished out of the money supply. ... our money supply declines as bank credit is repaid." The Staff Director of the NY Fed's Public Info Dept. verfies this, "If, for example, the person repays the loan in cash, the removal of cash from circulation reduces the money supply, and, if the repayment is made with a check, the reduction in the amount of money in checking accounts reduces the money supply." (personal letter from Edward I. Steinberg) The following quote is available in Senate document #23 of the 76th Congress, First session; it is made by Robert Hemphill who served 8 years as the credit manager for the Federal Reserve Bank of Atlanta, "If all bank loans were repaid, no one would have a bank deposit and there would not be a dollar of coin or currency in circulation." How can a bank's profits be the difference between the interest they earn and pay out when they do not keep any interest payments! Since banks create virtually every dollar in existence, where is the "profit" for the banking industry going to come from? Your interest payment is simply somebody else's bank created principal. As far as the purpose these unusable interest earnings serve, consider this: 1) What a loan repayment does is shift more reserves from required to excess than were shifted from excess to required when the loan was originally made. This enables a bank to use these new excess reserves for the previously stated purposes. 2) What would happen to the money supply if interest earnings and bank fees were not destroyed? It would skyrocket due to the interest-free bank expenditures made for salaries and the such, and this does not happen. The destruction of interest and bank fee payments serves as the banking industry's way of "taxing" their interest-free expenditures out of circulation, thus leaving us with a M1 that is 98% bank owed debt. 3) If the M1 is 98% bank owed debt, then it is mathematically impossible to ever repay all the loans. This guarantees bankruptcy. Banks then get to keep your collateral for failing to repay money that they created at no cost or expense to themselves. A few quick words on inflation: Inflation has often been defined as "too many dollars chasing too few goods". If you wish to use that argument, then you must state it properly: Too many bank created debt dollars chasing too few goods. How is it possible to have "too many dollars" when every dollar is some form of a bank loan that must be repaid? The Gross Domestic Product is over $6 trillion dollars, according to the Federal Reserve. The M1 is just over $1 trillion. When was the last time in this country that the M1 exceeded the GDP, or was even close to it? A certain percentage of the public must continue borrowing since it is impossible for everyone to get out of bank owed debt; what do you think businesses will do with the increased interest costs that they incur? Pass them off to consumers. Other References: Debt Virus - Dr. Jacques Jaikaran Federal Reserve Fractional Reserve and interest-free Government Credit Explained - Dr. Peter Cook ------------------------------------------------ (This file was found elsewhere on the Internet and uploaded to the Radio Free Michigan archives by the archive maintainer. All files are ZIP archives for fast download. E-mail bj496@Cleveland.Freenet.Edu) Other sites are invited to mirror these files, with attribution to RFM.