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Saturday, December 10, 2011

The Fractional Reserve Farse

Ask yourself what is the one thing all or most people would wish for if they found a magic lamp. Most people would wish for money because with money you would be able to buy anything. Why? Because those who have the money have the power. They control the world.

In the USA all money is issued by the Federal Reserve and everybody knows by now that this institution is privately-owned. Yes, private citizens issue money to the US Government, which of course gives you an idea as to who really controls the United States. What makes this so interesting is that this money does not exist until through a bit of clever trickery it is created. It works as follows:

1. The US needs money and prints what is called government bonds (official-looking paper) for the value of let's say $1 Billion.
2. These are given to the Federal Reserve Bank and the Fed authorises the US Mint to print money to the value of $1 Billion or a simple electronic transaction is made with no cash even printed.
3. The amount of $1 Billion is now available for use by the US Congress, but they have to pay it back - at interest so for 10% the US Government would have to pay back $10100000, an extra $100 Million, which never existed anywhere in the world.
4. Now with the fractional reserve system the Federal Reserve and most other banks are authorised to create ten times as much money out of thin air ontop of the original $1 Billion. This money only exists as ledger entries.
5. Banks can now lend this money to people at interest again.
6. In this way debt is continually created and guess who must pay back the debt and the interest - the US Taxpayer of course.

History shows us that this is not the only system used. At one point for hundreds of years England used "Tally Sticks" for money. These simple sticks with grooves cut into them were issued by the authorities of the day debt- and interest-free. In US history we find that at one point the US used their own debt-free money as well called the Colonial Scrip. This currency was issued by the government debt- and interest free. Later during the American Civil War Lincoln issued the Greenback, also debt-free. He was later assassinated and with him died the Greenback. In 1963 Kennedy signed Executive Order 11110, which authorised the printing of an independent money-source also debt-free by the US Government. He was also assassinated.

In fact throughout its history the US managed to escape the power of the bankers six times, but the bankers always managed to come back and the Federal Reserve has now been in power of the US since 1913. These central bankers also are responsible for creating depressions and recessions by tightening the money supply. This is done by calling in loans and not issuing new loans. In this way the money-supply is lessened and thus there is not enough to go around. All this is done in order to create a situation where they can benefit from lower stock-market prices. As people die of hunger these fat cats roll in the dough.

The world needs to get rid of all privately-owned Central Banks and governments should print their own debt-free money. Any currency declared "good to pay taxes with" by the government is given value. The little island of Gournsey in the English Channel does this without problems and in the days of the Talley Stick, Colonial Scrip and Greenback there were also no problems with the exception of a period during the American Revolutionary War when the Scrip lost value due to the fact that England also printed and distributed it and thus as there was too much going around it lost its value.

Many people suggest going back to the Gold Standard, but that would also be a mistake. There is not enough gold going around in the world and most gold is owned by these bankers anyway. Without actual gold in your pocket all you would have would be promissory notes, which would place you back to square one where there would be more paper money than the actual gold going around. In such a case the bankers could control the system again. Most important here is a system where the government not only issues the money, but controls the quantity as well ensuring there is not too little to cause depressions and not too much to cause it to lose value.


hank_F_M said...
This comment has been removed by the author.
hank_F_M said...

The Federal Reserve is an instrumentality of the United States

It was established by an Act of Congress.

The governing board is appointed by the President with advice and consent of the Senate.

I.e. It is not privately owned: it is a US Governemnt agency.

Yes, there are a number of problems with the Federal Rserve, but those hackneyed urban legends distract from real problems.

I'll bet a dollar to a donut that the South African Reserve Bank has similar real problems.

Werner K said...

At first I also thought so, but I have come to disagree with your viewpoint due to repeated evidence and common sense.

Show me evidence that I am wrong and I will listen.

hank_F_M said...


The Federal Reserve system was established by the Federal Reserve act of 1913. The act as amended It performs functions of any Central Bank.

The structure is a little strange which causes some confusion. The Congress did not want the private banks controling the Fed but also they did not want it subject to the day to day control of working politicians who might be tempted to use it to improve their political position at the expense of the country.

The Bank itself is governed by a 14 member board which serves 14 year terms. The Chairman is a member of the board who serves a 4 year term. Members and Chariman are appointed by the President and confirmed by the Senate per the constitutional requirement for senior officials. This gives it quite a bit of independence from day to day control but still leaves it accountable in a long term way. Is the Federal Reserve accountable to anyone?

The bank has 12 regional Federal Reserve Banks. (How is the Federal Reserve System structured?)

This is where the confusion comes in.

The 12 regional Federal Reserve Banks, which were established by the Congress as the operating arms of the nation's central banking system, are organized similarly to private corporations--possibly leading to some confusion about "ownership." For example, the Reserve Banks issue shares of stock to member banks. However, owning Reserve Bank stock is quite different from owning stock in a private company. The Reserve Banks are not operated for profit, and ownership of a certain amount of stock is, by law, a condition of membership in the System. The stock may not be sold, traded, or pledged as security for a loan; dividends are, by law, 6 percent per year. (Who owns the Federal Reserve?

Congress mandated that private banks deposit money (3% of assets) in the Federal Reserve Banks and decided to call the paper they received in return "stock". The word stock causes quite a bit of confusion it is more like my monthly deposit statement form the local bank.

More reading

The Federal Reserve System> site.
The FAQQ page

From Wikpedia

Central Banks in general. The section on a Central Banks role in Currency issuance is well done.

The article on the Federal Reserve system

For the comparison the South African Reserve Bank

Hank’s Eclectic Meanderings

Werner K said...

I wasn't talking about stock. I was talking about actual money. Hank, you have not disputed any of my points made.

Also tell me:

Has the Fed ever been audited?
How does the Fractional Reserve System work?
Why were so many US Presidents opposed to it?
Why were US Presidents opposed to it killed or almost killed(Jackson, Lincoln, Kennedy)?

hank_F_M said...


A partial answer.

Why were so many US Presidents opposed to it?

In the 19th century Generally Presidents from the East supported the idea of some sort of central (National) bank and those from the West opposed it. Reflections on different ideas on the function of government.

There was, and still is in a much muted form, a constant debate between people on the East coast who thought a national bank would be good to promote the economy and foreign trade, and a large group in the west who thought that a solid gold standard would be best and thus no need for a central bank. Andrew Jackson was a leader of the Western group. I do not know what Lincoln thought of tit but it desn't get much mention in his biographies. His primary constituency was from the west.

I do not know what President Kennedy thought about it, he did not do any thing to eliminate it. I would think, given the financial interests of the kennedy family he would be at least indifferent.

A small part in a larger discussion over a century and half with many turns and twists.

The general effect of not having a central bank was that the larger commercial banks performed the functions of a central bank. Sometimes to their advantage.

By the early 20th Century because of the growth of the country and the increasing complexity of the economy private banks functioning as a central bank was becoming unworkable.

Thus Congress created the Federal Reserve system to get Central bank functions out of private hands.

Why were US Presidents opposed to it killed or almost killed(Jackson, Lincoln, Kennedy)?

President Kennedy was assinated by Lee Harvy Oswald a genera loser who thought of himself as a mmarxist revolutionary. There is not credible evidence that he was part of a larger conspiracy.

Presidnt Lincole was assinated by John WIlkes Booth, an ardent Confederate supporter just after the end of the Civil War. There is no evidence of anything other than that.

President Jackson. Well the assign was upset about Jackson's opposition to the National bank. I'll just quote from WIkipedia

On January 30, 1835, what is believed to be the first attempt to kill a sitting President of the United States occurred just outside the United States Capitol. When Jackson was leaving through the East Portico after the funeral of South Carolina Representative Warren R. Davis, Richard Lawrence, an unemployed housepainter from England, aimed a pistol at Jackson, which misfired. Lawrence pulled out a second pistol, which also misfired. Historians believe the humid weather contributed to the double misfiring.[52] Lawrence was restrained, and legend told that Jackson attacked Lawrence with his cane. Others present, including David Crockett, restrained and disarmed Lawrence.
Lawrence told doctors later his reasons for the shooting. He blamed Jackson for his loss of his job. He claimed that with the President dead, "money would be more plenty" (a reference to Jackson's struggle with the Bank of the United States) and that he "could not rise until the President fell." Finally, he told his interrogators that he was a deposed English King—specifically, Richard III, dead since 1485—and that Jackson was his clerk. He was deemed insane and institutionalized.

Nothing but coincidence.

Hank’s Eclectic Meanderings

hank_F_M said...


Does the Federal Reserve ever get audited?

The Feds Office of the Inspector General contracts for annual outside audits of the Federal Reserve System and each regional Federal Reserve bank.

(Each major government department has an inspector general appointed from outside the agency by the President with Senate confirmation for a fixed term and not under the control of the agency head.)

The Governmental Accountability (formerly Accounting) Office conducts numerous targeted audits. The GAO is an agency of Congress. Both majority and minority can request audits of any government activity, as well as committees and individual members of Congress of something they think needs to be audited. Often a Congressman gets word of a questionable item and an audit is requested. I will assure you that a GAO audit is no fun.

Hank’s Eclectic Meanderings

I have to do some other things, I fill in some more in a few days.

hank_F_M said...


About Fractional Reserves.

To keep this simple we will work through several levels from the bottom up.

Level 1

Some one deposits money in a bank. Dollars, rands, pounds, euros, yen, gold, (and I would suppose tally sticks), it is pretty much the same everywhere.

The bank loans the money.
Problem: What if the depositor wants his money back before the loan is due?
Solution: It only lends out a fraction of the deposits and keeps a fraction on hand. With many depositors most of whom do not want all there money back on a given day there should be enough reserves to cover the withdrawals without calling back loans.
Thus you have a "Fractional Reserve" system the bank holds a fraction of the deposits in reserve.

Of course it never works that nicely.

Thus governments establish central (or reserve) banks in which local banks are usually required by law to put a fraction of their deposits to be sure there are reserves. If a bank gets in trouble the reserve bank will loan them money from the reserves of other banks.

Before the Federal Reserve Act banks failing was not that uncommon, either due to bad luck or bad decisions, and once in a while embezzlement. Banks often tried to increase profits by running with the bare minimum reserves and just as often got into trouble.. The Act required reserves and centrally pooled some of them so there would be enough if a bank got into trouble. There were a lot less bank failures as a result.

There are two alternatives. A full reserve and a zero reserve.

A zero reserve has no reserves and banks fail quickly as people want their money.

A full reserve system which holds all the deposits and makes no loans. WIkipedia has good artile on ideas to switch to a Full reserve banking

If one is going to have a banking system that works it will at least have a major make use of a fractional reserve system

hank_F_M said...

Level 2.

One deposits a $1000.00 in a checking account. This works for other currencies as well.

Since it is a checking account it pretty much like cash they can write a check pretty much everywhere whenever they want. Until they write the check they still have a $1000.00

The bank loans out as much as it can after holding the required reserves. (this varies from time and a place I'll use 10% because it is the current Fed rate it also keeps the arithmetic simple). That is $900.00. So the borrower has $900.00 dollars to spend and the depositor still has a $1000.00 dollars. There is now $1900.00 in circulation. The borrower deposits the $900.00 in a bank which holds $90.00 as reserves and loans out another $810.00. There is now $2710.00 dollars in circulation. And so on.

This is called the multiplier effect. Like it or not if you have demand or checking accounts this is a fact of life. It can be very inflationary.
Wikipedia on the Multilier

Reserve rates are set in part with the intent to control inflation by preventing a infinite increase of funds from one deposit. An infinite increase is what would happen with a zero reserve system, until some one would try to withdraw funds that are not on hand. Most countries leave the rate relatively constant and control inflation the interest rate the central bank charges on the reserves it loans back to local banks.

The policy of most central banks is to maintain a steady amount of money circulation to prevent inflation or deflation and provide the conditions for economic growth.

Level 3

The Central bank. THis is a bank, the government is it's biggest customer. When the Government deposits money it ends up being loaned to the local banks which a reserve is kept and it is loaned out causing the multiplier effect. I think this is what you were objecting to in the main post.

To a certain extent this is necessary for the day to day work of the government.. They also use it to manage the money suppoy. In the exaple you cited where the goverenment issues a bond which the central bank teates as a deposit and the loans the money to local banks. If money was printed by the treasury it would not make any difference because it would end being deposited dth bankin system.


Yes there are real problem with this sort of set up. The current recession is the result of a number of bad decisions, almost all of the made in good faith, from insufficient data, ignorance, or myopia. Actual corruption was a very small portion.

But without it we could just abandon any hope that the economy would big be enough for economic development let alone maintain current levels of prosperity. While there are choices in detail there is no real alternative.


A merry Christmas and happy New Years to you and yours.

Hank’s Eclectic Meanderings

Cuan Potter said...

One thing that has been left out of the ensuing debate is the matter of "interest".

Money existing: $1000

Depositor deposits $1000 into his bank account (his worth $1000).
Borrower borrows $900 from the bank. (his worth $900)
Bank deposits 10% into Reserve bank
Bank's worth: $100 (holding + banked)
Reserve Bank's worth: $10 (we'll take this element out of the example)

Prime lending rate: 10%
Bank's markup: 10% (total 20%)

Bank charges Borrower compounded interest over term (10 months) at the prime lending rate plus their markup.
Bank pays Depositor compounded interest over term at prime/10, for example.

Month 1
Total money existing: $1900
Bank's balance: $100 (including reserved deposit)
Depositor's balance: $1000
Borrower's balance: $900

Loan repayment agreement: Principle + interest / term (10 months)
Deposit interest: prime / 10

Month 2
Total money existing: $198 + $10 + $792 = $2000
Bank's balance: $100 + $108 - $10 = $198
Depositor's balance: $1000 + 1% ($10) = $1010
Borrower's balance: $900 - Principle + interest ($108) = $792

Month 3

Total money existing: $295.9 + $1020.9 + $684 = $2000.80
Bank's balance: $198 + $108 - $10.10 = $295.90
Depositor's balance: $1010 + 1% ($10.10) = $1020.10
Borrower's balance: $792 - Principle + interest ($108) = $684

Month 4

Total money existing: $393.70 + $1030.30 + $576 = $2000.00
Bank's balance: $295.90 + $108 - $10.20 = $393.70
Depositor's balance: $1020.10 + 1% ($10.20) = $1030.30
Borrower's balance: $684 - Principle + interest ($108) = $576

Month 5

Total money existing: $491.40 + $1040.60 + $468 = $2000.00
Bank's balance: $393.70 + $108 - $10.30 = $491.40
Depositor's balance: $1030.30 + 1% ($10.30) = $1040.60
Borrower's balance: $576 - Principle + interest ($108) = $468

And so on...

At the end of the day - at 10% - the money supply, on this level and scope, remains relatively constant, with $1000 generated from fractional reserve lending + interest alone. The depositor's balance has increased slightly, the borrower's account has depleted by almost half after 5 months and will be -$72 after 10 months, and the bank's balance has grown by almost 500% after just 5 months of the 10 month term. That does not even account for their finance charges, ATM fees, over-the-counter charges, etc. that they add to their pie.

Now, in South Africa, the fractional reserve rate is something like 3% and yet we have some of the highest banking charges in the world, I've heard. Borrow some food for thought. ;)