The Root of Money

Money, it’s a gas

Grab that cash with both hands and make a stash

         —Pink Floyd, Money


Have you ever asked yourself what money is?  I mean, what is it, really?

It’s not what you think, and you’re not going to like the truth.

As children (at least those of us who grew up before the ubiquitous use of credit and debit cards), we at some point gain an awareness of money as the metal coins and green paper rectangles our grandparents sometimes gave us to stick in our piggy banks.  But that’s not really “money”; that’s “cash,” or “currency,” which are only symbols or representations of money, but are not money in themselves.

In Ayn Rand’s Atlas Shrugged, copper baron Francisco d’Anconia gives an extended lecture on the nature of money as a means of exchange:

Money is a tool of exchange, which can’t exist unless there are goods produced and men able to produce them.  Money is the material shape of the principle that men who wish to deal with one another must deal by trade and give value for value. 

Conceptually, this is an excellent theoretical description of what money was supposed to be.  And in a system in which money is in fact a representation of value, Miss Rand’s instruction above would be accurate.  Unfortunately, that’s not the world in which we live.

If we were ever in a world where money represented actual value, I long ago accepted the fact that that was lost in 1933 when the U.S. government effectively severed the dollar from, and criminalized private ownership of, gold.  At that point, money ceased to be tied to any intrinsic value, and instead derived its worth merely from the say-so of the government. In other words, money no longer represented value, but represented nothing.

I’ve come to learn that it’s even worse than that. To understand this, you have to understand where money really comes from.

If you’re like me, you’ve believed that the problem with “fiat” money—money with no backing commodity—is that the government can and will devalue it by printing more cash.  While it’s true that the government does that, and it’s bad, that’s only a small fraction of the amount of money that “exists.”  The vast majority—95% or more—of money isn’t created by Treasury printing presses, or even by the government at all.

OK, Rusty, where does money come from?

Almost all money in existence is actually created by private banks, and “exists” only in the form of accounting entries of bank credit.  Here’s how it works.

Most of us are under the impression that what banks do is collect money from their depositors, and loan that money out to borrowers.  But because of the practice called “fractional reserve banking,” that’s not in fact how banks operate.  Under fractional reserve banking, banks need only actually hold a small portion of real assets—say, 10%—relative to the amount of loans they can grant.  So a bank with assets of $1 million in assets can make $9 million in loans, thus creating $9 million in “money” in the process.

Consider this example.  Barry goes to BankAmerica for a loan of $10,000.  Barry signs the loan contract, thus indebting himself to BankAmerica. BankAmerica does not then reach into a depositor’s safe deposit box and hand Barry $10,000 in cash.  Instead, it simply types $10,000 into a computer showing the data for Barry’s account.  Voila! $10,000 in money is created based on nothing but Barry’s debt to a bank.

But it doesn’t stop there.

Barry uses the $10,000 to buy a car from Bill, who deposits the money into his account at Citibank.  Under a 10% fractional reserve requirement, Citibank then sets aside $1,000, and now has $9,000 to give a home loan to Hillary, if she can qualify.  Citibank makes a computer entry of $9,000 in Hillary’s account, thus creating an additional $9,000 of money—remember, Bill still has the original $10,000—and she then writes a $9,000 check to Joe.  Joe deposits the $9,000 with Chase, which sets aside a reserve of $900, and then has $8,100 to loan to Paul, just because he likes debt.  Chase makes a computer entry of $8,100 in Paul’s account, thus creating an additional $8,100 of money; Bill still has the original $10,000, and Joe still has the secondary $9,000.

Thus far in our example, the banks have created $27,100 in money.  This process will repeat itself over and over, each time the bank retaining 10% and creating new money by loaning the remaining 90%. Ultimately, from Barry’s original debt of $10,000, the banks will create $100,000 in new money.  And every dime of it based on nothing but debt.

Some 95% of all money is created in this fashion: by private banks from debt.  Worse, what do you suppose the banks do with the 10% of assets they have to hold as reserves?  Most of it they invest in government bonds—debt.  Those bonds count as assets for purposes of the reserve requirement, thus enabling the bank to make even more loans, creating even more money out of debt.

So what the bankers have done is cleverly fashioned an industry where collect interest by loaning money they . . . do . . . not . . . have.

The ugly truth is, the money in your bank account isn’t based on value.  It’s not even based on nothing.  It’s based on debt—less than nothing.

But here’s the real punch line.  When BankAmerica makes its loan to Barry, it only creates the $10,000 it typed into his account.  It does not create the additional interest Barry has to pay back on top of the principal.  And that’s true on down the line as successive banks made subsequent loans and created additional debt-money.   This leaves us with a sobering mathematical reality:

There isn’t, and can never be, enough money in existence for everyone to be able to pay back everything owed to the banks. 

Necessarily, inherently, inevitably, some people will not be able to obtain enough money to repay all they owe the bank in both principal and interest.  At that point, the bank forecloses—the bank gets that person’s stuff.  Some will say that’s a bad deal for the bank, because the bank will then have to sell it at a loss, but at a loss of what?  All the bank is out is the remaining unpaid amount of principal, which was money the bank never had in the first place.  The bank makes less than it would had the borrower repaid the loan, but the bank still ends up with more money than it had before it made the loan.  And because essentially all money is based on debt owed to the banks with interest, over a long enough time horizon all the money and all the stuff ends up in the hands of the banks.

Even those who can manage to repay their debt are on the losing end of this proposition.  As the banks create more and more debt-money, the purchasing power of all money diminishes.  Since the creation of the Federal Reserve in 1913 the U.S. dollar has lost over 90% of its purchasing power.  Your ability to acquire goods and services is diminishing just as surely as if someone were physically taking dollars from you.  All by this fractional reserve system managed by the Federal Reserve, which—contrary to deliberately-deceived common belief—is in fact not a branch of the government, but an organization made up of private banks.

This doesn’t happen in a system where money is based on a value—like gold—and can only be created by the sovereign—as the Constitution requires.  But that’s not where we are.  Money is no longer based on value, and the sovereign has ceded the power of creating money to the private banks, which then create money based on debt owed to themselves through a system created and governed by themselves.

Give you one guess as to who, at the end of the day, gets to pass “Go” and collect $200, and who doesn’t.


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