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.




I gave you my heart, and I tried to make you happy

But you gave me nothing in return

You know it ain’t so hard to say

Would you please just go away?

            —The Commodores, Sail On


Did you know that at one time it was illegal in this country to own gold?  It’s true.

Up until the early 20th Century, our money in this country was tied directly to gold and silver.  Most of it was literally gold and silver coinage.  Paper “money” really consisted of certificates redeemable at any national bank for a specified amount of gold or silver, and thus a paper “dollar” derived any value it had from its holder’s ability to convert it into gold or silver.  In 1900 the Gold Standard Act pegged the value of the dollar at 25.8 grains of .9 fine gold (23.22 grains of pure gold).

The benefit of such a system is that you know your money is always going to have a relatively stable value because it is (or is backed by) physical gold and silver, which have been accepted as currency basically since the beginning of civilization; i.e., gold and silver have always been real money.  The limitation of this system, however, is that because you had to mint your coins out of gold or silver, or be in a position to redeem any paper certificates presented by exchanging gold or silver for them, your ability to mint or print money was limited to the amount of gold and silver you had on hand.  And this poses more than a little nuisance to progressive politicians who like to spend money without having to worry about where it’s going to come from.

With that background, meet Fred Campbell.

In October 1932 and January 1933, Mr. Campbell bought twenty-seven bars of gold (at the time, about $200,000, or $3.4 million in today’s money) which he deposited at Chase National Bank in New York for safekeeping.  On March 9, 1933—just five days after taking office, and building on restrictions originally enacted by Woodrow Wilson—Franklin Roosevelt signed the Emergency Banking Act, which amended the 1917 Trading With The Enemy Act to grant the executive branch sweeping powers to regulate money, including the power to regulate the hoarding or transfer of gold.  On April 5 FDR issued Executive Order 6102, the first of a series of orders that—with extremely limited exceptions—outlawed private ownership of gold, and required all privately held gold to be turned over to the Federal Reserve in exchange for $20.67 per ounce in paper currency.  When Mr. Campbell later tried to retrieve his gold from Chase, the bank—to no one’s surprise—declined to give it back to him.    Campbell was then indicted for violating the executive orders.

The federal district court that heard the case (Campbell v. Chase Nat’l Bank, et al., 5 F. Supp. 156 (S.D.N.Y. 1933)) began by correctly observing that gold and silver have forever been recognized as the basis of trade—as money.  And thus, whether as legally monetized coin or as commodity bullion, gold and silver are necessarily and inherently tied to the concept of money.

But then the court went off the rails.  Because gold and silver are the basis of money, according to the court, they are affected with “public interest.”  Uh-oh.  And because they are a matter of public interest, they must be within the scope of Congress’ “plenary” (total) power to regulate money.  From this, the court then upheld the government’s action of taking Campbell’s gold—his money—as a valid exercise of the government’s sovereign power of “eminent domain” (the power to seize property):

“The frontiers of necessary action by the federal government are constantly shifting, and, as a result, the methods of using federal governmental powers have to change from time to time, and hitherto unused powers have to be invoked to cope with the varied exigencies encountered . . . The incidence of the right of eminent domain, as will be seen from what is hereinafter said, is not, however, limited to commodities affected with public interest, but involves the right of the government to take private property of any kind when it is deemed necessary, by the appropriate authority, for the public good.”

Notice the dangerous thinking embedded in the court’s expansive language.  The limits of the federal government’s power are not fixed, but are instead infinitely flexible to allow the government to take action in response to the self-declared emergency of the moment.  And thus the government’s sovereign power of eminent domain extends to allow it to take anything from you it deems necessary for the public good.  Even your money.

But Rusty, we see eminent domain used all the time to build roads, and the government always has to pay fair compensation for what it takes.

True enough.  But without getting into the argument over whether people who have their land taken from them ever really receive fair compensation, consider that in this instance we’re not talking about a forced sale of land.  Nor are we talking about a taking for use by the general public.  We’re talking about the government taking your money for itself and replacing it with less money (or with what is arguably not even money at all).

Later in 1933 the government, having confiscated all the gold, took it upon itself to raise the exchange rate for gold to $35 an ounce, conveniently allowing it then to sell that gold internationally and claim for itself the profit it denied to the rightful private owners of that gold.  People who were forced to accept $20.67 in U.S. currency in exchange for their gold in effect took an immediate 70% loss, as illustrated in what became some of the “Gold Clause Cases” decided by the U.S. Supreme Court in 1935.  The plaintiff in Nortz v. United States, 294 U.S. 317 (1935) was denied the difference between the value of his gold on the open market and the dollar face value of the currency he was given in compensation for its confiscation.  In Perry v. United States, 294 U.S. 330 (1935), the plaintiff was denied the difference between the gold value of a U.S. Treasury Bond originally payable on its face in gold and the devalued dollar face value of the bond.

For the next 40 years, private gold ownership was illegal in the United States.  Although U.S. currency was technically backed by gold held by the U.S. Treasury, you couldn’t actually redeem it and collect that gold.  In the mid-1960s the Treasury phased out silver coinage.  In 1971 President Nixon officially ended the gold standard; since then, neither gold nor silver have been considered money in this country.  With no tie to an objective value, U.S. currency became “fiat” money—money that has value solely because the government says so.  And because it’s not subject to being redeemed for gold (or silver), the government can then print as much as it wants, because there’s no risk of a run on inadequate gold reserves to back it up.  Of course, like anything else when you increase supply (in this case, by printing more dollars) you drive down its price; in the case of dollars, that means inflation—the same number of dollars buys less than it used to.

Thus, the government was able to take people’s money in the form of forcibly confiscating their gold in exchange for devalued currency.  Then the government was able to take it again (and again, etc.) by printing fiat dollars resulting in inflation that made the paper money that replaced the gold worth less and less.  This illustrates the problem with an unbridled power of the government to just take what it wants in the name of what it says is the “public interest”: your private property is no longer safe.

George Will wrote yesterday about a disturbing case in Virginia where Old Dominion University has commandeered the City of Norfolk to use its eminent domain power to seize private land, not for public use, but for the University’s use.  And although your ability to own gold was reinstated in 1975, there’s precious little to stop the government—potentially by executive decree of the President—from confiscating it again just as FDR did in 1933; only this time they’ll be compensating you not with devalued gold certificates, but with inflationary fiat currency.  Indeed, what’s to stop the government from then seizing your fiat money accounts themselves and compensating you with 20 year Treasury bonds?  We’ll have gone from gold, to gold certificates, to Monopoly money, to IOUs.

What happens when there’s nothing left to seize?