"The process by which banks create money is so simple that the mind is repelled."
-- John Kenneth Galbraith
Money is the vital medium within which we live our economic lives, and it is the central element around which many of our interpersonal relationships are organized. It is no exaggeration to say that the quality and essence of our medium of exchange, our money, are crucial to the quality of our lives -- our social interactions, our personal priorities, our relationship to the earth, and our very ability to satisfy basic human needs. As water is to the fish, so money is to people. We are largely unconscious of it. But when the water is polluted, the fish sicken and die; when money is "polluted," our economy sickens and people suffer as their material needs go unmet.
Although the existing systems of money, finance, and exchange are severely flawed, few people understand the structural nature of these flaws, much less how they might be remedied. Most of us take money for granted. Oh, it occupies plenty of our attention as we try to get enough of it to make ends meet, but we don't normally stop to think about what it really is, where it originates, or how it comes into being. We pay a huge price for our ignorance. Money has become an urgent problem.
Since money is an information system, let us describe the fault in terms of the information which it conveys and explain why that information is inaccurate, incomplete, or false. Indeed, the present official monetary system has become a mis-information system. As the tightly controlled news media in totalitarian states are to a free and independent press, so is our monopolized and political system of money and finance to a system of free money and free exchange. Just as the news industry can be perverted into a propaganda machine to serve the interests of a dictatorial government, so has the finance industry been perverted into a machine of privilege to serve the interests of centralized power.
The symptoms are easily evident and our news media are daily filled with reports of them -- inflation; unemployment; bankruptcies; farm, home and business foreclosures; ever-increasing indebtedness and impoverishment; homelessness; and a widening gap between the "haves" and the "have-nots." These in turn probably account, in large measure, for a secondary level of social and environmental decay -- violent crime, suicide, drug and alcohol abuse, theft, embezzlement, along with land, water and air pollution. These are not accidents; they derive from the inadequacies and errors inherent in structures which humans have themselves created.
Conventional money malfunctions in three basic ways: (1) there is never enough of it to serve the purposes for which it is created, (2) it is misallocated at its source, going, not to those who are most in need or who will use it most effectively, but to political power centers and those who already control large pools of wealth (like large corporations), (3) it systematically pumps wealth from the poor to the rich. Each of these will be explained in turn, but to do so we first we need to explain how money is created in the current monetary system.
Wealth creation and money creation are two entirely different things. Wealth is created by the application of human skills to natural resources in the myriad ways which produce useful goods and services. Planting crops, assembling computers, building houses, and publishing a newspaper, are all examples of the production of wealth. Money, on the other hand, is a human contrivance; it is a symbol created by a deliberate process involving entities called "banks of issue." In the United States, it is mainly the commercial banks which create the bulk of the money supply in the form of bank deposits (or bank credit).
That's right, most of our money consists of deposits in checking accounts. Only about 30% of the money supply is in the form of coins or circulating paper currency, the familiar Federal Reserve Notes which we use every day. According to the Federal Reserve Bank of Chicago:
"..currency is a relatively small part of the money stock. About 69%, or $623 billion, of the $898 billion total money stock in December 1991, was in the form of transaction deposits, of which $290 billion were demand and $333 billion were other checkable deposits." 
Even Federal Reserve notes, however, while printed by the United States Treasury, are put into circulation by the banking system which buys them from the Treasury for the cost of printing. Money gets created as bank credit. Paper notes may then be exchanged for bank credit whenever depositors prefer to have paper. Whatever amount of paper money is withdrawn from banks is debited against someone's bank account balance. Thus, even that part of the money supply which appears as paper currency, begins as bank credit.
The amount of credit money which the banking system as a whole can create, is determined by the policies of the Federal Reserve, the private banking cartel which has been given power over money in the United States. The share which is allocated to each individual bank is determined by the amount of deposits which a bank is able to attract from customers and use as "reserves." 
Banks act both as creators of money and as depositories of money. When you deposit your paycheck in a commercial bank the bank is acting as a depository. This money is then available for you to write checks against. But, the money which you deposited had to begin somewhere. You got it from your employer; your employer got it from a customer; the customer got it from his/her employer or customer; and so on back to the beginning. The important thing to understand is the nature of that beginning. Banks create money by making loans. The money which you received in your paycheck was created at the point when the bank, acting as a creator of money (or bank of issue), granted a loan to someone and credited her/his account for the amount of the loan.
Here's the way it works. Company XYZ goes to a commercial bank and receives a loan to expand its business. The bank simply credits the account of Company XYZ for the amount of the loan. Where did the bank get the money to lend to Company XYZ? It didn't get it anywhere; it created it. Unlike savings banks, savings and loan associations, and other "thrift" or depository institutions, which primarily can only lend out money that has been deposited with them, commercial banks actually create money out of nothing and put it into circulation by making loans.
As the Federal Reserve itself describes it:
"Debt does more than simply transfer idle funds to where they can be put to use -- merely reshuffling existing funds in the form of credit. It also provides a means of creating entirely new funds...
"...a depositor's balance also rises when the depository institution extends credit -- either by granting a loan or buying securities from the depositor. In exchange for the note or security, the lending or investing institution credits the depositor's account or gives a check that can be deposited at yet another depository institution. In this case, no one else loses a deposit. The total of currency and checkable deposits -- the money supply -- is increased. New money has been brought into existence by expansion of depository institution credit. Such newly created funds are in addition to funds that all financial institutions provide in their operations as intermediaries between savers and users of savings." 
"(All bank deposits, originally) come into existence as banks extend credit to customers by exchanging bank deposits for the various assets that banks acquire -- promissory notes of businesses and consumers, mortgages on real estate, and government and other securities." 
This is just an obscure way of saying that the bank credits your account for the amount of the loan, and you, in return, give the bank your promissory note or a mortgage on your house. Those instruments, promissory notes, mortgages, and securities, are assets to the banks. They are claims which the banks have against the property of its customers, but to the customers, they represent debts owed to the banks.
Debtors are always required to pay interest on these debts. Thus, the commercial banks lend something which they create out of nothing, and then require that the "borrower" pay interest for the privilege. Not only that, but banks usually require that the borrower pledge some "collateral," which they will confiscate if the borrower fails to repay the loan. The principal amount is created at the time the loan is made, but the money to pay the interest due in subsequent periods has not yet been created. Thus, debtors, in the aggregate, are in an impossible situation of always owing more money than there is in existence. They must vie with one another for the available money in order to avoid defaulting on their loans and losing their collateral. 
The Federal Reserve unabashedly admits that it purposely tries to maintain the scarcity of money. It clearly states in one of its official publications the mistaken notion that "Money...derives its value from its scarcity in relation to its usefulness."  This may indeed be true for politicized and improperly issued money, but it is decidedly not true of money which is properly issued and subject to the discipline of the free market. If the central government and the financial sector claim a disproportionate share of the country's wealth, then, of course, they must limit the amount of money made available to everyone else. The current system is based upon the "myth of scarcity," but the world needs systems and structures which affirm the truth of an abundant universe. That does not mean structures which allow inequity and waste, but structures which are efficient and which allow enough latitude for all to satisfy their own real needs.
Money, as it emerges from the banks which create it, is not distributed fairly because the allocation decisions are not made democratically but rather by elite groups of bankers who are not held properly accountable. They act in their own interests pursuing goals which are typical of any corporate business -- profit and growth. As Ralph Borsodi explained it:
"It is a sad but outrageous fact that banking is conducted today as a business by men who label themselves businessmen -- which presumably means an enterprise conducted for profit. In its essential nature, banking is a profession, and like every profession should be conducted to render a service by men who's motivation is service first, last and all the time. They must, of course, be properly compensated for their work, but this, in its essence, should be a professional fee, not a business profit." 
The greatest abuses, however, derive from the politicization of money, banking, and finance. Banking and government have become intertwined and mutually dependent. In return for its privileged position, the banking cartel must assure that the central government is able to borrow and spend virtually any amount of money it wishes. Despite their public protestations, the banking system will always "float" the necessary budget deficits of the central government, by "monetizing" the debt. What this means is that the banking system will create enough new money to allow the market to absorb the new government bonds which must be issued to finance the deficit. Thus, it allows the government to spend as much as it wishes without raising taxes directly. The result is inflation, which has been called a "hidden tax."
Economists often argue that inflation is caused by too much money in circulation. This would seem to refute the contention that money is chronically in short supply. The answer to this is that inflation is not caused by the amount of money per se, but by the fact that some of the money in circulation is improperly issued and misallocated. Such is the case when the banking system "monetizes" the government debt, as described above. This phenomenon will be discussed more thoroughly in Chapter 9.
The people have been cut out of the most important decision process, that of determining how the aggregate wealth of the nation, the fruits of everyone's labor, will be spent. Massive expenditures for weapons, military interventions, and legalized "bribes" to client governments, along with S&L and corporate bail-outs which benefit the wealthy, well-connected few and increase the gap between rich and poor, are but a few of the abuses.
In this regard, I speak not of the very poor, who have little or no wealth-producing capacity, but of the vast majority of people who work for a living but have little or no financial net worth. The "debt trap" is the bane of that class of people. Debt within the current system is destructive in two ways, first because of the interest (usury) that must be paid for the use of money (bank credit), and secondly, because of the collateral which must be forfeited when the debtor is unable to make repayment.  The chronic insufficiency of money assures that there will inevitably be some forfeitures. It is interesting to note that the word "mortgage" derives from roots which mean "death gamble."
Everybody pays the cost of interest, even those who do not borrow directly. Interest costs are included in the price of everything we buy, whether it is provided by the business sector or the government. The production of whatever we buy must be financed in some way, and interest is the cost of using financial capital. Margrit Kennedy gives some examples which show the percentage of the cost which goes to pay interest on capital. Though her examples are drawn from her native Germany, it is clear that the pattern would be similar for all industrial nations, since their monetary and financial structures are all basically the same.
Kennedy shows that the cost of interest on capital, as a percentage of the fees paid by users were 12% for garbage collection, 38% for water, 47% for sewers, and a whopping 77% of rentals paid for public housing.  She also shows a comparison of the interest paid and the interest gained for the population of then West German households divided into 10 different income groups of equal size. This comparison indicates, as expected, that the lower income groups, because they tend to be net debtors, pay much more interest on their debts than they gain in interest on their investments. Indeed, the 80% of households having lower incomes, on average, pay more interest on their debts than they gain in interest on their investments. The highest 10% gain about twice as much interest as they pay, and the richest of these gain progressively more.  Lending money at interest, either directly or through financial intermediaries is one of the primary mechanisms by which the rich get richer and the poor get poorer.
Money carries information, but the present monetary system is dysfunctional because it carries flawed information. If information is the essential quality of money, then the next logical question is, what kind of information does it, and should it carry? The answer which immediately presents itself is that money should carry information about "merit." If money allows its possessor to claim wealth from the community, what is the basis for that claim? The possession of money should be evidence that the possessor has delivered value to the community, and is therefore entitled to receive back a like amount.
If money is improperly issued though, the information which it carries is polluted at the very source. By issuing money to unproductive or privileged clients of the money monopoly, and by demanding interest (usury), the banking system redistributes wealth from producers to privileged non-producers. The consistent pattern of official action over the past several decades has been to concentrate economic power by centralizing control over the medium of exchange, limiting access to it, and charging exorbitant prices for its use (in the form of interest/usury).
The Usury Trap
In his story, The Financial Expert, R. K. Narayan's main character is a man named Maragaya, a small-time money lender who conducted his business under a banyan tree outside the banking office. Maragaya was fascinated with the idea of compound interest. It was an idea which had served him well, not only in directly multiplying the money that he lent, but also in allowing him to acquire properties upon which he had made loans, for inevitably some of his clients were unable to repay him. This is the picture of the usury trap which Narayan vividly and movingly portrays.
They (the peasant borrowers) went by the evening bus, but leaving their mortgage deed (with Maragaya), and carrying in their pouches three hundred rupees, the first installment on which was already held at the source. The first installment was the real wealth -- whose possibilities of multiplication seemed to stretch to infinity. This was like the germinating point of a seed -- capable of producing hundreds of such germinating points. Lend this margin again to the next man, as a petty loan, withholding a further first installment; and take that again and lend it with a further installment held up and so on.... it was like the reflection in two opposite mirrors.
You could really not see the end of it -- it was part of the mystic feeling that money engendered in Maragaya, its concrete form lay about him in his iron safe in the shape of bonds, and gold bars, and currency notes, and distant arable lands, of which he had become the owner because the original loans could not be repaid, and also in the shape of houses and blocks of various sizes and shapes, which his way of buying interest had secured for him in the course of his business -- through the machinery of 'distraint'.
Many were those who had become crazed and unhappy when the courts made their orders, but Maragaya never bothered about them, never saw them again. "It's all in the business," he said, "It's up to them to pay the dues and take back their houses. They forget that they asked for my help." People borrowed from him only under stress and when they could get no accommodation elsewhere. Maragaya was the one man who easily lent. He made the least fuss about the formalities, but he charged interest in so many subtle ways and compounded it so deftly that the moment a man signed his bonds, he was more or less finished. He could never hope to regain his possessions -- especially if he allowed a year or two to elapse.
There were debt relief laws and such things. But Maragaya nullified their provisions because the men for whom the laws were made were enthusiastic collaborators in his scheme, and everything he did looked correct on paper.
-- R. K. Narayan, The Financial Expert 
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