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Fractional-Reserve Banking is Pure Fraud, Part I - Jeff Nielson

Fractional-Reserve Banking is Pure Fraud, Part I - Jeff Nielson
By Jeff Nielson 2 years ago 16296 Views 75 comments

Jeff Nielson is co-founder and managing partner of Bullion Bulls Canada; a website which provides precious metals commentary, economic analysis, and mining information to readers/investors. Jeff originally came to the precious metals sector as an investor around the middle of last decade, but soon decided this was where he wanted to make the focus of his career. His website is www.bullionbullscanada.com.

November 23, 2015

This is a commentary that should never have needed to be written. What is euphemistically called “fractional-reserve banking” is obvious fraud and obvious crime. By its very definition, it transforms the banking sector of an economy into a leveraged Ponzi scheme; as with all Ponzi schemes, there is no possible happy ending here.

Mathematical principles are often illustrated best through the use of an extreme numerical example. We have no need to construct any hypothetical extremes, however, when we already have real-life insanity in our current monetary/regulatory framework.

Here it is important to note that in order to conceal the criminality and insanity of our present system to the greatest degree possible, the bankers have to hide their dirty deeds within their own convoluted jargon. Thus, presenting “fractional-reserve banking” to readers requires some brief investment of time in definition of terms.

Fractional-reserve banking evolved from the opportunity for all bankers to perpetrate fraud. Down through the centuries, under normal circumstances, it has always been observed that only a tiny percentage of depositors will claim their actual wealth at any one time. Thus the temptation is for bankers to “lend” more funds than they actually possess; they are “lending” what does not even exist. This is “fractional-reserve banking” – the ultimate euphemism of banking and fraud.

It goes without saying that any person or entity that endeavours to “lend” something that does not exist is perpetrating fraud. But before examining this inherent fraud more closely, it is important to back up and look at the Law. Even when banks “lend” money that they actually do hold on deposit (as trustees for the depositors), it is already wholly illegal. This is the crime known as“conversion.”

Criminal conversion:

A person who knowingly or intentionally exerts unauthorized control over property of another person commits criminal conversion.

When your bank lends out money you deposited, which it claims to be “holding” for you as trustee, does it seek your prior authorization before lending out your property and thus putting it at risk? Of course not. The banks get around the naked criminality of their lending operations through general authorization. In the small print of all bank deposit contracts is a clause whereby the depositor “authorizes” the bank to lend out their property to Third Parties.

We therefore start with a basic fact: “banking” as we know it (bankers taking deposits, and then lending those deposits) is literally institutionalized crime. But “fractional-reserve banking” goes far beyond this original level of criminality.

Not only are banks allowed to lend what they don’t own, they are allowed to lend what they don’t even possess – and by many multiples. “Banking” is institutionalized crime. “Fractional-reserve banking” piles on a systemic and enormous element of fraud by “lending” what does not even exist. But this isn’t even the most shocking aspect of fractional-reserve fraud.

Here, readers need to understand the consequences of allowing banks to lend what they do not possess. A simple, hypothetical example will illustrate the principal of insanity that is the basis of our current monetary system.

Suppose JPMorgan holds $1 billion in total deposits. In the original form of our fractional-reserve fraud, the fraud ratio was set at 10:1. This meant that for every dollar that a bank actually held, it was allowed to “lend” $10. Now for the simple arithmetic.

JPMorgan is holding $1 billion of other peoples’ property, but it is allowed to “lend” a total of $10 billion. Where does the other $9 billion come from? It is conjured out of thin air via fractional-reserve fraud. Thus, for many readers, this represents their first actual glimpse of the full scope of fraudulence of our current monetary system.

In the original form of our “fractional-reserve” monetary system, for every $1 that our central banks officially printed, the banking system created an additional $9 out of thin air via fractional-reserve fraud. Simply put: 90% of all the actual “money” in our monetary system and our economy was conjured out of thin air by private banks via fractional-reserve fraud.

This is fractional-reserve banking presented as the naked fraud that it is: bankers “lending” not only more than what they possess, but lending out “money” which grossly exceeds the amount of capital in existence. Conjuring oceans of paper out of thin air. It is inherently criminal. It is inherently fraudulent.

It automatically transforms our monetary system into an institutionalized Ponzi scheme. By definition, all “fractional-reserve banking systems” would automatically collapse if all depositors simply claim a tiny portion of their deposits at any one time.

Depositors claiming their deposits is euphemistically known as a “run on a bank.” Here, however, the euphemism is intended to insinuate that the mere act of depositors taking possession of their own property is somehow a “crime” against the financial system. Indeed, directly implying as much, our own governments will institute “bank holidays.” This is yet another banking euphemism where depositors are legally prohibited from taking possession of their own property. The most recent example of such financial oppression was in Greece.

How can governments justify such financial oppression? While it is never explicitly acknowledged, the justification is entirely singular: to prop up a Ponzi scheme. It thus becomes necessary for governments to abandon the Rule of Law and legally prevent their citizens from taking possession of their own property as the only means of preventing the complete implosion of that system.

Observe how totally perverted and criminalized the current system of fractional-reserve fraud is. The banks are legally allowed to commit the crime of conversion, or “lending” what they do not own. The banks are legally allowed to commit fraud by “lending” what does not even exist. But if depositors seek to take possession of their own property, they are treated like criminals.

The bankers are granted absolute legal protection to perpetrate their fraud/crime, at the direct expense of the law-abiding citizens of that society.

However, this marks only the starting point for our present system of monetary/financial fraud. In its original form, fractional-reserve fraud was already entirely criminalized and entirely fraudulent. Why would our governments have ever turned our entire financial system into such institutionalized fraud?

They were convinced to do so on the basis of the promise of the bankers. The bankers promised that they would respect the enormous legal privilege that they had been granted by acting in a responsible manner and doing nothing to jeopardize this institutionalized Ponzi scheme.

In reality, the banks have done the precisely the opposite. First the Big Bank crime syndicate had their servants in our puppet-governments tear up the legal distinction between “banking” (institutionalized fraud) and “investing” (institutionalized gambling). Overnight, our banks were transformed into bank-casinos.

Not only were these “banks” lending funds which grossly exceeded their current assets, they were gambling with these funds, and at even greater ratios of leveraged fraud. The result of combining extreme fraud with extreme financial recklessness was the Crash of ’08. The Big Banks literally “blew up” the Western financial system with their extreme, reckless gambling – gambling which began with the deposits that they claimed to be holding as trustees.

Instead of our governments punishing these Big Banks for their extreme, reckless fraud, they rewarded them. Using our money, these Traitor Governments indemnified the Big Banks for every cent of their reckless, fraudulent gambling. Then they did something much, much worse.

Our Traitor Governments bowed to the will of their banker Overlords, and dubbed these institutions of fraud as being “too big to fail.” Translation? Instead of preventing these institutions of financial crime from continuing their reckless gambling, they promised to pay off all of the banksters’ gambling debts, forever.

What happens when you tell any Compulsive Gambler that you will make good on all of their gambling losses? The Gambler runs wild. Observe what the banking crime syndicate calls “the derivatives market.” It is a private, rigged casino, where the total amount of ultra-leveraged betting is twenty times as large as the entire global economy.

To go with the institutionalized crime and the institutionalized fraud of “fractional-reserve banking,” our Traitor Governments then added institutionalized extortion: allowing the Big Bank crime syndicate to blackmail our governments in perpetuity with the threat, “bail out all of our bad debts, or else…”

Following the Crash of ’08 and the literal sell-out by our own governments to the Big Bank crime syndicate, all of these Traitor Governments made the same promise to us: “never again.” Supposedly, they would never again allow the Big Banks to blow up our financial system; to keep this promise, they all pledged “tough new laws” to restrain the reckless gambling of the Big Bank crime syndicate.

What these Traitor Governments actually did was the exact opposite of everything they promised. Instead of reducing and restraining the insane, reckless gambling of the bankers that led to the Crash of ’08, they institutionalized that as well.

This will be the subject of Part II: taking a system that was already wholly criminal, ridiculously fraudulent, and completely unstable, and making it much, much worse.

Dwain Dibley 2 years ago at 2:24 PM
The credit generated by the Fed and the banks is not 'money', 'funds' or a 'currency'.

Jeff Nielson 2 years ago at 11:46 AM
A good analysis, Dwain! And some interesting numbers thrown in. I will be addressing the War on Cash, at least briefly, later in this series.
Dang 2 years ago at 6:12 PM
Yes your spot on here but its actually whole not bigger then this. The latest fraud by the gov was this $45 trillion dollars. We are talking about all the QE monies here fed pumped 4.5 trillion into the banks and turned it into $45 trillion through fractional reserve banking. Stake horsing the gov and the road to a new world gov and not using one dime to help our economy out. Its pathidic.
Jeff Nielson 2 years ago at 3:36 PM
You're quite right, Dang, but give me some more time. This will ultimately be a four-part series, and further along I will explain how what we have seen so far is just the tip-of-the-iceberg.
brett rasmussen 2 years ago at 9:34 PM
"for every $1 that our central banks officially printed, the banking system created an additional $9 out of thin air"
Jeff, is it not also true that the original $1 was also created out of thin air by the central bank? I think this point needs to be highlighted because it demonstrates the the fairy tale nature of our baseless monetary system.
Jeff Nielson 2 years ago at 3:43 PM
Yes and no, Brett. Here things get somewhat fuzzier.

You may be aware that Canada and the U.S. have been "borrowing" their currencies into existence over recent decades. Borrowing currency into existence is NOT (quite) the same thing as just conjuring it out of thin air...


On the other hand, every penny of so-called "quantitative easing" (another euphemism of fraud) IS "conjured money", in every sense of the word -- and thus intrinsically worthless.

So, yes, PART of the U.S. monetary base is conjured money leveraged atop conjured money: fraud "squared". Utter insanity. And apparently Canada's corrupt central bank is now contemplating its own QE fraud.
James R. 7 months ago at 1:08 AM
Thank you very much for explaining this. The way you have unraveled this for me, is the fact that you have spelled out the reality that this holding assets for safe keeping institution, which I always thought it actually was since I was a teenager or whatever, is not only what it isn't, but that it is something that it never was. With the fundamental principles you've shown me, now that I listen to all these people on the likes of financial programs, radio or television, giving "advice" and offering programs with what to do with [your] money, what on earth are you able to buy, pun intended, as valid financial advice coming from everyone else who constantly use mostly euphemistic and insider jargon that apparently they only have through their "experience", euphemistic jargon, where you can come out ahead in the "market" (is that also another name for casino as well?) inside of, or in spite of operating within as system that is already on its best day criminal and corrupt to begin with(?) I hope I can manage to get to the other parts of your lesson and learn something. Thank you.
Dwain Dibley 2 years ago at 12:12 AM
Why highlight an erroneous assertion? The Fed does not print money out of thin air. The Fed has no legal authority to create money, and they don't. The way most economists interpret fractional reserve banking is ass backwards, reserves have absolutely zero to do with a bank's ability to generate credit and the "money multiplier" theory is a busted myth. Banks are not intermediaries between savers and borrowers, that too is a myth. The actual legal tender monetary system was gutted by the Fed and the banks with their debt based credit expansion. 100% of all inflation is driven by credit/debt generated by the Fed and the banks, the actual legal tender money supply had nothing to to with it. Mr. Nielson is closer to the truth than most, but he still has a way to go.
Chris Rimmer 2 years ago at 7:29 AM
Dear Jeff,

This is a topic I've been studying for 8 years now, and while I understand your position, I'd be grateful if you'd temporarily put aside your current understanding and consider fractional reserve banking from another point of view for a minute, before trying to reconcile the two views. Consider the following:

1. Bank-created money is a *liability* of the bank to the deposit holder i.e. it is a legally-enforcible promise of the bank to provide the deposit holder with that value of the bank's assets. It is *not* an asset of the bank.

2. Yes, banks generally do not normally keep enough FRNs to pay up if all depositors show up at once. But if they have enough assets (e.g. promises by borrowers to repay their loans), the banks can either sell or mortgage them in order to raise the funds to pay depositors. There is only a problem if the bank is insolvent i.e. it doesn't actually have enough assets. (Solvency is infinitely more important than liquidity - solvency can be used to obtain liquidity, but not vice-versa).

3. I could try to write my own IOUs to buy things with, but they won't be accepted for general circulation, because it is unclear whether they will be honoured. What I need is a third party who is trustworthy and well-known, and has a high net worth, to insure my IOU, so that if I fail to deliver on my IOU by exchanging it for goods and services, the holder can collect from the third party. That third party is a bank - it insures IOUs, and collects premiums (interest) like any other insurance company. Instead of directly endorsing my IOUs, it does the equivalent: it gives me a negotiable IOU from it (a bank deposit) in exchange for me giving it an IOU from me. Obviously, this only works if the bank is solvent, which is why it is so important to liquidate them (sell the assets and pay the creditors) before they reach that stage.

In essence, I don't consider the banking *system* fraudulent, in the same way that I don't consider the car insurance industry fraudulent just because it couldn't afford to buy everyone a new car if their existing ones simultaneously went up in flames. The system is fine as long as the bank's capital exceeds defaults. On the other hand, I find Bill Black's view convincing - that there has been a huge amount of fraud *in* the banks, based around making deliberately bad loans so that the short-term profits look high (more bonuses) but defaults (actual and inevitable) accumulate and exceed the capital.

I hope you find that a useful alternative perspective. Let me know what you think.
Jeff Nielson 2 years ago at 10:38 AM
Chris, I find it impossible to get past your first point:

"Bank-created money is a *liability* of the bank to the deposit holder."

This is absurd. The banks "create" money based upon their "fractional reserve". The only way this new money would be a liability owed to the depositor is if the depositor created the money.

Banks conjure money out of thin air, loan that conjured money to Third Parties, and those Third Parties owe a liability to the BANK, not the original depositor.
Chris Rimmer 2 years ago at 12:57 PM
Dear Jeff,

Thanks for the reply - it's appreciated. I'd just ask you to put aside your existing model for a little longer e.g. "money would only be a liability owed to the depositor if the depositor created it", and evaluate what I say below in its own terms before trying to reconcile it to your existing understanding.

First, evidence that what I said is right: look at any bank's balance sheet, and you'll see deposits in the liabilities section. For example, look at Bank of America's 2014 annual report - the link to the PDF is near the top of this page:


On P24, you will see that deposits of $1.119 trillion appear in the bank's liabilities, and loans of $0.881 trillion appear in assets.

When a bank makes a loan of $10,000, its gains one $10,000 asset (the loan i.e. the debt from the borrower to it) and one $10,000 liability (the deposit i.e. the debt from it to the borrower), so its net worth (assets minus liabilities) remains unchanged.

The process is actually no different from my local credit union where I volunteer - I used to have to regularly examine the balance sheet. The only difference is that total loans are limited to a fraction of what has been saved. (And even that allows an explosion of leverage to occur: the borrower could buy something from someone who then saves it at the credit union).

Suppose Tophat Bank starts up with Mr Tophat's initial capital of $1 million in cash.

Assets: $1 million Cash.
Liabilities: $1 million Shareholder Equity (owed to Mr Tophat).

Now it makes a loan to Mr Ninja to buy a car:

Assets: $1 million Cash; $10,000 Loan -- Mr Ninja (debt of Mr Ninja to Tophat Bank)
Liabilities: $1 million Shareholder Equity; $10,000 Deposit -- Mr Ninja (debt of Tophat Bank to Mr Ninja)

Now Mr Ninja buys a car from Mrs Twocars, who has an account at Tophat Bank:

Assets: $1 million Cash; $10,000 Loan -- Mr Ninja
Liabilities: $1 million Shareholder Equity; $10,000 Deposit -- Mrs Twocars (debt of Tophat Bank to Mrs Twocars)

This deposit is definitely a debt from Tophat Bank to Mrs Twocars. If she wants, she can demand $10,000 of Tophat Bank's cash. It is owed to her. Let's say she does:

Assets: $990,000 Cash; $10,000 Loan -- Mr Ninja
Liabilities: $1 million Shareholder Equity

Now the bank (and especially Mr Tophat) is relying on Mr Ninja to repay, perhaps by selling something of value to Mrs Twocars. If he instead defaults, it's the bank, and therefore Mr Tophat, that takes the loss:

Assets: $990,000 Cash
Liabilities: $990,000 Shareholder Equity

When I was going through the process of trying to understand this stuff, I discovered it's very helpful to ask at each point: what would happen if the bank was liquidated at that point (i.e. if the assets were sold, the liabilities paid if possible, and anything remaining went to the owners)? Who would get what? As you can see above, if Mr Ninja defaults, it's the owners who are left with the loss. (The big problem with banking comes if the defaults exceed the capital, in which case some of the depositors or other creditors of the bank will not get what they were promised, as happened in Cyprus and Greece).

I think the reason that you consider it absurd that deposits are a bank's liability is that in your model, creating money confers wealth on the creator, in the way that mining gold does. But bank money is valuable to its users not because it is inherently valuable, but precisely because it is a promise by the bank to give the holder some of *its* wealth in future.

When thinking about this subject, I've found it really helpful to start from the loan which creates the money, follow it around the economy, and then examine its destruction (plus any interest payments). If you have a chance to look, I wrote about it here:



Jeff Nielson 2 years ago at 10:32 AM
Chris, what I criticized in your first comment is this statement:

"Bank-created money is a *liability* of the bank to the deposit holder."

Then, in your example above, you discuss how DEPOSITS are a liability of the bank to the depositor. Of course this is true regarding deposits, and I would never argue the point.

But the bank-created "money" which is leveraged atop the original deposit is a credit to the bank's ledger, and a liability to whomever is loaned the bank-created money.

Banks don't "create" deposits. Banks ACCEPT deposits. Banks "create" money by conjuring it out of thin air, as a credit onto their own ledger. Pure fraud.
Chris Rimmer 2 years ago at 6:28 PM

First, thanks again for debating this seriously and politely.

To avoid any miscommunication, I think I need to define a couple of terms I've been using, because they can be extremely misleading if you're not used to it.

"Deposit". This means money created by a bank. Yes, that's an absolutely terrible term for it, completely contrary to common sense. As you said, when banks create money (i.e. deposits) nobody is depositing (in the conventional sense) anything at the bank. But this is in fact what banks call it. See below for proof of this.

"Deposit holder". The owner of the bank account in which the deposit resides. When a loan is first made, the deposit holder is the borrower, but when they buy something with it, the deposit holder is now the seller (because e.g. the buyer wrote the seller a cheque). I've tried to avoid the term "depositor" because it implies someone who has deposited something with the bank.

So when I say that "bank-created money is a liability of the bank to the deposit holder", I mean that the deposit (the bank-created money) is a legally-enforcible debt from the bank to whoever currently has the deposit (the bank-created money) in their bank account.

Perhaps that will clarify some of what I wrote earlier.

As to your main point, if it were true that when banks make a loan they add an asset to their balance sheets but no liability, thereby increasing their net worth at the stroke of a pen, then I would wholeheartedly agree with you that that would be outright fraud. So the only question is: is that what actually happens, or is it as I have said i.e. that the bank creates both an asset (the debt from the borrower to the bank a.k.a. the loan agreement) and a liability (the debt from the bank to the borrower a.k.a. the new money a.k.a. the new "deposit")?

Here's a document from the Bank of England which says that banks *create* new "deposits" when a loan is made:


It's stated on the first page (labelled P14), as the first bullet point in the Overview box. And on the second page (labelled P15) near the end, at the top of the section "Money creation in reality", it states:

"Broad money is made up of bank deposits — which are
essentially IOUs from commercial banks to households and
companies — and currency — mostly IOUs from the central
bank.(4)(5) Of the two types of broad money, bank deposits
make up the vast majority — 97% of the amount currently in
circulation.(6) And in the modern economy, those bank
deposits are mostly created by commercial banks

And on P16, it has some charts showing how new loans affect the assets and liabilities of the central bank, commercial banks, and consumers. You'll find that it fits in with what I've been describing:

1. Deposits are assets of consumers and liabilities of banks i.e. they are debts from banks to the consumers.

2. Loans are liabilities of consumers and assets of banks i.e. they are debts from consumers to banks.

3. Banks' net worth (assets minus liabilities) does not increase when they make new loans. They simply exchange one IOU (new loans) for another (new deposits). The point of this exchange is that sellers do not need to trust every single buyer's personal IOUs - as long as they can trust the bank's IOUs they can be confident of receiving a fair quantity of goods and services later in exchange for what they sell to the buyer now.

By the way, the process of creating deposits when a loan is made is exactly the same at a credit union. A new loan involves creating a liability (a new "deposit" for the borrower), and an asset (the loan i.e. the promise of the borrower to repay at a particular point in future).

I'll stop there for now. Please let me know what you think, or if there's anything I can clarify.

Kind regards,

Jeff Nielson 2 years ago at 2:33 PM
Chris, for the sake of argument, let me accept your banker-talk that "liabilities" are "deposits", and that DEBTS are ASSETS.

I don't, for one second, attach any legitimacy to such semantics. However, even if I did, it has all been rendered moot. By fudging on "reserve" requirements, and to an absurd degree, with the new Basel III rules, your point is now moot.


You can define the "liabilities" (and thus the leverage) of these fraud-factories any way you want, but when they are effectively not required to carry ANY reserves, it still spells only one thing: F-R-A-U-D.

Lastly, even if we (hypothetically) accept your semantics; your argument is rendered moot for a second reason. Far from being an "optimal" path towards economic development; fractional-reserve fraud is the WORST form of financial system which could possibly be devised, and thus (by any definition/semantics) we should never have such a system in place.

Chris Rimmer 2 years ago at 3:57 PM
I wonder if I misunderstood your reply. I'm not suggesting that a new loan creates money which is a liability to someone who previously paid in some money. It is a liability to the borrower.

Bank-created money is often called a deposit, but it needn't have been "deposited". It is created when a loan is made, circulates round the economy, and is finally destroyed when the loan is repaid. That's why I think it's better to look at the complete life cycle starting from the creation of the money, rather than from the point where someone somehow obtained some pre-existing money and deposited it at a bank, and seeing what the bank may or may not do afterwards. It was only when I followed the closed loop that I managed to understand the relationships between different events in banking in particular and in the economy in general.

Specifically, if someone borrows (new) money, spends it, sells something, and repays the loan, the debt situation of the whole economy is as it was before the loan was made. But the debt situation changes dramatically between someone taking money to the bank to deposit, and the bank subsequently making loans which are a multiple of the amount deposited.

(I still stand by what I wrote above, and I hope you find it useful).


Sckcdi 2 years ago at 11:07 AM
Chris, what proof is there that the loan which is paid back to the bank is destroyed? When the loan is repaid, does it not remain on the balance sheet as an asset?
Chris Rimmer 2 years ago at 8:34 PM
> Chris, what proof is there that the loan which is paid back to the bank is destroyed? When the loan is repaid, does it not remain on the balance sheet as an asset?

That's a very good question Sckcdi, and one I've been asked before so I wrote an explanation, which you can find here:


In essence it doesn't make sense for the asset to remain on the balance sheet unless there is a matching liability.

I'll focus on the repayment step here. Repaying a loan means transferring money to the lender. Mr Ninja needs some money to do this, so let's assume he builds Mrs Twocars a new garage for $10,000. Mrs Twocars pays Mr Ninja using the money which she has - the $10,000 deposit, which is an IOU from Tophat Bank to her.

Tophat Bank now owes $10,000 to Mr Ninja, and nothing to Mrs Twocars.

Mr Ninja can now repay the loan. Let's look at Tophat Bank's balance sheet before and after he repays the loan. Before:

A: $1 million Cash; $10,000 Loan - Mr Ninja
L: $1 million Shareholder Equity; $10,000 Deposit - Mr Ninja

(note this is exactly the same as the situation immediately after the loan is made. Mr Ninja owes $10,000 to Tophat Bank (the loan) and Tophat Bank owes $10,000 to Mr Ninja (the deposit)).

And after the loan is repaid, these equal and opposite debts are extinguished:

A: $1 million Cash
L: $1 million Shareholder Equity

What if the asset were not removed? You'd have the following situation:

A: $1 million Cash; $10,000 Deposit - Tophat Bank
L: $1 million Shareholder Equity; $10,000 Deposit - Tophat Bank

Since Mr Ninja paid Tophat Bank the $10,000, it now owns the $10,000 deposit (it is an asset on its balance sheet). But the bank still has a liability of $10,000 to the owner of the deposit. Together these say that Tophat Bank owes itself $10,000. It could leave its accounts like this, but there's not really any point. It may as well simultaneously remove the asset and liability, destroying the money in the process.

It simply wouldn't make sense for it to keep the asset side of the debt but not the liability. It would be claiming that it is owed $10,000 by itself, but that it does not owe itself $10,000, and that it is therefore somehow $10,000 better off. You could do the same yourself, but it wouldn't make it true for you either. Even if it obtained a court order against itself to enforce the debt, the court would have to rule that either (i) it *is* owed $10,000, in which case it also owes $10,000, or (ii) it is *not* owed $10,000, in which case it does not owe $10,000. You either have both the asset and liability or neither. There is no such thing as a one-sided debt.

You may wonder what happens if Mr Ninja works for Mr Cashhoarder, and is paid in cash, which he uses to repay his loan. Here's how Tophat Bank's balance sheet would look before and after repayment. Before:

A: $1 million Cash; $10,000 Loan - Mr Ninja
L: $1 million Shareholder Equity; $10,000 Deposit - Mrs Twocars


A: $1,010,000 Cash
L: $1 million Shareholder Equity; $10,000 Deposit - Mrs Twocars

So I'm not saying that cash used for repaying a loan is destroyed. But do remember that Mrs Twocars is still owed $10,000 by Tophat Bank. The situation is exactly the same as if Mr Ninja had worked for Mr Cashhoarder, then used that $10,000 cash to buy the car from Mrs Twocars, and Mrs Twocars had deposited the cash with Tophat Bank.

Having thought about this subject for a very long time now, I think that the amount of money in existence is much less important than many people think. What really matters is whether the bank has enough assets to honour all its IOUs i.e. all of its deposits (money).

I hope that explains it, but I'm more than happy to continue the discussion.


Jeff Nielson 2 years ago at 5:40 PM
Time for a reality-check here, Chris. If all this new, fraudulent debt is being "repaid" (as you claim); why is there well over $200 TRILLION in outstanding global debt today, roughly THREE TIMES total, global GDP??

As a matter of definition (for any/all fractional-reserve fraud), it is mathematically IMPOSSIBLE to retire the mounting debts-and-interest, GUARANTEEING economic implosion in the form of debt-default.
Chris Rimmer 2 years ago at 4:39 PM
Hi Jeff,

I've been trying to decide how to address your question, but unless you can look at it from the understanding that bank deposits are valuable to the deposit holders precisely *because* they are debts owed *by* the bank, I'm not sure it would be very helpful.

If you sold cars, and I said I'd pay you in 12 monthly installments of $1,000 for a $12,000 car, I'd be doing something very similar to what banks do: I'd be making a legally-binding promise to pay you in legal tender in future. In the scenario, I don't have all the money now - only the prospect of obtaining it in future. But you can validly count my promise to pay you as an asset of yours - because it is my liability.

I have a challenge for you: try to create a simple scenario in a tiny economy (just a handful of people) in which a bank can make as many loans as it likes, but is not allowed to charge interest, and the bank's owners are able to consume more goods and services than they would by sitting at home, doing nothing. I find that thinking about specific cases rather than thinking in the abstract, is a great way to test theories about economic subjects. It's what convinced me that the circular flow model in macroeconomic theory is seriously flawed.


James Kiely 2 years ago at 3:13 AM
Chris, you have an excellent understanding of the double-entry method of accounting and how a bank/credit union maintains solvency. The problem is that the act of lending increases total bank liabilities in the banking system. This inflates the money supply. This new 'money' gains its value at the expense of existing money. THAT is the theft/fraud that is occurring.

Regarding your insurance analogy: In a system without a central bank or federal deposit insurance, all deposits could be classified as investments which carry risk, and therefore, all bank liabilities would not be created equal (since some banks are more reckless than others) . Each liability would only be as good as the bank that issued it, just like any normal citizen.

The government, by creating a central bank, has socialized the cost of deposit insurance and now the banks can loan as much as anyone is willing to borrow.

The fact that the original loan needs to be repaid plus interest and is, therefore, deflationary in the future only increases the likelihood of a severe depression if people don't continue to borrow. Hence the description, Ponzi scheme is justified.


Chris Rimmer 2 years ago at 2:59 PM
Dear James,

Many thanks - I appreciate the positive comment.

If you don't mind though, I'd like to challenge you on the idea that the new money gains its value at the expense of the existing money. In the short term, I agree that it could be said to, but in the long term, it does not, because either the borrower or the bank is required to sell goods and services to the value of the new money, which brings them back in balance. It only fails if the defaults exceed the bank's capital.

It is probably best to point you to my essay on it, rather than go into details here:


The FDIC has a legal responsibility to take prompt corrective action if a bank is in danger of becoming insolvent (i.e. liquidate it), but does not seem to be doing so, causing losses to spread beyond the banks.

If banks knew that they would be liquidated if they became insolvent, that would set the limit on the loans that they would make, since more loans mean more defaults.

Karl Denninger (market-ticker.org) also claimed that the system is deflationary, but the interest is recycled back into the economy, as I show in the link above, so it is completely neutral. The borrower is simply paying for a service from the bank. The only way that it could be deflationary would be if the bank refused to spend its income, and how would bankers keep buying fast cars and top hats then? :-)

I firmly believe that the amount of money could reduce to zero with absolutely no harmful effects, and am prepared to debate that.


Jeff Nielson 2 years ago at 4:54 PM
Sorry, Chris, but you're operating with several false premises here.

"I'd like to challenge you on the idea that the new money gains its value at the expense of the existing money. In the short term, I agree that it could be said to, but in the long term, it does not."

This is absurd. The principle is dilution. When a corporation prints new shares, all existing shares lose value. Add water to lemonade, and ALL the lemonade loses value because it is "weaker" (i.e. diluted). Add enough water to the lemonade, and it BECOMES WATER (i.e. worthless).

What you're inferring is what ALL the monetary charlatans infer: that you can create INFINITE currency, but (somehow) the value of the currency doesn't go to zero. Impossible.

''...interest is recycled back into the economy"

Yeah, right. Tell that to the TRILLIONAIRES.

Chris Rimmer 2 years ago at 8:08 PM
Hi Jeff,

If a company simply prints extra shares and gives them to the directors, then yes the existing shares lose value. But this is not the equivalent situation with money.

A better analogy with debt money is like this:

1. Fred borrows $1 from the bank.
2. Fred buys an apple at the market, introducing the extra $1 into general circulation.
3. The next day, Fred picks a pear from a tree and sells it at the market for $1, removing $1 from general circulation.
4. Fred repays the loan.

This is basically equivalent to Fred taking a gold coin from his safe, buying an apple with it (temporarily increasing coins in circulation), selling a pear for a gold coin the next day (reducing coins in circulation), and putting the coin in his safe.

It's not possible to create (and use) infinite currency, because:

1. The borrowers would not be able to spend it all, since there isn't an infinite amount of stuff to buy.

2. The borrowers would not be able to sell an infinite amount of stuff to obtain the infinite money which they would need to repay it.

The limit to lending comes from the fact that more loans lead to more defaults, and the bank's capital is finite.

By the way, are you suggesting that interest is accumulated by banks? Do you accept that interest is the banks' income, which is how they pay their suppliers and employees, and pay dividends to shareholders? If the interest is not making it out of the banks, you would expect to see it accumulating in the banks' balance sheets.


James Kiely 2 years ago at 10:35 PM
Thank you for the conversation, after reading your article it is clear that I have some misconceptions regarding the exact mechanisms of our monetary system. I have some queries regarding certain aspects. If you wouldn’t mind, could you help me to understand?
I’ll address certain aspects of your posts and you can correct any errors.

“If you don't mind though, I'd like to challenge you on the idea that the new money gains its value at the expense of the existing money. In the short term, I agree that it could be said to”

Is this the kind of situation reflected in the stock market bubble from 1925-29? Where prices increased ~3 fold over this time period. I think this was related to the 9:1 margin leverage used by many investors at that time. Is this wrong? What is your alternative explanation?

“but in the long term, it does not, “

Yes, the money supply will contract and prices will fall (deflation) as people repay loans and something like the 1929 stock crash will occur.

As I currently understand, there is a boom/bust cycle caused when, on average, banks are expanding their balance sheets (money supply growing/more debt) faster than production (boom). This boom phase results in prices rising and bad loans being written. At some point, people stop borrowing more money and, as current loans are repaid, balance sheet contract (bust). This results in prices falling relative to bank assets which increases defaults, which results in more bank becoming insolvent, further reducing the supply until all the bad debt is liquidated. I left some parts out of this theory but is this roughly correct?

Are you were saying that lately banks get bailed out when they should be liquidated to write off all the bad debts and let the bad banks fail?

“I firmly believe that the amount of money could reduce to zero with absolutely no harmful effects, and am prepared to debate that.”

Are you saying that money velocity will rise to compensate and/or prices will fall? Are you saying this will this sort itself out without government interference? And what recommendations (if any) would you make to improve the current system?

Sorry for all the questions, I just want to understand this properly.

Regards, James
Chris Rimmer 1 years ago at 10:52 AM
Hi James,

I hope I can answer your questions. I started writing something that got far too long for the comment here, so I'll put it on my web site soon, but here's a shorter (!) version.

To me, existing money can only be said to have had its value diluted if it can't be used to buy the same quantity of things which it could have bought before. If I intended to buy a $10 steak, and it still costs $10 after a huge sum of new money is created, I don't think that my money's value has been diluted.

So if I borrow $1 trillion to buy a few existing skyscrapers, and the previous owners keep the money instead of going on a consumption binge, I don't think the value of anyone else's money has been diluted by this vast amount of new money. The new money was only used to buy something which was added to what was on the market.

Maybe when I come to repay the loan, I will sell several major businesses, which I own privately, to the previous owners of the skyscrapers. That will soak up the new money, and again nobody else is affected by it. The only net result is that I have exchanged some businesses for some buildings.

But there are situations where, in the short term, new money can increase prices. If lots of people remortgage their homes, and use the proceeds to buy new cars and furniture, and eat out all the time, that will tend to make things more expensive for other people. It is not the new money itself that is to blame - it is the decision by people to consume their existing net worth. (There would be the same effect if they were to sell their houses, start renting, and use their lump sums to increase their consumption; or if they simply decided to spend their savings on consumption). If they continue to consume more than they produce, they will eventually run out of net worth, and their consumption binge will have to stop suddenly, at which point the distortions in prices due to the unsustainable extra demand will stop. Prices are likely to drop below the original level for some time, as people produce more than they consume to rebuild their net worth, before returning to the original long-term stable level.

The most harmful situation is a bubble. In this case, people are able to consume more than their true net worth for an extended period, because inflated asset prices make their net worth appear higher. If the defaults of the borrowers exceed the capital of the lenders, then in this case it is true to say that the value of other people's money has been diluted. The banks were issuing money which in theory gives the holder a claim on an equal value of goods and services later, but that promise cannot be honoured. This is equivalent to a pure fiat currency - money which is supposedly valuable because the government simply claims that it is. When a bank is insolvent in this way, the ultimate resolution will involve either some of its creditors not being given what they were promised (bail-ins), or some third party (e.g. taxpayers or solvent banks) being forced to compensate the deposit holders at the failed bank. Even then, the bail-in money or third-party money is destroyed, and the value of the remaining money is restored.

It seems clear to me that the stock market bubble of 1925-29 was like that - it enabled people to consume more than their net worth, so they were effectively consuming others' net worth.


The problem with analysing business cycles is that they are affected so much by the decisions of people who do not have perfect information, and I believe that economists generally overestimate their abilities to model this mathematically.

I can't really go into details here, but I don't think it's true to say that the boom/bust cycle is caused by the expansion and contraction of bank balance sheets. If you think of a bank as a means for a borrower to obtain spending power through pledging either existing assets or future production, you can perhaps see how banks are said to lubricate the economy - they allow the smooth flow of goods and services between people who do not want to have to deal in barter, or to have to accept IOUs from unknown people. It works as long as the banks are solvent.

Bank balance sheets expand when people decide to borrow in order to buy things without having sold something first. They will have to sell something later to repay the loan. If lots of businesses borrow to invest in expanding their production, and then trade their new production with each other, the banks' balance sheets will initially expand. They will then contract to their previous level as the investment loans are repaid, but there is no bust - only an end to the expansion. The extra money is no longer required because all the new factories have been built. Only enough money to trade the output of the factories is needed.

As you suggest, the bust only occurs if banks made bad loans during the boom. At some point, it becomes clear that bad loans were made (because the borrowers are unable to repay, even by selling all of their assets), and losses fall on others. In this environment, businesses (including banks) sensibly do not offer credit so easily, and economic activity is reduced until (ideally) there are only credit-worthy organisations left. Once this occurs, confidence is restored and more investment can take place if there is a demand for new production.

So I don't think that banks' balance sheets contracting causes a bust. What it does do is to expose the bad loans, because those borrowers can no longer hide that they are consuming more than they are producing.


I definitely think that banks should be liquidated rather than being bailed out. A credit crisis is where people do not trust others to keep their promises, and liquidation simply forces people to prove that they can keep their promises. Once people can see which promises are being kept and which are not, a real confidence can be restored very quickly, as I have read happened in the depression of 1920-21.

New banks can easily take the place of old ones. It's a business with plenty of demand, and it is profitable for those who do it well. It really doesn't matter who does it, as long as they are solvent. I think it's implausible to suggest that nobody would set up new banks if several of the major banks were liquidated. In the short term, small community banks could set up, using basic systems. It probably would not take too long for, say, a successful retailer to buy up the premises and systems of a liquidated bank, employ some of the existing employees, and be up and running.

What seems to have happened is that the banks lent to people to buy assets at bubble prices, and the borrowers couldn't obtain enough money to repay the loans. Instead of being honest about this, and allowing the asset prices to contract back to a level which reflects the actual demand for them i.e. what people are willing AND able to pay, enough of the losses were distributed around the economy to allow the banks to continue to operate. But the prices are still too high for people to afford without obtaining more loans which can't be repaid. It's like a pyramid scheme which runs out of people willing and able to join in, and instead of the government shutting it down and prosecuting those who started it, it instead promises to make sure that everybody at the bottom of the pyramid will be compensated. The problem is that they are effectively making taxpayers the new bottom level of the pyramid, and the scheme still can't continue. It may restore a feeling of confidence, but that confidence is misplaced. Real confidence can only come from the outstanding promises being ones which can and will be kept.


I sort of indicated above that bank balance sheets could reduce without any ill-effects. Money is created when it is borrowed, because the borrower wants to buy before selling. If, by some amazing coincidence, everyone happened at the same time to reach a point where they had sold exactly as much as they had bought, all the money in existence could be repaid to the banks with no harmful effects. Of course, it would not last long - as soon as someone wanted to buy before selling again, they would then have to borrow some money into existence.

Credit money is a temporary thing. It gets created, spent by the borrower, and circulated through the economy, then it eventually returns to the borrower (once they have sold as much as they originally bought with it), is repaid, and is destroyed. The actual quantity of money outstanding just represents the amount of incomplete trades of goods and services, where one person has bought and not yet sold, or has sold and not yet bought.


Thanks for the questions - it has helped me to think about them more. I hope that my answers have helped you too, but feel free to get in touch again.



P.S. Thanks, Jeff, for allowing this conversation to continue. If you'd prefer us to continue it away from this site, would you do me a favour and forward my email address to James please? Thanks.
James 1 years ago at 2:24 PM
Hi Chris,

Thanks for your detailed reply. I think I understand your position now and I think we agree on most things. I will attempt to clarify my position on a few points below. Also, I’ll have few more questions for you at the end if you don’t mind answering them.

“It is not the new money itself that is to blame - it is the decision by people to consume their existing net worth. … It (stock market bubble) enabled people to consume more than their net worth, so they were effectively consuming others' net worth.”

I agree, this is a good description of what happened. Regarding the new ‘money’, I think it facilitated increased ‘consumption’, i.e. asset consumption. The increased ‘consumption’ then pushed asset prices upwards (I will admit this is only temporary). Since asset prices rise, people perceive that their net worth has increased and their real consumption increases (commonly called ‘wealth effect’). Some will even increase leverage to maximize profits from the asset price increases. As you say, this is a bubble and eventually the assets are re-valued to their original price as the loans are re-paid. Which reveals their foolish consumption of net worth.

I will be careful to point out that I do not blame the banks for this but, as you say, these bubble are harmful to the majority of people. I do blame the central bank because I believe that their lower than market interest rates incentivized borrowing. I don’t know exactly how much of an effect this had on the market but I can’t see how it made things better. It appears to me, given that stocks bought on margin credit made up 8% of the market at one point, that the lower rates at the Federal Reserve’s discount window contributed to the bubble in the late twenties.

“I can't really go into details here, but I don't think it's true to say that the boom/bust cycle is caused by the expansion and contraction of bank balance sheets.”

I agree. What I should have said banks balance sheet's expand during the boom and contract in the bust (as do many companies). It is not possible to assign cause-and-effect solely to the banks with so many variables in play. I should have chosen my language better, I did not mean to place blame upon the banks for the business cycle; just indicate that they facilitate the process as part of a general change in the behavior of businesses. And that the business cycle could not occur without banks double-entry accounting.

“So I don't think that banks' balance sheets contracting causes a bust. What it does do is to expose the bad loans, because those borrowers can no longer hide that they are consuming more than they are producing.”

Yeah I agree, I was still somewhat on the fence as to whether fraction reserve banking would be considered fraud absent central bank involvement. After reading your comments, I am now quite sure that, in a free-market situation, double-entry bookkeeping is not fraud and is probably a force for good over the long term (by facilitating increased competition by upsetting the status quo for established businesses).

To clarify the main point of my original post. I need to differentiate between a system with a central bank and one without.

In a system without a central bank: The possibility of a bank run exists and it provides pressure upon individual banks to maintain some quantity of reserve funds. These reserve funds are obtained by bidding in the market for savings from productive individuals. Banks must maintain a quantity of reserves based upon their estimated likelihood of a bank run in the future and their need to make day-to-day payments. Thus, their supply of loanable funds is limited by the quantity of reserves they feel the need to hold and their loanable funds interest rates will depend upon this. Also, an liability from this institution will carry a risk that it cannot make the payment due to some event causing a lack of confidence i.e. ‘bank run’ or ‘credit crunch’ (like 2008 where banks would not lend to each other and couldn’t make payments).

My point being, that in this system, any liability from a bank carries a risk and, therefore, a bank which has a low reserve ratio is increasing that risk. Also, the bank has had to bid for its money in the market from the people.

Whereas, in the current system, the central bank honors all payments and the only upon lending is the central bank interest rate and the capital adequacy ratios; the reserve ratio is irrelevant. Therefore, additional loans are NOT increasing the risk of a failure to make payments. And, the banks can borrow at rates fixed by the central bank and do NOT need to bid for money from the people in a market.

1. Have I explained anything insufficiently (especially that last paragraph above) or do you dispute anything I said?

2. Do you agree that the cost of the risk failure to honor payment of new liabilities (loans) is being subsidized by the existence of the fixed central bank interest rates?

3. Do you agree that this subsidy will need to be paid for in some way?

4. Would you agree that, by depressing interest rates over a long period, this increases the money supply over the long term which results in each individual unit of money being worth less?

5. Are you in favor of a free-market or do you feel that central banks have positives?

6. Do you feel that current levels of global debt in relation to global income are excessive?

7. Do you think depressed interest rates have contributed to an increase in the level of global debt or has it simply reduced the burden upon individual borrowers?

Thank you very much for answering my previous questions in such detail, Chris. I appreciate any additional answers. This has been a very productive conversation for me.

Chris Rimmer 1 years ago at 10:47 AM
Hi James,

As you say, I think we're pretty-much in agreement on most things. I have a few thoughts about what you wrote though:

"I will be careful to point out that I do not blame the banks for this but, as you say, these bubble are harmful to the majority of people. I do blame the central bank because I believe that their lower than market interest rates incentivized borrowing."

I would say that the banks do bear much of the responsibility when they lend to people who they know, or should know, can't repay. Their whole purpose is to guarantee the promises of their borrowers, so if they get it wrong, they should be held accountable (by being left with the losses). Of course it is difficult for publicly-traded banks to hold out against making bad loans in an environment where their competition are doing it and appear to be much more successful in the short term. It is particularly difficult if the central bank is manipulating interest rates lower, implicitly promising to transfer banks' losses to the taxpayer. Deposit protection schemes also make it harder, as they subsidise depositors of reckless banks at the expense of prudent ones, although I'm not completely against deposit protection.

"the business cycle could not occur without banks double-entry accounting."

I half-agree with this, but can I just first draw a distinction between double-entry book-keeping (where each transaction is recorded in a book or file as a debit to one account and a credit to another, with cross-references between the two), and creating money as liabilities? Balance sheets (showing what you own, what's owed to you, and what you owe) are a much more fundamental concept than debits and credits. A balance sheet can be drawn up for anyone, whether they use double-entry book-keeping, single-entry book-keeping (just a list of all transactions), or even in principle no book-keeping at all (by doing a stock check, and looking through their files for outstanding debts).

On the business cycle, even if you used a commodity money, I would expect there to be periods where confidence and business activity would wax and wane. For example, the high profits on early railways led to an over-expansion and surge of economic activity, before it was realised that some of the lines were not profitable, losses had to be recognised, and net worth had to be rebuilt. But I do agree that the creation of money as a bank's liability can greatly amplify the business cycle, in that it is much easier for firms to obtain funds through large bank loans than by marketing shares or bonds to the general public.

"To clarify the main point of my original post. I need to differentiate between a system with a central bank and one without."

I eventually concluded that there is not such a big difference between the two systems (i.e. with or without central banks).

Banks need to maintain reserves in either case, both for withdrawals and for settlement between banks (e.g. if I have an account at Bank A, and I write you a cheque for $10,000 which you pay in to your account at Bank B). If a bank's assets are not liquid (e.g. property, or loans not due for several years), it may take the bank a long time to obtain enough money to settle, and then the bank will rightly gain a reputation for poor service. Banks ought to handle these transactions quickly. They have a treasury team, whose job is to anticipate these needs for cash, and manage their assets so that they have enough at any point in time. (For example, they can keep some government bonds, which have traditionally been easy to sell or use as collateral for an overnight loan from another bank or the central bank).

"in the current system, the central bank honors all payments"

If by that you mean that central banks honour all liabilities of retail banks, then I'm sure that's not true. At least not in theory. The central bank is only supposed to be an extra possible place where a bank can go to borrow money, in case it can't sell assets or borrow money from somewhere else. If the bank does not have good assets to use for collateral for a loan, it is supposed not get the loan and then it *will* default on some of its liabilities. (See Bagehot's Dictum). So making additional loans to higher risk borrowers *does* increase the risk of a failure by the bank to make payments to its creditors (including those with deposits), whether or not there is a central bank.

Having said that, the system has become corrupted by creating a "too big to fail" category of bank, whose liabilities *are* honoured by the government or central bank. This is a terrible situation. Those banks can make as many bad loans as they want, report huge profits, and pay themselves bonuses, knowing that when the losses are finally revealed they will fall on taxpayers or people who were expecting to receive benefits from the government.

To answer your specific questions:

1. I think you explained it well. See above for comments. :-)

2. I agree that low central bank interest rates and TBTF subsidises banks which make bad loans.

3. I agree that the subsidy will need to be paid for. Nobody can be subsidised without someone subsidising them.

4. I agree that the quantity of money (I don't like the term "money supply" which sounds like a flow) is increased by central banks depressing interest rates, but that that is not the most important issue. Depressed interest rates, together with the explicit aim of causing inflation, encourages people to consume more of their net worth now instead of later, making each unit of money worth less now. But because it reduces their ability to consume later, it tends to produce disinflation later, making each unit of money worth more later, assuming we have a free market. Ultimately, consumption is paid for with production, not with money, and in a free market you can get more for your production by waiting for this period of pulled-forward demand to end. I think we are reaching the point at which governments and central banks are going to do one of two things: (i) recognise that you can't keep paying for new goods and services with new promises, leading to a major disinflation and probably depression (which could be quite short if everyone is forced to be honest about their actual net worth), or (ii) print and print money until it is worthless, so that sales which occurred in the past are converted to donations, and once again people will be taught that it is better not to save for the future. (i) would be better for humanity in the long run. (ii) will lead to a very precarious existence, since without saving you have to live day-to-day.

5. Yes, I am in favour of a free market. I think that central banks could be fine as long as they follow Bagehot's Dictum, but there is a big incentive for powerful people to exploit a central bank's monopoly power for their own aims.

6. Debt-to-income ratios certainly feel too high to me. But I firmly believe that the biggest problem is the erosion of people's net worth.

7. I certainly think that depressed interest rates have increased global debt. It has reduced the burden on borrowers who would have borrowed the same amount at a higher interest rate, but for many borrowers, the lower interest rate is outweighed by the fact that they have had to borrow more to buy the same things.

It's been a very interesting conversation for me too. Thanks. Feel free to contact me at chris5c02 at my domain (see earlier links), or post here again.


James Kiely 1 years ago at 9:24 PM
Hi Chris,

I have tried to find your contact details on the bluehydra website but I cannot find them.


Chris Rimmer 1 years ago at 11:42 AM
Hi James,

My email address is chris5c02 at that domain. Sorry it wasn't clear. I'm just trying to avoid being spammed by keeping the address separate from the domain in these comments.


Doug Kelly 2 years ago at 1:03 PM
Mr. Rimmer, while I'm sure you are better apprised that I on this subject, my understanding of fractional reserve banking has only to do with the process of lending of money, wherein the bank lends the borrower $100, only $20 of which comes out of the bank's own money, and the 80% balance is simply credited to the bank for the loan. The borrower repays the full $100 + accrued interest, and the bank has essentially created $80 out of thin air, which the borrower has repaid. The interest is only the claimed, disclosed earning.

This process has nothing to do with depositors' money, which is the bank's liability and the depositor's asset.

If you think I misunderstand this, please correct me. I do know that Henry Ford once said that if the people actually knew how banking works, there would be an uprising.
NK 2 years ago at 2:28 AM
If the bank pays $100 and creates an asset, it needs to create an equivalent liability in the balance sheet. $100 = $20 (Equity) + $80 (borrowed, could be deposits or market borrowings). So nothing is coming out of 'thin air'.
In case of insolvent bank, deposits have the first charge on the bank (i.e. needs to be paid first, some of it is insured for which the bank pays a premium), followed by senior debt, sub-debt and finally equity shareholders.
The fractional reserve banking concept stems from the fact, that banks will lend out $90 out of every $100 borrowed funds (deposits or money market), keeping $10 with the Central Bank. This process repeated ad-infinitum creates a money-multiplier of 10x. So, it is this 9x which is being termed as 'thin-air' money. So 1x is the base money with a 10x leverage. If fractional banking were to be demolished, we would go back to a near barter system, and banks will charge you for keeping your paper currency (deposits) and will become a locker box.
Someone should read the history of banking.
Doug Kelly 2 years ago at 8:15 PM
don't follow your explanation. You say, "If the bank pays $100 and creates an asset, it needs to create an equivalent liability in the balance sheet. $100 = $20 (Equity) + $80 (borrowed, could be deposits or market borrowings).
I've never worked for a bank, but I have worked for financial lending institutions, and I see no reason why a bank must create an equivalent liability in its balance sheet to exactly offset the created asset (of the loan amount). If such were done as you say, wouldn't that create a zero net worth on a balance sheet? In which case, it would not really be a balance sheet in the normal sense of the term.
If fractional reserve banking does not create new money, then a bank with a money-multiplier of 10x is extremely highly leveraged and would by any other measure be considered insolvent.
I would differ with your opinion about fractional reserve banking, which must pre-suppose a central bank, that without a central bank we would need to go back to a barter system. The US as did most countries in the world, got along fine without a central bank. Albeit, several were formed then dismantled during the course of the our country's life. Speaking reading the history of banking, the only use a central bank has is to enable the government to deficit spend. The result of such deficit spending is an incredible expansion of the credit market. For the government, that means financing a standing army and therefore the endless wars we are currently engaged in. It allows the spending on government credit, bonds and so forth, for any array of needless and useless government programs, which means a blank check for congress and the infinite number of agencies of the executive branch. And this has resulted in banks and companies being bailed out (TARP) of the consequences of their own doing. "Too big to fail" is a euphemism for political collusion with big banks, big business, and corrupt politicians. Over-leveraged banks created derivatives that were bundled and sold to the lenders of last resort -- Fannie Mae and Freddie Mac -- that were also not being operated with the correct oversight of congress. And this gave us the extreme recession/mini-depression that began in 2008 and is still effecting the economy with its after-shock.
New banking laws were of course, quickly passed by the congressional oversight committees; i.e., Dodd-Frank and other less known laws that are killing small banks with compliance duties that are primarily little more than paperwork and filings that few read or watch.
The US central bank has been issuing fiat money since the early 1970s after Nixon took the country off the gold standard causing wild inflation to follow. More recently since the debacle of 2008, the central bank has issued incredible amounts of money under its Quantitative Easing program. This vast amount of fiat money, in my opinion, should have been used for legitimately enlarging the economy by forcing banks to use such monies to boost small business and thus increasing employment. But that is not what the banks did. In fact, too many banks simply used it to buy up other banks, possibly failing small banks. which did nothing tangible to help the economy grow. This was just more the same --- bailing out banks that may or may not fail. The small business community employees approximately 80% or more of all workers, and for the most part, it was completely ignored in favor of letting the SBA insure loans and the banks keep their money for the good or betterment of the stockholders of the banks.
It's highly unlikely that the nation would have to go back to a barter system, but it would mean the present, over-heated economy would slow down and mild-deflationary factors would be in play. I'm quite conservative, so my view is skewed by the desire to create free markets and expand business -- the source of the only real growth of any economy.
Dwain Dibley 2 years ago at 11:32 AM
The U.S. 'gold monetary standard' ended in 1933. The Federal Reserve has not issued incredible amounts of fiat money, there are only $1.39-Trillion in fiat money currently in circulation around the globe. Fractional Reserve banking does not create money, it expands credit/debt.
Doug Kelly 2 years ago at 1:00 AM
The gold standard did not end in 1933. FDR and the Congress lowered the value of gold to $34/ounce, but did not eliminate it. It was a hat tip the gold reserves the US held against foreign currencies. We in fact, went to the Silver Standard with each bill bearing the world "Silver Certificate" and that the currency was backed by the full faith and credit of the US.
Use of Fractional Reserve banking is the way n which new money gets into circulation. When the Federal Reserve -- the US version of a central bank -- loans money automatically to banks to cover their fractional reserve lending it does create new money. The more the Central Bank makes available the more credit there is available. Credit is what this economy operates on, and that is the singular reason for the unbelievable national debt the US now is subject to repay to all those entities that have bought the bonds to finance the expansion of money. This enables the banks to essentially create money, which they keep and use to loan or invest depending the kind of bank it is. If this were not the case, then Paul Krugman's idea of minting a $7 trillion dollar coin to pay off the debt. This from a Noble winning economist.

Dwain Dibley 2 years ago at 1:22 PM
The gold standard did indeed end in 1933 when the use of gold as money was outlawed throughout the economy, an international gold settlements system, notwithstanding. We did not go to a "silver standard", silver was merely included in the fiat money supply, until it wasn't.
Fractional reserve banking does not introduce any new money into the economic system, it expands credit and reduces the amount of actual money in use within the economy, diverting it towards maintaining and expanding reserves. The Fed does not "loan money automatically to banks", they call the Fed "the lender of last resort" for a reason. Banks loan first and reserve second, they do not loan from reserves. Neither the Fed or the banks possess the legal authority to create money, and they don't.
How Currency Gets into Circulation: https://www.newyorkfed.org/aboutthefed/fedpoint/fed01.html
Sorry Doug but, you are wrong on just about everything.
Robin 2 years ago at 5:01 PM
Thank you, Dwain, but would you define your use of money, debt, and credit, please? The more I read here the more confused I become.
Dwain Dibley 2 years ago at 6:22 PM
Well Robin, it's not "my use" or "my definition" of legal tender money, it is defined by law. The law also stipulates who owns it, who has the authority to print it, and how that legal tender money gets into circulation.
I explain this, with links, on my blog.
Neither the Fed or the banks possess the legal authority to create money. There is no law anywhere the designates or acknowledges the credit they do generate as being a money, a currency or a medium of exchange. By that same token, there is no law the prevents them from generating credit.
Doug Kelly 2 years ago at 11:17 AM
Dwain, I don't believe I'm as wrong as you say, maybe just not as articulate as I should be. Since you seem to be intimately familiar with the process, our difficulty in communicating with each other is perhaps a mater of semantics.
For instance, you write: "Fractional reserve banking does not introduce any new money into the economic system, it expands credit and reduces the amount of actual money in use within the economy, diverting it towards maintaining and expanding reserves." You use the word credit where I would use the word money. Credit is money borrowed, but it is still money; i.e., debt monetized as it is paid back. Such credit can be used to pay for tangible goods to which a value is assigned and agreed to by the seller and buyer. .
When credit is created, new money is created by virtue of the fact that the credit has been monetized and will be paid back in full plus interest charged for the credit. Money loaned by a bank in cumulative amounts that are greater than the banks legal reserve it must hold (FDIC) is borrowed from the central bank making up the difference between the bank's reserve and the amount of the loan. The bank makes money by loaning depositors' money and the borrowings from the central bank at a higher rate of interest than it is paying to the depositor or the central bank.
If this doesn't expand M1 and M2, essentially creating more of it, which in turn creates new assets by the borrower in the form of consumer goods, real estate, industrial equipment and so on that would otherwise not exist then this increases values in goods and services in addition to the original loan amount that is repaid. What is the name, for the sake of semantics, you assign to this growth? It's economic growth, but specifically, what do you call the mechanics of such growth?
Dwain Dibley 2 years ago at 1:27 PM
Doug, why do you believe repeating the fraudulent practices of the Fed and the banking system, refutes my argument or mitigates their theft and fraud? If you want to argue against the facts as I've presented them, then you're going to have to come up with something more substantive than erroneous, theory based, opinion, which you've also managed to get wrong.
SRV 2 years ago at 4:11 PM
Re: The Auto Maker / Banker analogy

You seem to discount the "fact" that the auto maker sells his customers a product. A tangible product that is the result of labor, skill and effort of hundreds of human beings...
Yet the banker simply puts down his coffee and copy of the WSJ to make a single computer entry, then goes back to his comfort zone and counts the profit as it rolls in.

Hardly analogous.
SRV 2 years ago at 4:20 PM
Oops, that was auto insurance not maker... my bad... but the facts still stand regarding the completely untenable privilege given to banks around the world.

Banks are a convenient and necessary service... they should of course be non profits operated by the government of the people. But then we had that in countries like Libya (no interest loans for all, no cost healthcare and education for all, and no real poverty)... thank goodness the west saw fit to rid the world of this abomination before it took root elsewhere (it took a month to implement the western fractional reserve model)... hmmmm.
Rusty Maosn 2 years ago at 12:32 PM
Chris Rimmer is right. There is nothing wrong *per se* with fractional reserve banking. Id est, there is nothing wrong with the face value of promises to pay not matching 1:1 your current holdings. It is up to the holders of your debt instrument to determine your credit worthiness. What is fraudulent is to misrepresent your financial position so that debt holders cannot do that.
Jeff Nielson 2 years ago at 10:36 AM
Rusty, of course there is something wrong with fractional-reserve fraud, and to illustrate this, I'll simply take a quote from a later installment of this series (Part III):

"Under a gold standard, the “Golden Handcuffs” function to prevent both the excessive money-printing produced by fractional-reserve fraud and the extreme debt-levels (Debt Slavery) of our governments. Indeed, a true gold standard is totally incompatible with fractional-reserve “banking.” With a proper gold standard, if a bank wants to “lend” capital, that capital must actually exist. What a concept! "

With fractional-reserve "banking" the banks are "lending" WHAT DOES NOT EXIST. Prima facie fraud.
SRV 2 years ago at 1:52 PM
Isn't it telling that even those with years of on the ground experience still can't agree on the convoluted mess (for very good reason) that just happens to be the most consequential set of policies in our society!
Deposits are a liability on the bank balance sheet... yes, before you even get a whiff of your earned income (which is almost 100% direct deposit and you have no options) it becomes a liability of the bank... your have loaned your pay to the bank for almost zero return (and yes, as principal is returned it is removed from the balance sheet... but the money was of course spent into the economy, effectively diluting the currency value at the alter of big fat lazy banker profits!
And we haven't even touched the subject of why the first years of a loan (lets use a mortgage) payments are almost entirely interest payments... hmmmm, tell me more!
Of course it is so 'Mr Global' (who owns most of BB shares) gets his cut for doing nothing a sovereign government couldn't do for free (as Canada proved for decades) so he can build the tallest skyscraper in every large city on the planet, pay his CEO $15M, and bribe politicians to pass ever more laws to enable their relentless process of wealth extraction.
Canada (one of the final holdouts) borrowed without interest until the early 70's and had but a few million in sovereign debt. We were bullied into lending from private banks at interest (do it or we tank your economy... and I challenge anyone to find any records... they're wiped clean!) and today our incredibly "responsible" banking model has put us half a Trillion in debt... with almost all 'compound interest' owed to the fabulously wealthy Big Five banks!
How about we gift our Social Service sector with this power, instead of the greedy bankers, and use the trillions in profit to fund a basic income for all... you know, use it for good instead of greed, fraud, and war (I know, what was I thinking)?

Thanks to Jeff & Sprott for this series... and shame on any who would go all "pretzel like" trying to defend the indefensible.
Jeff Nielson 2 years ago at 11:05 AM
Thanks for the support, SRV!

Yes, we have a totally criminalized system, a system of coercive theft -- in other words, hardcore fascism. The marriage of Big Business and Big Government, for the purpose of looting the people.
Chris Rimmer 2 years ago at 4:49 PM
The funny thing is that we agree that the marriage of big business and big government loots the people. We're just disagreeing on the mechanism by which it works. And it needs to be studied and understood clearly, because blaming the system for the fraudulent acts of particular people will just lead to the same people abusing the replacement system.

I'm convinced that a government-owned bank monopoly would be significantly worse than the cartel of "too big to fail" banks that we have at the moment.

Jeff Nielson 2 years ago at 7:34 PM
"...I'm convinced that a government-owned bank monopoly would be significantly worse than the cartel of "too big to fail" banks that we have at the moment."

Really, Chris?

If you sincerely believe those words, then first you need to watch these two, outstanding documentaries...


..and then you need to read (re-read?) Part II of this four-part series:

Chris Rimmer 2 years ago at 7:08 PM
Hi Jeff,

I hope it's clear that I'm not claiming that everything is fine. I'm just claiming that there's nothing inherently wrong with the current banking and monetary system, as long as banks are forced into liquidation before they become insolvent (i.e. more liabilities than assets).

But as to whether a state monopoly on the creation of money is a good thing, consider the following hypothetical example:

A family - the Blueswords - have managed to become the most powerful group of bankers in the world. They have close links to governments, heads of state, central banks, business leaders, and other powerful institutions. Then the people decide to elect someone who replaces the monetary system with one in which the state has a monopoly on creating money.

Do the Bluesword family say, "Looks like we've been beaten. We'll just let our wealth decline as we fade into obscurity."? Or do they say, "This is a fantastic chance not just to be the most powerful group in banking, but to directly control the entire monetary system."? I think it's more likely to be the latter, so I'd want to see more competition, not less.

The abuse will only stop when enough people demand that insolvent banks are liquidated, bringing an end to the Ponzi scheme of bubble after bubble after bubble, and stop believing that their poor decisions can be bailed out at someone else's expense. Once a Ponzi scheme gets going, someone is going to suffer, and given how long the current one has gone on for, it's going to be very bad.

Joshua 2 years ago at 11:42 AM
Chris, Rusty... If that's the case then why is a "ponzi scheme" perpetrated by say Bernie Madoff so abhorrent to the general public not to mention highly illegal (he is in prison) if, when all he really did was use someone else's money to speculate for himself. His main crime being he was not running his assets and liabilities 1:1. If it's wrong for him, how can it be ok for the banking or insurance business for that matter. Let's face it its all a scam, and in our institutionalized world view, they are "too big tofail" so we just keep Justifying their behavior while paying their bills..... It's not going to get better
Derek 2 years ago at 7:11 AM
"Using *our* money, these Traitor Governments indemnified the Big Banks for every cent of their reckless, fraudulent gambling."

In fact, it is not "our" money. In the case of, say, the Federal Reserve System, Federal Reserve Notes are a privately-owned currency. They own it; we don't. Here's proof:

Jeff Nielson 2 years ago at 12:20 PM
You're quite right, Derek. When I talk about the funny-money created by these central banks as being "our" money I'm using the term in more of a colloquial sense than a legal one.

The currency used by our nations, the currency OF our nations, is "our" money. The (legal) fact that we do NOT own the currency of our own nations is (as you're implying) one of the greatest outrages of our fraudulent/criminal monetary system.

"Give me control of a nation's money supply, and I care not who makes the laws."

-- Mayer Amschel Rothschild
Dwain Dibley 2 years ago at 3:45 PM
Federal Reserve Notes are owned by the people via the U.S.G. The Fed not only pays for their printing, they are also required to post and maintain collateral of equal value to the notes received. Congress has specified that a Federal Reserve Bank must hold collateral equal in value to the Federal Reserve notes that the Banks receive. This collateral is chiefly gold certificates and United States securities. This provides backing for the note issue. The idea was that if the Congress dissolved the Federal Reserve System, the United States would take over the notes (Fed liabilities). This would meet the requirements of Section 411 (Federal Reserve Act), but the government would also take over the assets, which would be of equal value. Federal Reserve notes represent a first lien on all the assets of the Federal Reserve Banks, and on the collateral specifically held against them.

FRNs are not borrowed or spent into circulation, the only way they enter into circulation is through bank customer requests for the medium.
Raw 1 years ago at 2:32 PM
That's a fair account of the situation. The word is "Odious" Which means this "institutional Debt Slavery system is Odious, and the people who never "benefited from the fraudulent loans, need not pay it.This is based on International Law.If the so call banks want this "presumed" debt, they have to get it from the individuals they lend it to.
Chris Rimmer 1 years ago at 6:19 PM
Hi Raw,

In a fractional reserve system, borrowers get a deposit which is a newly-created liability of the bank. They use this deposit (i.e. debt from the bank) to buy goods and services, which they otherwise would not be able to (unless the seller accepted a personal IOU). The bank now owes the seller the amount of the loan.

So if I borrow $1,400 from the bank, and use it to buy 1oz of gold (from Jeff) which is then my property, can you honestly say that I have not benefited from the loan?

In that scenario, here are the changes in balance sheets before any interest is charged:

A += loan : Chris Rimmer ($1,400)
L += deposit : Jeff ($1,400)
{net worth unchanged}

A += 1oz Au
L += loan : Bank ($1,400)
{net worth += (1oz Au - $1,400)}

A += deposit : Bank ($1,400)
A -= 1oz Au
{net worth += ($1,400 - 1oz Au)}

In what way is my debt to the bank odious? If I didn't have to pay it, I'd have got 1oz of gold for nothing, and the bank would owe Jeff $1,400.

There's no real causal link between the money being saved with the bank and the money being lent out. The lifecycle of money is:

1. Money is created (as a deposit - a debt to the borrower) in exchange for a debt from the borrower.

2. It circulates in the economy.

3. The borrower, who has previously bought goods and services without selling any, now sells goods and services without buying any, leaving him with some money.

4. The borrower repays the debt, which is extinguished together with the deposit.

Mladen Fernezir 1 years ago at 4:04 AM
It's funny how there's still so much basic misunderstanding about money, banking and sovereign state monetary operations.

In the general and abstract sense, there's many different kinds and forms of money. First of all, there's money you see when you take out your dollar bill or coin from your wallet and there's money that the central bank types into existence for example when it buys some government bonds. These two are of the same kind. The later one is the one banks hold in their accounts at the central bank and along with cash in their volts, both equivalently and interchangeably constitute "bank reserves". If banks want to get cash, their accounts at the central bank get debited for the same amount and vice versa, if they provide cash to the central bank their accounts get credited for the same amount.

Banks are mostly private agents which do not lend out any of those two forms of money. To reiterate and emphasize, they don't go and lend away somebody's cash nor do they lend out bank reserves. They also don't actually multiply anything. What they do is they simply type in their own electronic money into existence when somebody comes in and gets a loan. It is as if they are writing their IOU on a piece of paper. Then the customer goes about and trades with other customers using his bank's IOU. At any point some customer may require the bank to give him cash for his IOU. Sure enough, the bank will give it and then the electronic deposit (or paper IOU if it were in that form) puffs out of existence. And if the customer wants to transfer his deposit to another bank, the first bank transfers reserves to the second bank. The old deposit puffs away and the second bank types in its own IOU.

So, what we're mostly doing is trading with private promises or obligations to repay. We trust the banks to be able to give cash if desired and we just trade with the money they create out of nothing. They type it into existence every time somebody takes a loan. Whatever the actual cash or reserve position they hold may be at that moment, cash and reserves just stay put. Nobody is lending them. Naturally, we trust the banks because we know there is a central bank behind them that will always help out any bank with its power of bank reserve creation if it is just a temporary liquidity problem for the bank to provide cash and if it otherwise has a nice and positive balance sheet.

In this story, there may or may not be at all some proscribed amount of reserves before creating deposit money. In any case, reserves and cash are of completely different kind when compared to bank deposits. No commercial bank could have ever created or multiplied reserves nor cash. The creator of those is the central bank and indirectly, the government. It is the government that created the original bond which at some point got to the central bank that typed in new bank reserves to acquire it. To get government bonds, one has to provide bank reserves. Another point worth mentioning. One also must provide cash or bank reserves to pay taxes. Private money that regular banks created won't cut it. If you have a deposit in your bank, it will puff away and your bank will have to provide bank reserves to the government in the same way like in the cases where it has to provide you cash or transfer reserves to another bank if you tell it to transfer your funds. Therefore, one key to understanding is to clearly distinquish bank reserves and deposits that bank create. They are distinct concepts, differently created and always clearly separated, with bank deposits being claims on the former.

Regarding inflation, sure enough, if banks create many IOU deposits there could be inflation in the sense that the prices could keep going up and up. However, just because there's more money it doesn't necessarily mean there will also be inflation since the prices might stay the same if production rises. Or, even though there's now more money, the prices could still be going down and down, i.e. there could be deflation. The central banks hope to control the amount of private money creation with interest rate setting and in some countries by reserve requirements. There are other more important requirements as well, e.g capital ratios and so on.

The banks are delegated to flexibly create and destroy money as the need arises in the real economy since it would be very hard for anybody to centrally decide how much is just the right amount at any given moment and where exactly should it go. When the need arises, some credit money gets created ad hoc. We can imagine the created deposit changing hands, economic activity increasing and finally the deposit coming back to the original creditor. The creditor returns the debt to its bank and the deposit goes away back into nothing. The purpose of banks is not to lend existing money, their purpose is to create credit. Obviously, credit as a concept opposed to only lending some existing sum of money has many potential benefits.

Regarding central bank regulation, we can see that sometimes the methods central banks use in the attempt to influence private money creation just don't seem to work. As we've seen, the interest rates can be almost zero and even negative, but darn banks just seem to be creating too few of their banking monies. The problem is, all of those benefits like low interest rates and plenty of reserves are not helpful if the potential borrowers already have too much debt on their hands and if they are not certain if they could repay the loan. After all, there's also some interest that has to be paid to the banks and it has to come from somewhere.

The solution is what is often ideologically dismissed. Still, it's the one practical thing to do. There is always the federal government that isn't really bound with household considerations. It is the government that can keep on issuing bonds and spending, knowing that there is always the power of its central bank to buy. The central bank can go on and on and accumulate government debt. The government will go on and on and issue new debt and eventually, the central bank will buy it. If it wishes, the central bank will just keep on buying and push the yields to whatever low number it desires. This process will and does go on everywhere where governments issue debt in the currency their central bank has the power to create out of nothing. It is the government that borrows foreign currency that is potentially in huge trouble. The interest could go up and there is no out of nothing money creation so that government actually has to behave like a good old household when it comes to foreign money.

To get back to domestic money creation, it is this bank reserve creation via government bond issuing and central bank key stroking that actually creates what I'll loosely call "free money" for everybody else. To get credit money from your bank, you also have to give some obligations to the bank. On the other hand, government deficit spending ends up as central bank reserve creation, i.e. pure money without credit obligations to the one receiving it. Without that influx from government deficit spending, you'd end up with deflation and massive credit write-downs. Credit interests wouldn't get paid and you'd also get money appreciation when compared to everything real that is constantly growing and multiplying. While the banks can create new deposits, they can't create this kind of pure money. The bank and its creditor combined still have their assets and liabilities at zero while government spending and central bank key typing creates net assets for those receiving it. The key observation is that the government can and should be permanently more and more negative in its own currency. That negative is matched dollar for dollar with positive balance for everybody else.

One of the key worldwide political problems is that there's still so much confusion regarding all of this. Some believe that government debt could eventually explode since they fail to understand that it can be perpetually financed via the central bank at zero or even negative interest. They also think that the country may go bankrupt for constant deficit borrowing in its own currency. Others conflate different types of money and believe that somehow commercial banks finance the government with their money creation. There is also a principle-based, but misplaced disdain for government deficit spending as if it was something immoral. You may not like it, but that's how you get to create what is called net financial assets for everybody else besides the government. The central bank just swaps one financial asset with the other, but is the government that originally put it in the system. Free money not burdened with obligations to your creditor, like I've said above. Also, it is this fiscal action that has the most powerful potential to ramp up inflation if that's what the economy needs or to dampen it with a reverse process, i.e. reduced spending and increased taxation. This is the monetary mechanic and the world we are living in.

Since we can see that central banks around the world have pretty much exhausted what their monetary operations can do to stimulate the economy, let's hope we'll see more decisive fiscal actions coming from the government itself without mistaken and deeply harmful notions of having to balance its budget like a good household. Luckily, we do have where to look for guidance for quite some time now, if we are up for the task to go down the financial rabbit hole. The guidance is called Modern Monetary Theory.
Chris Rimmer 1 years ago at 7:52 PM
Dear Mladen,

I fully agree with the first half of what you wrote - up to "They are distinct concepts, differently created and always clearly separated, with bank deposits being claims on [bank reserves/cash]." I'd like to debate the remainder with you, using balance sheets as the basis of my reasoning. Balance sheets show assets (what you own plus what is owed to you), liabilities (what you owe to others) and net worth (assets minus liabilities).

My first observation, which I expect you agree with, is simply that bank deposits are liabilities of private banks, and bank reserves and cash are liabilities of the central bank. This is why private banks can't create bank reserves or cash - you cannot (at least not legally or morally) give someone a claim on a third party. That would be blatant counterfeiting.

As to inflation, your point is valid in the short-to-medium term that the general level of prices is not determined by the quantity of money alone, but also by the supply of, and demand for, goods and services. However, I think you, like many people in positions of authority in government and central banking, are missing a crucial factor, which dominates in the long run, as I will now describe.

When a bank makes a loan, it swaps IOUs with the borrower. This is true for both private and central banks. The borrower's IOU is usually not accepted in transactions, but the bank's is, so the bank's IOU can be used as money. The question which I would like you to consider before reading on is this: what happens if the borrower defaults? (Think specifically of whose balance sheet is affected).




Here's my answer, based on my experience of 8 years of study and debate, performing many thought experiments, and volunteering in a credit union where I had to study the balance sheet:

When a borrower defaults, the deposit (or bank reserve) which the bank created still exists. It is currently a debt from the bank to someone else in the economy. However, the asset which was created at the same time is no longer there. It has to be removed from the asset side of the balance sheet. So liabilities are unchanged, and assets are reduced, which means that the bank's net worth is reduced by the amount of the default.

(There are two other actors whose balance sheets are worth considering. (i) Whoever now has the bank's IOU is unaffected - they still have the deposit. (ii) The person who defaulted has their liabilities reduced by the amount of the default, and their assets are unchanged, so their net worth increases, although probably from a negative value towards zero because otherwise the bank would probably pursue them for repayment).

In summary, there has been a transfer of net worth from the bank to the defaulting borrower.

A bank is supposed to have a positive net worth. This allows a certain number of defaults to occur, leaving the bank with enough assets to meet all of its liabilities. As its net worth is eroded by defaults, it must be replenished from operating profits or by obtaining new share capital.

But what if a bank's net worth goes negative? Then you have a big problem. The bank has a number of outstanding IOUs, but it doesn't have enough assets to be able to keep its promises. If the bank were liquidated, some of its creditors (employees, suppliers, bondholders or depositors) would not get what they are owed. This is a huge problem. In the short-to-medium term, creditors may be satisfied with seeing that they can still buy things with the bank's IOUs, but if there is a reduction in confidence, and people start testing the bank's promises, the bank's insolvency is exposed and the value of the bank's IOUs rapidly reduces to (and for some time probably below) its liquidation value.

So while in the short-to-medium term, the value of the bank's IOUs come from supply and demand in the economy, in the *long* term, the value of the bank's IOUs come from its solvency, which in general depends on the borrower's ability to obtain enough of the bank's IOUs to repay their loans, which depends on their ability to sell something of value to the people who have money.

I have written a short essay, with diagrams, on this topic at http://www.bluehydra.co.uk/ACE/Post03-MoneyLifecycle.html

Now, let's look at the second half of your comment. You suggest that the government can continue indefinitely issuing debt, and the central bank can keep on buying. Remember, what I said above is as true for central banks as it is for private banks. Defaults reduce the bank's net worth, and when a bank has a negative net worth, its IOUs are not worth what the bank claims.

It is true that a central bank whose IOUs are legal tender can't be forced through bankruptcy: it can issue as many as it likes even if it is insolvent, and by law the creditors have to accept them. But that doesn't mean that people will have confidence in the money of an insolvent central bank, especially one which is either indifferent to, or even enthusiastic about, becoming increasingly insolvent. At some point, the people will realise that the central bank is not interested in the value of its money, and once confidence is lost in the long-term value of a currency, it is essentially impossible for the issuer to regain it. This is likely to happen very slowly at first, and then all of a sudden.

You might argue that the government could not actually formally default, but just decide that it will never repay the debt. I would say that those two things are identical: you can't have it both ways. Either the government debt is an asset of the central bank, in which case the government must also acknowledge it as a liability (which it must meet through taxation), or the government can admit that it never intends to repay, in which case the central bank must write it off, reducing its net worth and probably rendering it insolvent. You can't create a debt which is an asset of one party, but not a liability of another, just as I can't make myself, or the whole economy, better off by claiming that you owe me $1 billion. Either you owe it to me or you don't.

There is only one way that you can increase the net worth of the whole economy, and that is by producing something more valuable than what was consumed in the process (e.g. a table from wood). Production increases net worth, consumption reduces net worth, and absolutely *everything* else is just transferring it around. You cannot add to net worth by fiat. There is no such thing as a one-sided debt, which is an asset of one person but not a liability of another. By looking at balance sheets, you can see that "free money" is not really free at all - it is just a transfer of net worth from someone (to be decided later) to the government. It may be a specific group of taxpayers, or it could be holders of money in general, but balance sheets make it clear that, for someone to get something for nothing (without producing a new asset), someone else must get nothing for something.

By the way, commercial banks *can* effectively finance the government with their money creation. Consider the following scenario (with the bank's balance sheet changes shown in curly brackets):

1. Tophat Bank initially has $2 billion in bank reserves.
2. It buys $1 billion of government bonds.
{Assets += $1 billion (bonds). Assets -= $1 billion (bank reserves)}
3. Government spends $1 billion buying, say, a new fighter aircraft from Warplanes Inc., which banks with Tophat Bank.
{Assets += $1 billion (bank reserves). Liabilities += $1 billion (bank credit)}. Net result {Assets += $1 billion (bonds). Liabilities += $1 billion (bank credit)}.
4. Repeat ad infinitum.

I have to say that everything I have read about MMT suggests that it believes that effectively wealth can be created by fiat. I therefore reject it on the grounds of mathematics and physics, unless you can persuade me that I've misunderstood.

And yes, after long and careful study, I consider government deficit spending to be immoral, except in the limited case of issuing an on-balance-sheet bond for a specific programme with a large initial capital expenditure but for which the benefits will be obtained over a long period of time, such as a bridge or a major road, or even perhaps a warship. There is nothing to stop a government from funding its full current spending programme from taxation, and I firmly believe that that is the correct thing to do.

I appreciate your input to the debate. Let me know whether I've convinced you, or if you can defend MMT against my charge that it ignores physical and mathematical truths demonstrated by balance sheets.


Mladen Fernezir 1 years ago at 4:44 PM
Hi Criss, I'm travelling on a holiday and my mobile phone just ate an hour long text. I'll be very happy to comment on all of this as soon as possible.
Mladen Fernezir 1 years ago at 2:09 AM
Ok, here we go down the rabbit hole. I have read or thought about the same examples myself when I was learning the subject so let's go through it all. I'll try to address everything you said.

First of all, MMT is based on balance sheet descriptions and that's definitely the way to go. Also, it doesn't say nor think that fiat creates wealth. That's misunderstanding the theory. Let's not conflate real assets with financial assets and liabilities. One can create assets all day by growing food or whatever else, that's besides the point.

There was an apparent dispute about bank deposits being a claim on bank reserves. You could do the same and issue your own IOUs which could serve as money. If you have cash, a house or some other asset, you could issue your liabilities and promise anybody that comes to you that you will give cash or that other asset for the return and cancelation of your liability. Possibly not immediately and there might be other terms, but if your customers agree there's nothing wrong with that. If you don't have all the cash immediately, but you are good for it, there is no problem. Moreover, if it is decided that for public interest it is best to have the central bank supply liquidity to all solvent banks, that's cool to. It's when it comes to helping banks to stay solvent when we have a problem of socialized losses for private gains.

You are also quite correct that it's all about your solvency and trustworthiness if your money is accepted or not. This is stated in MMT terms as "everybody can create money, the trouble is in getting it accepted." If you haven't already, I'd recommend Randall Wray's Primer as a great read. It is also true that you and the bank in question could default. And that's fine. After all, you'd be doing it to make profit and potential gains can bring possible failures. Nobody is forcing the customers to do business with you either.

Let's move on to balance sheet considerations. You are correct with your balance sheet descriptions for private banks. Credits create deposits and there are 2 pairs of assets and liabilities. Deposit is an asset for the customer and liability for the bank. At the same time, credit contract is an asset for the bank and liability for the customer. If the customer defaults, the later pair gets deleted. You pretty much stated all of that.

Let's note a key observation. For every financial asset, there is a corresponding liability. In total, whatever happpens, they all sum to zero in the aggregate at any time. We'll come back to this later. For now, we can see that all private money creation created a total of zero net finacial assets. This is a key MMT concept and we'll come back to this when I address government spending and central bank operations. It's also called horizontal or inner money creation.

Now, your analysis starts to fail with central bank considerations and government spending. Let's move to the plane buying example first and I'll come back to other issues.

First of all, if the government has enough money at its accont at the FED, it just spends its electronic bank reserves. It's like giving cash to the manufacturers and them putting it in their bank of choice. The bank receives cash/electronic reserves and creates a deposit for the customer. At no point could have privately created IOUs financed anything. Government paid with the reserves it already had.

Now, let's cut to the chase and assume that the government doesn't have the funds at its central bank account. It simply issues a bond. It's irrelevant that the central bank won't buy it directly. Somebody in the private sector will give electronic reserves, not bank deposits, to get the bond. Then at some later point, the central bank will buy the bond and call it monetary operations. It will buy the bond by typing some bank reserves with a few keystrokes.

Let's examine balance sheets for everybody involved. Our plane manufacturer got reserves which he entrusted to his bank like we do it when we deposit cash. His bank created a deposit for him in return. Bank's assets and liabilities are at zero (reserves vs the deposit). Plane builder has a plus (his deposit is an asset for him). The central bank is also at zero. It has a new liability (bank reserves) and a new asset (government bond). The government of course has a net liability, matching the asset. All is well and net finacial assets for all involved sum to zero. In terms of real resources, the manufacturer lost a plane and the government took it. Continuation equations of the universe are happy.

Okay. Now, how does the government pay its debt? It can always honour its obligations. How? It will simply issue another bond, indefinitely. The government can always become more and more negative and as a result, the private sector will become more and more positive when we talk about financial assets. Simple accounting.

Note there is a fundamental difference between all private money creation and government IOUs in the form of government bonds. The private bank is promising to give something that it cannot create itself. On the other hand, the government is presumably not issuing debt which promises payment in some foreign currency or gold.

One should recognize that cash, coins, electronic reserves and government debt in its own currency are logically just different formes of the same thing. They are mutually interchangeable and form a closed circuit. At no point do private IOUs finance the government. The government issues debt which is just the same as reserves since the central bank will make that exchange.

When this is understood, then trust and laws become irrelevant. Btw, legal tender is often misunderstood. It just says that you can pay your debt and other obligations with that what is legal tender. It says what is sufficient, it doesn't actually order you that you have to use it at all if you don't want to. FED has it in its faq. There is no need to prescribe by law that domestic currency must be used and as a matter of fact, it generally isn't.

What MMT teaches us is that first of all, we have the certainty that the government won't default like some private IOU issuer could. That's simply because essentially, the government is just promissing a different form of its IOU for the first one. That's why the government is different. The government is not like a household. Secondly, if all trust fails, there is one power left to make it all work. It is a sufficient method if all else fails. If the government manages to impose and implement tax collection in its own IOU, there will always be a need for government money. Taxes are also an instrument of influencing inflation. They are not really a means to enable spending. Quite a different story from conventional wisdom about having to collect taxes to be able to spend. This is just not true and one should recognize this illusion. Government spends ar will. If it has bank reserves which it collected from taxes, fine. If it doesn't, it issues new money in the form of debt which translates to bank reserves via the central bank. You are quite right though that government spending is also a means of getting real resources for the government. There is no question about that and you can see Wray explicitly writing about it in his Primer.

Let's also remember and get back to the fact that the only way for everybody else to increase net finacial assets is for somebody else to accumulate the negative. This is government's purpose and conceptually, it is solely the government that should do such a thing. Until the money reaches the private sector, it's like it is not even there. For example, one could think of the central bank as having infinite amounts of money at any given time. It is irrelevant. It could also have negative net worth in its domestic currency, it doesn't matter. The central bank does asset swaps and it is the government that has the democratic mandate on what to spend. And this deficit spending is actually new money creation for everybody else. So not only it isn't immoral, it is a necessity. It is a basic feature of the entire monetary system. Just imagine, you could not have a normal economy in the private sector if you'd eliminate the vertical influx from the government. You'd have net finacial assets for the private sector at zero. You couldn't have a growing real economy and maintain that position without deflation crashing everything. Money would keep on increasing its value compared to all those growing and productive real assets. You wouldn't have the money to pay credit interests. In any case, the real world works by governments constantly adding new money via central bank debt purchases.

Small note on government debt yields. MMT teaches quite a lot about how government spending influences them. What matters most is that the central bank could keep them down permanently, by simply buying and pushing up prices. That's why you have Japan and others at zero or negative, regardless of the government debt size. Bond vigilantes have no control if the central bank doesn't allow it. They can only push those poor countries that borrow in foreign currencies.

Finally, currency value will depend on what is happening in the real economy, with real productive assets. There's no dispute about that. Even more, this is emphasized. However, we are leaving in a monetary economy and not in some sort of a big bargain. If the monetary part is misunderstood and mismanaged, we'll have massive real economic failure. Ask yourself how come that there are millions of unemployed people in Europe while the inflation is low. Tons of unutilized real resources wasted. MMT is all about helping to utilize the real economy, instead of worrying about nonsential issues by themselves like the amount of debt the government owns in its own currency at any given moment.

This part regarding government fiscal position is of course a political matter. What matters is that we get a shift from misunderstanding to realizing what's really important. You will find it often repeated that the focus should be on real resurces and that is were to look for limitations. If the government spends too much compared to the productive limits of the economy, then it should tighten. MMT changes the decision logic from looking at debt to looking at real effects on the economy. It prevents blunders like increasing sales taxes in the middle of a long term recession and deflation environment just because the contry has created whatever amount of money by issuing debt. It also prevents nonsense talk about banks lending out reserves and causing hyperinflation. It exposes the money multiplier nonsense and misconceptions about how fractional banking works. It explaines why the yields can be low at high debt levels. All in all, it's an indispensable tool in a world of economic alchemy as if we are living in the dark ages.

What I think that bothers you the most is the relation between real, physical assets and financial assets. You wrote how it is production that creates wealth. That's fine, but also consider the following. There is always useful work to be done and one could produce many useful items, for oneself and others. However, we are not in a bargain. If there is not enough money, people won't buy it. In the plane building example, the government uses spending to command real resources. This is what money does, for better or for worse. That government command may or may not benefit the general public and may or may not create real wealth. Also notice the following. After selling the plane, the manufacturer is in a much better position to command real resources than he was before. Except for having the money to pay for taxes, why else would anybody give up a plane for a piece of paper? Also notice that he is now in a better spot than he would be by taking a loan. It is better for him to have net positive financial assets. It is better for the private sector in the aggregate to have positive financial assets than to have a net of zero finacial assets.

Regarding deficit spending, there are two claims to be made. First of all, the government can. It's always possible to deficit spend by issuing new debt which the central bank will continue buying. It is also possible to do it at zero or negative yields, regarthless of the debt size. Debts wil always be honored. The concern is wheather or not the command on real resources by the government and by people receiving the money creates something productive resulting in real progress or does it simply pushes up prices and leads to waste. Concerns are real rather than the ones worrying about amounts of fiat money the government posseses.

Secondly, the government should. It is better for the private sector to have net positive financial assets than to have zero or negative financial assets. With positive finacial assets, the private sector will have more power to command real resources. If that power is misused, the government should decrease spending or increse taxes. Not because the government needs the money. It couldn't care less. In that case, it would be for the benefit of the real economy to influence and reduce private command of the real resources.

Anyway, I've written quite a lot about what can be understood from MMT. While it may feel counterinuitive at first, it is actually all quite straightforward and logical.
Chris Rimmer 1 years ago at 8:31 AM
Dear Mladen,

Thanks for the in-depth response, and again I agree with the first part, but not the second. I think this is going to be a good debate, and after reading the opening two chapters of Wray's primer on the New Economic Perspectives web site, I even feel reasonably confident that I can persuade you that MMT is flawed (but I'll keep an open mind myself, of course). :-)

I could respond point-by-point to what you wrote, but I think it would be better to try an overall approach first. Maybe we can move on to the details later.

The whole of MMT seems to me to rest on the idea that the private sector needs net financial assets i.e. IOUs from someone outside the private sector. I fundamentally disagree, and if I can convince you that the private sector *as a whole* doesn't need net financial assets, I think I'm most of the way there.

I'm sure we agree that a successful modern economy, with large numbers of people with high levels of specialisation, needs not just money, but the ability to have more or less money according to how much is needed at any point. An IOU system seems ideally suited to this. The question is: who gets into debt in order for other people to have money or financial assets for savings? Does it have to be someone outside the private sector? The answer is: no!

First I'd like to simplify things a little by getting rid of banks. Not just ignoring them, but showing that they aren't needed in the analysis. A bank's job is just to allow someone to swap their own IOU, which isn't generally accepted in payment, for the bank's IOU, which is. So the original issuer of the IOU has a debt to the bank, and the bank has a debt to the holder of the new deposit. The bank doesn't add any net financial assets to the rest of the economy - it just takes one IOU out of circulation and replaces it with another one which is a more liquid form of debt. One way to look at it is that the bank is insuring the value of the borrower's IOU, because even if the borrower defaults, the bank still must honour its own IOU.

The process is that the borrower swaps IOUs with the bank, then buys something with the bank's IOU. They later sell something in exchange for the bank's IOUs, and then the borrower and bank reverse the original swap, cancelling out the two debts. (It's very slightly more complicated with interest, but not much). From the point of view of everyone apart from the borrower and the bank, there is no difference between someone paying with an IOU and someone swapping a new IOU with a bank and paying with the bank's IOU: a new debt is used to buy things, and it is later redeemed when the loop of payments eventually gets back to the original IOU issuer.

Having gone through that, let's look at a simple economy on an island with 4 people. (If an economic theory is general, it should work for a small economy as well as a large one, right?)

Arthur has an apple, but wants a banana.
Beryl has a banana, but wants some cheese.
Charles has some cheese, but wants a DVD.
Daisy has a DVD, but wants an apple.

They could all try to meet up, and exchange their goods simultaneously. But that's very inconvenient for everyone. It's far simpler if someone issues an IOU to lubricate the commerce. For example:

Arthur goes to Beryl, and gives her an 'IOU 1 apple' promise in exchange for the banana.
Beryl goes to Charles, and uses Arthur's IOU to buy some cheese.
Charles goes to Daisy, and uses Arthur's IOU to buy a DVD.
Daisy goes to Arthur, and redeems the IOU for an apple.

The great thing about this approach is that the IOU existed for as long as it was needed, but was eventually extinguished when the promise which it represented was fulfilled. And the apple which it promised to provide already existed - it was not an empty promise.

Now take a much more complex society of millions of people. Who could issue the IOUs in that case? One possibility is that anyone with any tangible assets could. If Eric has a chair which he wants to sell, he could write an IOU for a chair and buy something with it. The IOU would circulate through the economy, and eventually it would find its way back to Eric, who would exchange it for the chair. But better still would be for the business sector to issue the IOUs. They are perfectly capable of fulfilling the role that government plays in MMT, but there is a major advantage: their debt is actually backed by a positive net worth - they have tangible assets, they are producing more assets (increasing their net worth) all the time, and they also generally have a quantity of equity to back up their IOUs even if they don't have enough tangible assets.

Now let's reintroduce money, so IOUs are denominated in dollars. People in this example have an idea of the value of $1 - suppose they consider $5 to be the value of an hour's unskilled labour.

Francine is an entrepreneur, who sees a business opportunity making oak tables. She sets up Nice Oak Tables Inc., transferring $50,000 of her own money into it and taking 100% ownership, and she issues a prospectus for a 2-year $1 million bond offering, at 10% return per year. The firm claims that it should make a respectable profit, and of course the first losses fall on Francine as shareholder. The bonds are new IOUs introduced into the economy. The firm spends this money on a factory, wood, tools and employees. It then starts producing tables, which it sells. After one year, it has spent $800,000, but has sold $500,000 of tables. It now pays out the first interest payment of $100,000, leaving it with $650,000 cash. After the second year, it has spent another $200,000, but has sold $900,000 of tables, and still has $100,000 worth of tables left. It pays the second interest payment of $100,000 and repays the $1 million of bonds, leaving it with $250,000 of cash and $100,000 worth of tables. Francine decides to close the company at this point, and sells the remaining tables to a table wholesaler for $80,000, leaving $330,000 in the company. As she closes the company, she transfers this $330,000 to her personal account, leaving her with a profit of $280,000. She can now buy $280,000 worth of things from the rest of the economy, the bondholders can buy $200,000 worth.

In this example, the IOUs which gave the rest of the economy some extra net financial assets were not just empty promises, but were bonds promising assets of a valuable enterprise.

I'm going to anticipate and answer a possible objection - that the table maker's bonds might allow the buyers to save, but don't add to the stock of actual money.

My answer is that government bonds aren't money either. Have you ever tried to buy a car, or for that matter a meal in a restaurant, with government bonds? You might find someone who accepts them, but there's every chance you won't.

In order to buy something when you have bonds, as for any non-money asset, you take them to a bank and exchange them for the bank's IOUs. For most people, that would be a commercial bank, which will be more than happy to create some deposits in exchange for the bonds. You can then spend these deposits. The procedure is the same whether they are government bonds or the bonds of Nice Oak Tables Inc.

So there you have it - the government is totally unnecessary in order for people to obtain net financial assets. All you need is /someone/ to get into debt, and the entities best suited to getting into debt are those who have a positive net worth because of their ownership (and preferably ongoing production) of tangible assets. IOUs from an organisation without any assets to sell are literally worthless. Holders of the debt may be able to pass them off for a while, but when it comes to the crunch the government can only honour its debts to the private sector by either replacing them with identical IOUs or by taking wealth from that very same private sector. I don't see how that's different from a Ponzi scheme.

Once you have understood that the government is unnecessary for a functioning monetary system, and that government IOUs which can only be honoured by taking from the same group to which the debts are owed, I would say it becomes clear that MMT is barking up the wrong tree. Many of the points which MMT makes are true, and the use of balance sheets is making a big step forwards compared to traditional macroeconomics, but you can't just look at the financial (i.e. debt) side of balance sheets in isolation. You have to consider how the debts can ultimately be honoured, and that is through the ownership of tangible assets by debtors, (or more correctly through having a positive net worth, since it's ok to have a debt if you are owed (by someone who has a positive net worth) at least as much as you owe).

The issuing of more and more IOUs by an entity with negative net worth, no matter how apparently powerful, is the road to economic, social and political disaster.

Let me know what you think.


Jeremy Mastriano 10 months ago at 11:48 PM
Thanks for your research. These rootless hyenas are self addmited parasites among the nations, when in fact they are without one. This international clique and their ancient usurious financial practices are a crime against humanity. We must return to natural law/order for we have been berthed into this matrix
Burke Chester 5 months ago at 1:15 PM
For there to be fraud, there must be a misrepresentation. Where is the misrepresentation?

And banks do not hold our deposits in trust. We lend it to them.

This is pretty basic.
Dwain Dibley 5 months ago at 11:31 AM
The fraud is in misrepresenting the private credit they create as being a U.S. legal tender money. Neither the Fed or the banks possess the legal authority to create U.S. currency, or a money of any type.
Chris Rimmer 5 months ago at 1:42 PM
The credit which banks other than the Fed create in the U.S. is not legal tender in the U.S., and I don't believe that anyone represents it as such. Can you show me a reference where a commercial bank has claimed this? It is only Federal Reserve Notes, and their electronic equivalent, which is legal tender. The money which a commercial bank creates is a promise to *give* legal tender to the holder on demand.

Given that the money that banks create is just a debt from them to the holder, there is no reason for them not to be able to create it. Any adult and any corporation is able to create IOUs - it is up to people whether they are prepared to accept them in exchange for goods and services.
Dwain Dibley 5 months ago at 2:52 PM
Could you give me the current US money supply total and the source you used to get the total?
Chris Rimmer 5 months ago at 7:59 PM
The Fed Z1 seems to be the official source. Looks like FL173020005 is M1 (cash in circulation plus checkable deposits). In 2016 Q3 it was $1,982.7 billion.

(Source: https://www.federalreserve.gov/releases/z1/current/html/l6.htm)

Base money (which is legal tender) seems to be FL714100005. In 2015, it was $3,772.2 billion.

(Source: https://www.federalreserve.gov/releases/z1/current/html/s61a.htm)

That's quite troubling. Not only have the Fed already implemented the terrible "Chicago Plan", they've actually doubled it. It looks like it's impossible now for a run on the banks to cause them a liquidity crisis, which sounds great until you realise that any underlying solvency problems have been shifted to the Fed, and therefore the government, ultimately reducing the net worth of either taxpayers or holders of FRNs.
Dwain Dibley 5 months ago at 11:30 AM
The Fed is claiming bank debt (demand deposit accounts and non-monetary reserves) to be a U.S. legal tender currency, That's a misrepresentation of fact with the intent to deceive, it is fraud.

There is only $1.5-Trillion in U.S. legal tender money in circulation around the globe. Of that, $280-Billion is in circulation within the U.S. Of that, $78-Billion is held in bank vaults.

That $78-Billion in bank vaults backs the $1.9-Trillion in credited demand deposit accounts. It also backs the $9.3-Trillion in credited savings accounts. It also backs all commercial transactions, from Main Street to Wall Street, and all points between and beyond. It also backs all asset values.

And that, is the reality of Fractional Reserve Banking, and that, is one of the primary reasons for wanting to ban cash.

What does a 'ban on cash' really mean to the banks? It means 'DEBT JUBILEE' for the banks.

A deposit account represents a bank debt obligation to the account holder and what the bank owes is cash money. Ban/outlaw cash and the banks are relieved of their debt obligations to the account holders. Within the U.S., a ban on cash would represent a gift of about $13-Trillion to the banks. To figure out how much of a gift European banks will receive with the banning of cash, simply total their deposit account debt obligations and that amount will be your gift to them. They get a Debt Jubilee, and we get screwed. Now isn't that special.....
Chris Rimmer 5 months ago at 12:11 PM
First, I completely agree that trying to ban cash is an attempt to rob us, and your characterisation of it as a debt jubilee for the banks is a good one. While their debts to the public would nominally remain, they would never have to honour them, meaning that those debts are effectively worthless to the deposit holders i.e. us.

What I disagree with strongly is your claim that demand deposits are, or even should be, matched one-to-one with cash. Remember that cash is simply an IOU from the central bank, so what's so special about one bank's IOU over another? It is the complete set of assets of the bank which back its liabilities, not just the "liquid" assets. If the bank owes me $10, and the pizza take-away owes $10 to the bank, there's no need for cash in order for me to buy a $10 pizza using the bank's deposits using a cheque (sorry - I'm English!) or debit card. When I buy the pizza, my net worth increases by one pizza and decreases by $10 of bank deposits. The pizza shop's net worth changes in reverse. Then the pizza shop can use the bank deposit to cancel its own debt to the bank. The pizza shop's net worth decreases by $10 of bank deposits, but increases by $10 of debt to the bank being written off. The bank's net worth decreases by the $10 loan, but increases by its debt to the pizza shop being written off. Everyone is content with their transactions.

People treat money as a sort of magic. It's not. Whether it's gold coins or bank IOUs, money is just a simple and convenient way to transfer a part of your net worth to someone. It's the net worth itself which is important.
Dwain Dibley 5 months ago at 4:46 PM
Where did you get the erroneous notion that the US legal tender money is an "IOU from the central bank"? That's just nonsensical, and when you argue in that vein, all you are arguing is factless hearsay, myths, and lies. The FRN (US legal tender money) is not an IOU, it is payment, final and complete, and it is owned by the U.S.G. and issued to the Fed upon the Fed's posting of collateral of equal value to the notes received. Federal Reserve notes represent a first lien on all the assets of the Federal Reserve Banks, and on the collateral specifically held against them.

The monetary system is not based on opinions or theories, it is based in law. Deposits accounts are a legal claim on cash from the banks, cash is what the banks owe, by law, to their deposit account holders.

And, you are confusing a means of payment, the transfer of a debt obligation (credit), for the medium of exchange, what is owed as payment (an asset). By legal definition United States coins and currency, including Federal reserve notes, are legal tender money, a medium of exchange, an asset by law. Checks as well as debit cards, credit cards, money orders, etc., are a means of payment, referred to as a generally accepted (institutional) arrangement or method that facilitates delivery of money from one to another. Payment has not been made unless or until actual money proper has changed hands. All credit is debt outstanding.

When you use a debit/credit card, you are transacting with the bank, and the bank is transacting with the merchant. Banks are intermediaries (active participants) in all debit/credit card transactions. The bank is assuming the legal obligation to pay the merchant. The merchant can claim their cash property, which would finalize the transaction, or it can engage the bank in other credit transactions with other vendors and have the amounts deducted from the bank's debt obligation to him.

This is the process that occurs when you use a debit/credit card:
1) Card is swiped or keyed at merchant.
2) Merchant sends data to their processor, which is usually an acquiring bank.
3) Acquiring bank routes transaction through appropriate card network, e.g., VisaNet
4) Transaction reaches card holder's issuing bank.
5) Issuing bank approves or declines transaction.
6) Approve/decline sent back through network to merchant to complete purchase.
7) Acquiring bank settles with merchant.
8) Acquiring bank settles with issuing bank.

Anyway, the notion that we’re using ‘digital money’ or ‘digital currency’ or ‘digital dollars’ or credit dollars' or 'credit money' as a medium of exchange is nothing more than a trick of the mind, a figment of our overactive imaginations, a deception, it’s how we rationalize the transaction, and it's how the banksters get away with stealing our labor and wealth.
Chris Rimmer 5 months ago at 10:20 PM
"Where did you get the erroneous notion that the US legal tender money is an "IOU from the central bank"?"

I got the correct notion that the US legal tender money is a debt from the central bank to the holder from the facts that:

1. It is a Federal Reserve "Note" i.e. a debt instrument - a debt from the issuer to the holder.

2. It appears on the Fed's balance sheet as a liability i.e. a debt from the Fed to the holder.

Why is that nonsensical? If you look at https://en.wikipedia.org/wiki/Security_(finance), you'll find banknotes categorised under debt securities. Now I know that Wikipedia isn't the source of all knowledge and wisdom, but you should really provide a reference if you want to dispute that. If you check Investopedia, (http://www.investopedia.com/terms/b/banknote.asp) you'll also see that a banknote is a promissory note, which (http://www.investopedia.com/terms/p/promissorynote.asp) is a debt.

Now I will admit that Investopedia does say that an IOU is technically not quite identical to a note, in that an IOU merely acknowledges that a debt exists but not when it will be paid, which a promissory note specifies. But in everyday language I think it's reasonable to refer to a banknote as an IOU on the grounds that it acknowledges the existence of a debt from the issuer to the holder.

A few more comments on your first paragraph:

"The FRN [...] is payment, final and complete, "

While a FRN is often used as payment, final and complete, in exchange for goods and services, it is only complete as far as those two parties are concerned. The debt from the Federal Reserve Bank which issued it is still outstanding. However it is now a debt from that FRB to the seller instead of a debt from the FRB to the buyer. It is an asset of the seller, and a liability of the FRB.

"The FRN [...] is owned by the U.S.G. and issued to the Fed upon the Fed's posting of collateral of equal value to the notes received."

The Fed pays the U.S. Bureau of Engraving and Printing, part of the U.S. Treasury to print the FRNs for them, but that doesn't mean that the U.S.G. owns them. Have you got a reference that claims otherwise? The Fed can create liabilities (debts to other people) whenever it wants - it usually does it in exchange for U.S. Treasury bonds. The Fed doesn't buy FRNs with its collateral, it issues FRNs (or their electronic equivalent) to buy assets such as government bonds.

"Federal Reserve notes represent a first lien on all the assets of the Federal Reserve Banks,"

That sounds basically right to me, although I don't claim to know who has priority to the assets of the Fed.

" and on the collateral specifically held against them."

What do you mean by collateral held against the bonds owned by the Fed? I would have thought that you would call the bonds the collateral for the FRNs.

"The monetary system is not based on opinions or theories, it is based in law."

I'm not a lawyer, but I believe I have a reasonable understanding of how the law applies to debts.

"Deposits accounts are a legal claim on cash from the banks, cash is what the banks owe, by law, to their deposit account holders."

Deposits in accounts are debts from banks to the account holders, and the account holders can insist on the banks honouring their debt by paying cash, because that is legal tender i.e. the legally-recognised means of discharging a debt. But there's often no need for it. The deposit holder usually wants to buy something. The end result from someone withdrawing cash from a bank, buying a pizza with it, and the pizza shop depositing the cash is exactly the same as a direct transfer from one account to the other (including a transfer of deposits at the Fed between banks if the buyer and seller of the pizza have accounts at different banks).

"And, you are confusing a means of payment, the transfer of a debt obligation (credit), for the medium of exchange, what is owed as payment (an asset)."

I don't agree. Bank deposits have long been a medium of exchange. Investopedia (http://www.investopedia.com/terms/m/mediumofexchange.asp) defines medium of exchange as "an intermediary instrument used to facilitate the sale, purchase or trade of goods between parties. For an instrument to function as a medium of exchange, it must represent a standard of value accepted by all parties.". It does go on to say that this is usually currency, but I think it's clear that bank deposits function as the most common medium of exchange today.

Both bank deposits and currency are assets of the holder. Just look at any company's balance sheet, and you will find them both (often lumped together) in the assets section.

"Payment has not been made unless or until actual money proper has changed hands."

This claim of yours is disproved by barter - if I give you a bag of flour in exchange for a block of cheese, payment has been made. You do not need currency to make payment - anything which is acceptable to the seller is payment. If I use a debit card to buy pizza from a shop which banks at the same bank as me, no cash is transferred, but payment has been made. The result is exactly the same as if I withdrew cash from the bank, used it to buy the pizza, and the pizza shop deposits the cash.

I agree that there is still a debt outstanding between the bank and the merchant, just as there was previously a debt outstanding between the bank and me, but as far as the pizza sale is concerned, payment has been made.

I think in summary I'd say that your point of view seems to be that the liabilities of the central bank are somehow inherently valuable to the creditor, whereas the liabilities of a commercial bank are not. I'd point out that both are backed by the assets of their banks, which are generally debts owed to those banks. I'd actually say that the liabilities of a (solvent) commercial bank are more valuable than those of a central bank because a central bank can't enforce its claims against the government, whereas a commercial bank can enforce its claims against its borrowers.

The way that some bankers steal our wealth is not by issuing new bank credit - it's by asset-stripping the banks so that they become insolvent, meaning that they don't have enough assets left to pay their liabilities (bank credit). I don't honestly care whether I get a stack of pieces of paper with dead presidents on - what I care about is whether I can buy the goods and services I actually want. That's what the banking system, when run with integrity, achieves.
Dwain Dibley 5 months ago at 1:41 PM
Your understanding is abysmal and your sources are incorrect. I got my information from the Federal Reserve Act, the Coinage Act, U.S Department of the Treasury, the Federal Reserve as well as the Bank of England. FRNs are not "banknotes", they are "currency notes" issued to the Fed and owned by the U.S.G.

The Fed not only pays for the cost of producing the notes, they must also hold collateral of equal value to the notes received and issued into circulation. The collateral regulates the Fed's access to the notes. Federal Reserve notes represent a first lien on all the assets of the Federal Reserve Banks, and on the collateral specifically held against them.

All profits and interest payments on U.S. securities held by the Fed, that are received by the Fed, are returned to the Treasury as Seigniorage interest payments on the notes the Fed has issued for circulation.

The "Federal Reserve Note" label on the legal tender money is not a mark of ownership, it is a mark of liability, as in the Fed is held legally and financially accountable for the notes while they are under the Fed's purview.

While Federal Reserve notes cost the banks, they are a debt-free public money. They are our property.


Explained here: http://carl-random-thoughts.blogspot.com/
Chris Rimmer 5 months ago at 6:31 PM
Dear Dwain,

This debate would be a lot more pleasant without the insulting language. You seem like you're interested in the truth, and I hope that you'll accept that I am too, and yet we have different opinions. If my understanding is actually abysmal, please let me know, with evidence, exactly what is wrong with it, rather than just dismissing it. I'll try to do the same for you if I believe you are mistaken.

As it is, I appreciate some of your references - I now know more detail about the Fed: what a Federal Reserve agent is, exactly how the FOMC is composed, how the Federal Reserve Board is appointed, and how the different parts are related.

Now back to the debate. First I will demonstrate with the Fed's own financial statements that Federal Reserve Notes are liabilities of (debts from) the 12 Federal Reserve Banks:


If you click on the first link, it takes you to the combined balance sheet for all 12 of the Federal Reserve Banks.


On page 3 you will find that, at the end of 2015, the Federal Reserve Banks between them had $1,379,551 million of FRN liabilities. That means that the Federal Reserve Banks between them owed $1.3 trillion to the holders of those notes. That says clearly to me that the notes are not "debt-free".

I would also say that because FRNs are liabilities of (Federal Reserve) Banks, it is entirely valid to call them banknotes. They are promissory notes evidencing a debt by the Federal Reserve Banks to the bearer.

Now on to the collateral for the FRNs. Each Federal Reserve Bank has a Federal Reserve agent who acts as the representative of the Federal Reserve Board (it is always the chairman of the bank's own board). The collateral is supposed to be extremely high quality (unlikely to be defaulted), making it a sufficiently valuable asset to allow the FRN liabilities to be honoured. The intention, I deduce, is to prevent the Federal Reserve Bank from exchanging the high-quality assets for higher-yielding assets which might be defaulted on (or for things to be consumed), which would reduce the net worth of the Federal Reserve Bank, and could make it insolvent. Insolvency is a very bad thing - it means that other people believe that their net worth is higher than it really is because there are hidden losses.

I'll leave it at that for now. Please will you read the Fed's financial statements in particular, and if you still believe that FRNs are not liabilities of the Federal Reserve Banks, let me know how you come to that conclusion?


Dwain Dibley 5 months ago at 12:15 PM
Dear Chris,
You are misreading the Fed balance sheets, which is easy to do as they are intentionally misleading. Federal Reserve notes are a liability of the Fed in that they are, by law, legally/financially responsible and accountable for the notes in issue. That's why, as per Section 16 of the FRA, Federal Reserve notes represent a first lien on all the assets of the Federal Reserve Banks, and on the collateral specifically held against them.

The Fed, as the legally designated issuer of the notes for circulation, is being held legally/financially liable for the notes issued. That's also why the Fed is required to post collateral of equal value to the notes received from the Treasury, and that's why banks buy the notes from the Fed with assets, that conform to Treasury collateral requirements, of equal value to the notes they receive, and it is the reason for banks holding reserves at the Fed.

What you're failing to grasp is that; Federal Reserve notes are U.S.G. originated currency notes, they are a debt-free legal tender, public money. Section 16 of the Federal Reserve Act, as well as the Federal Deposit Insurence Act, regulate how the Fed and the banks will comport themselves while in possession of our money property, which was issued by the U.S.G. to replace the gold money property they confiscated.

Federal Reserve Notes are the official Legal Tender/Lawful Money of the United States, it is what the government owes in final payment of its debts and, more importantly, it is what the banks owe, by law, to their deposit account holders, upon their demand.

Currently, there is a total of $1.5-Trillion in U.S. Legal Tender currency in circulation around the globe. Of that, $280-Billion is in circulation within the U.S. Of that, $74-Billion is held in bank vaults as reserves. That $74-Billion is held in bank vaults backs the $1.9-Trillion in credited demand deposit accounts. It also backs the $9.3-Trillion in credited savings deposit accounts. It also backs all of the commercial credit transactions, from Main Street to Wall Street that occurs daily. It also backs U.S.G. expenditures.

And that, my friend, is the reality of Fractional Reserve Banking.
Chris Rimmer 4 months ago at 4:02 PM
Hi Dwain,

Sorry for the slow response. I've had a lot on, and I wanted to give you a decent response.

Thanks for explaining your position. I still believe that my interpretation is correct, specifically that FRNs are liabilities of the Federal Reserve Banks in the sense that they are debts from those Federal Reserve Banks to the bearers of the cash. But now I can ask some specific questions, which you might find interesting to consider. Here's the first one:

Suppose you are right, and that FRNs are debt-free money issued by the government, and that the Federal Reserve Banks just ask the government to produce some for their use, paying a small percentage of the nominal value. Why would the government need the FRBs to post collateral? If the FRNs are debt-free, they don't give the bearers a claim against anyone, so why not let the FRBs just use their collateral for something else?

I suppose another way of putting it is to ask what it means for the FRBs to be "legally/financially responsible and accountable for the notes in issue". What would that actually mean in terms of what they would have to give to whom in what circumstances?

I believe my interpretation is right - it makes more sense to me. FRNs are debts from the FRB to the bearer. The FRB has to keep an equivalent value of assets as collateral so that it is clear that the FRB has enough assets to meet its liabilities.

See this page too:


Under "What are Federal Reserve notes and how are they different from United States notes?", it says:

"Congress has specified that a Federal Reserve Bank must hold collateral equal in value to the Federal Reserve notes that the Bank receives. [...] This provides backing for the note issue." (i.e. the FRNs are valuable because they are backed by the assets held as collateral).

"The idea was that if the Congress dissolved the Federal Reserve System, the United States would take over the notes (liabilities). This would meet the requirements of Section 411, but the government would also take over the assets, which would be of equal value." (i.e. if the government takes over issuing money again, treating FRNs as liabilities of the US government, its net worth doesn't deteriorate because it takes over the assets held as collateral too),

"Federal Reserve notes represent a first lien on all the assets of the Federal Reserve Banks, and on the collateral specifically held against them." (i.e. holders of FRNs are creditors of the FRBs, and are first in line to the FRBs' assets if the FRBs are liquidated).

I've got at least one more question, but I'll leave that for another time.


Dwain Dibley 4 months ago at 5:54 PM
Well yes, FRNs are a liability of the Fed, and an asset for everyone else. They are not "debts from the Fed", that's just nonsense talk with no meaning and no correlation with fact. It's meaningless word salad. As was/is your 'arguments'.

I'm not going to address your 'argument' because you are demonstrably logically inept and lack basic reading comprehension skills, it would be a waste of my time and energy to even attempt to explain to you anything that may require you to think.

I give up on you, believe as you please.
Chris Rimmer 4 months ago at 2:06 PM
"you are demonstrably logically inept and lack basic reading comprehension skills"

... in your opinion.

It's a shame that you're not prepared to debate this issue, and are just resorting to ad hominems. I'm sure that anyone reading will draw appropriate inferences.

If you were prepared to engage in debate rather than name-calling, I'd have asked you to consider who gains or loses what at each stage of the money circulation. Here's my answer:

When a FRB requests $1 million of FRNs from the Treasury, the Treasury gives some bits of paper with ink on to the FRB, and the FRB pays for this by creating a deposit of, say, $10,000 for the Treasury. The deposit is a debt from the FRB to the Treasury, giving the Treasury first lien to the FRB's assets. The FRB's net worth decreases by $10,000, and the Treasury's increases by $10,000 minus the cost of printing the FRNs.

(The FRB has to set aside $1 million of its valuable assets so that they would be available to be distributed to the holders of the FRNs if the FRB were liquidated.)

When the FRB issues $100,000 FRNs to a bank, the FRB's deposit liabilities to the bank decrease by $100,000, but its FRN liabilities increase by $100,000. The bank's deposits with the FRB decrease by $100,000, but its cash holdings increase by $100,000. The net worth of the FRB and the bank are unchanged.

When the bank issues $100 cash to a customer at an ATM, the customer's deposit decreases by $100, but the customer's cash holdings increase by $100. The bank's cash holdings decrease by $100, but so do its liabilities to the customer. (The customer exchanges a debt from the bank for a debt from the FRB). The net worth of the bank and the customer are unchanged.

If the customer deposits $50 cash, the bank's cash increases by $50, but its deposit liability to the customer also increases by $50. The customer's cash holdings (debt owed by the FRB) decrease by $50, but their deposits (debt owed by the bank) increase by $50. No change to net worth.

If the bank has $80,000 cash more than it needs, it sends it back to the FRB, exchanging it for $80,000 of deposit. The FRB's cash liabilities decrease by $80,000 (it owes the debt to itself), but its deposit liabilities increase by $80,000. There is no change to either's net worth.

If the FRB has $200,000 of tatty cash, it can have it destroyed. Since FRNs are not a liability to the FRB when it has them in its own possession (it owes the debt to itself), the FRB has fewer pieces of paper, but its actual net worth is barely affected.

If someone buys a car with $10,000 of FRNs, the FRB owes $10,000 less to the car buyer, and owes $10,000 more to the car seller. The car seller has one less car, and the car buyer has one more car. If the car was fairly priced, the net worth of buyer and seller is unaffected by this consumption.

If someone buys a car with $10,000 of bank deposits, the bank owes $10,000 less to the car buyer, and owes $10,000 more to the car seller, exactly as above.

If the government imposes $1,000 of tax on someone, the government's net worth increases by $1,000 and the person's net worth decreases by $1,000. If they pay by bank transfer, the person's deposits decrease by $1,000, and their bank transfers $1,000 of its deposits with its FRB to the government's account. The person's net worth decreases by $1,000, the bank's net worth is unaffected, the FRB's net worth is unaffected, and the government's net worth increases by $1,000.

It's that simple. Production increases the net worth of the producer. Consumption reduces the net worth of the producer. Apart from that, all economic transactions consist of transferring assets and liabilities between people (and/or corporations), which has no effect on the combined net worth of the people involved.

It's important to allow your beliefs to be challenged. Even if you find you don't agree with the challenge, being open to it allows you to get a better understanding. I hope you reconsider.



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