Money Creation

By: Free World Economic Report

The vast majority of the public has no real idea how money works and how its even created.  Before we get started I felt it necessary to explain the difference money, cash and legal tender.

Money is any item or verifiable record that is generally accept payments for goods and services and repayment of debts in a particular country or socio-economic context. Money is historically an emergent market phenomenon establishing a commodity money, but nearly all contemporary money systems are based on fiat money. Fiat money, like any check or note of debt, is without use value as a physical commodity. It derives its value by being declared by a government to be legal tender; that is, it must be accepted as a form of payment within the boundaries of the country, for “all debts, public and private”.  

Cash is money in the physical form of currency, such as banknotes and coins. In bookkeeping and finance, cash is current assets comprising currency or currency equivalents that can be accessed immediately or near-immediately (as in the case of money market accounts). Cash is seen either as a reserve for payments, in case of a structural or incidental negative cash flow or as a way to avoid a downturn on financial markets.

Legal tender is a medium of payment recognized by a legal system to be valid for meeting a financial obligation.Paper currency and coins are common forms of legal tender in many countries. Legal tender is variously defined in different jurisdictions. Formally, it is anything which when offered in payment extinguishes the debt. Thus, personal credit cards, cheque and similar non-cash methods of payment are not usually legal tender. The law does not relieve the debt obligation until payment is tendered. Coins and banknotes are usually defined as legal tender. Some jurisdictions may forbid or restrict payment made other than by legal tender. For example, such a law might outlaw the use of foreign coins and bank notes or require a license to perform financial transactions in a foreign currency. Generally, designation of a particular form of money as legal tender means “that the designated money is valid payment for all debts unless there is a specific agreement to the contrary.

How Money is Created

If we ever hope to have a sustainable  society we must change, among other things, a systemic flaw in our monetary system: the way we create and circulate money.

The Problem

 

  •  A majority of the money in circulation has been created by private banks out of thin air as interest-bearing loans: money created as debt. 1 In essence, we’re borrowing from the future in the hope that continued economic growth will allow us to pay off this debt.
  •  Banks are part of the fractional reserve banking system. In fractional reserve banking, banks have to keep a certain amount of money (a fraction, say 10%) in the bank for every dollar they loan out. But in the 1990s, the reserve requirements  were phased out and today there are none. Reserve requirements normally determine the money supply multiplier effect, which now appears to be infinite.
  • Money to pay the interest on the debt is not created at all and so must come from the money currently in circulation. But that money is already owed because it was created as debt.
  • Because more money needs to be paid back than was borrowed (principle plus interest), the total money supply has to continually increase to avoid loan defaults. That is, the amount of debt has to keep growing simply to put more money into circulation in order to cover the interest owed on past debts. Alternatively, some people must—and do—default on their loans.
  • When someone defaults on their loan, say a mortgage, the private bank will repossess the home. Thus, the bank ends up with real wealth—the house—for simply creating the initial money out of thin air. In other words, the private bank puts essentially nothing of its own assets on the line in the transaction but, in this case, ends up owning a real asset.
  • If the private banks stop giving out loans (i.e., stop putting more money into circulation), the system will collapse, thus the private banks have control over the money supply, not the people.
  • The amount of debt is always greater than the amount of money in circulation and thus can never be fully repaid.
  • Inflation is inherent in this money creation process as the money supply tends to increase faster than the amount of goods and services available. It is important to understand that this money supply is debt, not wealth.
  • Economic growth is inherent in this monetary system in order to ensure that interest on the debts can be paid, but never ending economic growth is impossible on a finite planet with finite resources.
  • When economic growth stops, due to outside factors such as peak oil, the system will begin to collapse.

The Solution

 

  • Government borrowing from private lenders must be forbidden.
  • The Government rather than the private banks, must issue all the money and spend it into circulation free from debt.
  • Inflation would be prevented by tying government taxation and expenditure to the money creation. Remember, it’s not who creates the money that causes inflation, it’s how much is created and how it circulates.
  • The ability of the private banks to create money from thin air would be forbidden; the private banks must stop lending money they don’t have.
  • Because banks can issue loans that are far in excess of their deposits (fractional reserve banking), they can create money. If they only made loans from their money already on deposit, no new money would be created.
  • Private banks would still be able to lend money but they would not be able to create money, they would lend only the money they have on deposit and they would be required to hold 100% reserves.

 

Here are a few videos on the topic of money creation: