Bill Totten's Weblog

Sunday, December 28, 2008

Notes on "It's Your Money"

by William Hixson (1997)

Creating money is immensely profitably to a government or a banking system.

As of year-end 1994 the legal tender created by the US government (GCM or government created money) totalled $418.5 billion. It is made up of three components: $354.5 billion of currency held by the public, and $64 billion of bank vault cash and other bank reserves. However, only the $354.5 billion counts as part of the money supply since the $64 billion sits idle in the vaults. It's sole purpose is to back up bank-created money (BCM). The amount of BCM was not less than $2874.4 billion. Thus in 1994 BCM accounted for about 89 percent of the total money supply.

Government money creation worked with great success in various colonies before the War of Independence.

In 1973 the Fed (The Federal Reserve, the US central bank) held 18.9 percent of the federal debt. Had the Fed held 18.9 percent of the debt in 1993 instead of a measly 6.5 percent the government would have saved something like $50 billion annually in interest.

Our whole banking system I have ever abhorred, I continue to abhor, and I shall die abhorring. -- John Adams, Second President of the United States

Almost all bank deposits owe their origin to bank loans. It may seem it ought to be the other way about - that bank loans would owe their origin to banks deposits. But this is not so. -- The Federal Reserve System (Board of Governors, 1939)

All bank deposits consist either of money created by the Fed and spent buying government securities or of money created by banks themselves. -- College textbook

In 1994 the ratio of loans to reserves was 43.5 to 1.

Illiquidity is a constant condition of all banks at all times. That is to say, they never have on hand or readily available anywhere near enough legal tender to satisfy the demand if any large fraction of their depositors request cash. A bank is declared to be "insolvent" only if it has on its books so many bad loans that it could never raise enough cash to pay off all its depositors.

If banks were banned from creating money they would still be needed to perform their other services.

Between 1929 and 1933 over 10,800 banks (about 38 percent of all banks in the USA in 1929) had to close their doors.

By the time of the crash of 1929 the reserve ratio was 1:13. After the crash bankers were so "given religion" that even as late as 1940 it was almost 1:3, or about $30 in reserves for every $100 in deposits. Then it began to creep up: 1:8 in 1950, 1:11 in 1960, 1:15 in 1970, 1:31 in 1980, and 1:39 in 1990.

The more highly leveraged a bank is, that is, the higher the reserve ratio, the greater the profits from a given investment, and the higher the risk of insolvency.

Business loans must be backed by eight percent in capital but loans to government require no capital backing. This encourages banks to turn their backs on businesses and invest heavily in government bonds.

The most persistent fallacy about banking is that banks are intermediators between lenders and borrowers. In fact the cardinal function of banks is not intermediation but money-creation.

The total deposits of the banking system considered as a whole remain unchanged over short periods because the deposit of many checks will increase the deposits of the banks in which they are deposited by exactly the same amount as they will decrease the deposits of the banks on which they are drawn.

What banks loan "for the most part" is money they create - non-preexisting money.

If all bank loans were to be paid-off, checks to banks would have to be written to almost the full amount of all bank deposits. Hardly any deposits would remain. Or, as Robert H Hemphill of the Atlanta Regional Fed once remarked: "If all bank loans were repaid, no one would have a bank deposit".

At year-end 1994 the total amount of GCM was $419 billion. Only $64 billion was deposited in banks. Thus it was bank lending and bank money creation for that purpose that gave rise to the $2875 billion in deposits held by the public, not deposits made by the public that gave rise to the bank loans.

In making loans banks create enough money for the principal to be repaid, but not enough for the interest as well as the principal to be repaid. If all loans had to be repaid on the same day some borrowers would necessarily have to default. It is in the very nature of the system to create this type of problem. Banks are always in a "need to catch-up" situation. Thus every year on average the supply of bank created money (BCM) needs to be increased by at least the average rate of interest that banks charge on their loans. This assertion is true enough to be significant, but greatly oversimplifies the actual situation.

Investment = Savings + BCM

There is a tendency to ignore whatever cannot be fitted into our system of preconceptions.

Although the liquidation process is a far from simple one, no more BCM tended to remain in existence during the Great Liquidation period of 1929-1933 than some person or company was ready, willing, and able to pay interest on it. GCM was subject to no such undesirable limitation.

Professors Henry Simons of the University of Chicago and Irving Fisher of Yale concluded that if the entire money supply of 1929 had consisted of GCM, then no money would have disappeared and the Great Depression would either have been far less severe or would not have occurred at all. Thus they advocated that in the future the entire money supply of the nation should be GCM and that BCM should be phased out.

Banking is a sort of confidence game.

In 1990 the Federal Deposit Insurance Corporation (FDIC) had only $13 billion with which to guarantee $2650 billion in deposits, that is about fifty cents for every $100 it supposedly insured.

The government's motto often seems to be, "To them that hath it shall be given".

The Fed has the power to bring on a recession or a depression at will although it has not the power to bring on prosperity at will. The historical record shows that the Fed deliberately provoked recessions in 1974-75, 1980-82, and 1991.

The banks have the ability to shut down the economy at will. They can veto prosperity by refusing to make net new loans, and it is sometimes in their interest to do so.

It is not merely inappropriate but outrageous for bankers to get the lion's share of the something-for-nothing that goes with the money-creating prerogative.

Whenever it is proposed that the government should create more money, the instant cry is, "But that would be highly inflationary!" or "But that would send prices soaring!" However, since the banks use GCM to create at least ten times as much BCM, the problem of too much money chasing too few goods is primarily a bank created problem.

From 1929 to 1933 unemployment soared from 3.2 percent of the labour force to 24.9 percent. Output of goods and services fell by over thirty percent.

When a war against poverty and unemployment is proposed there is always a chorus singing, "you can't solve a problem by throwing money at it". There was no hesitancy, however, in dealing with the problem of war against overseas adversaries by throwing money at it; and throwing money at the problem at annual rates of increase unheard of earlier and unequalled later.

It was not the war per se that ended the Great Depression as is often said. It was money-creation and money-spending at high rates.

The money created to finance both world wars was 1:4 GCM and 3:4 BCM.

Inflation causes the purchasing power of money to decline, and when the purchasing power of money declines debts will be repaid with money that will buy less than the money that was lent. As lenders of money bankers detest inflation, and as friends of bankers, managers of the Fed (or officers of the Bank of Canada) make fighting inflation their top priority and make high interest rates (also liked by bankers) their method. It would be an entirely different story if the Fed were dominated by the agents of debtors instead of by the agents of creditors.

The Fed is always ready to destroy prosperity in order to save the economy from inflation.

Recent very high interest rates are not due to large government deficits. During the World War Two years the government ran truly enormous deficits. The deficit for each of the three years 1942, 1943 and 1944 averaged 27.8 percent of the GDP, yet the nominal interest on thirty year bonds was held to 2.5 percent. Contrast this to the ten years 1981-1990 when the federal deficit averaged a mere 4.2 percent of GDP and the nominal rate on thirty year bonds averaged 10.3 percent. Put another way, in the 1980s the Fed permitted about four times the rate of interest to be paid on a deficit that was only about one-seventh as large as in the 1940s.

For 1943 the real rate of interest (that is, the nominal rate minus the rate of inflation) on a federal debt equal to 27.4 percent of GDP was only 0.87 percent. For 1994 the real rate of interest on a debt equal to only 2.25 percent of GDP was 4.81 percent.

The bonanza that inevitably accrues to a creator of money should rightfully go to the whole people via their national government, not to private companies or private individuals.

Since almost all of the current annual federal deficits are due to interest on the federal debt, if the government had created the money that private banks created since 1946 there would not only be no federal debt but no annual interest on the debt and therefore no annual deficit. The reason the government owes about $5 trillion and has to run annual deficits on the order of $200 billion is that the government permitted private banks to create the money that the government should have created.

As of year-end 1993 the private banks held $740 billion in government bonds. These bonds were all purchased with BCM, that is, money the banks created from nothing. The annual interest the government pays on these bonds is somewhere between $25 billion and $35 billion. It's a government subsidy to banks.

The very idea of a government that can create money for itself allowing banks to create money that the government then borrows and pays interest on is so preposterous that it staggers the imagination. Either everyone in government in charge of the procedure is deficient in intelligence or they have been bought and paid for by those who profit from their venality and infidelity to the public interest.

There is nothing unprecedented in the proposal that all of our money supply should be GCM. Between 1928 and 1938 the government did just this. During this period the banks were too frightened to make loans and/or the public was too frightened to borrow from banks. The primary engine of recovery from the Great Crash was GCM.

We need more of the non-debt-bearing-non-disappearing type of money that government creates and less of the debt-bearing BCM that evaporates when banks fail and depressions occur.

Bill Totten


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