Our current monetary system is a sham, and although more people are recognizing its flaws, there are far too many who have no clue how it really works.
As a Registered Investment Advisor with 25 years of experience, I’ve talked to scores of people since 1993 that have no idea how money is created or how the flow and supply of money affects the economy.
For many of the past 25 years, I’ve also been an advisor to advisors, and I’m astonished by how few advisors understand the mechanics of money-creation and the fragility of our fractional reserve banking system. That includes people I’ve spoken with in key positions at banks.
Don’t worry. I’m not going to bore you with all the gory details, but I will give you a very broad overview, along with my five-step recommendations.
Here we go…
When the United States needs money, the Federal Reserve, a private (banker-owned) entity, essentially creates U.S. Dollars out of thin air and lends that money to the U.S. Government (indirectly) by purchasing U.S. Treasury Bonds that are sold through open-market intermediaries who hold Primary Dealer status with the Federal Reserve Bank of New York. That’s simplified, but it gives the broad strokes.
FYI – The primary dealers make money on each sale in the form of a markup on the bonds. So, they make free money from the creation of money, since the transaction is already arranged. I guess it’s good to have connections…
Who are the primary dealers? Goldman Sachs, JP Morgan, Citibank, etc.
For the uninitiated, bonds are essentially loans. The issuer (the U.S. Treasury) promises to pay the lender (Federal Reserve) a predetermined amount of interest for a predetermined period, with a lump-sum repayment of the initial loan (principle paid) at the end of the term.
When money is created this way, inflation is built-in because the U.S. Treasury must pay interest on the money created by the Federal Reserve, and to repay the interest, they must create more money, which creates more interest. It’s a never-ending cycle of interest and money creation.
Once the money begins filtering through the banks, more money is created out of thin air due to the structure of our fractional banking system and the ability to create loans.
Let’s see how $100 created out of nothing turns into $1,000 without the U.S. Treasury/Federal Reserve issuing any new currency.
When a bank receives a $100 deposit, it’s only required to keep a portion on reserve (maximum 10% – see below), so it can lend the remaining 90% to other bank customers in the form of secured (real estate, cars, boats, etc.) and unsecured (personal lines of credit, credit cards, etc.) loans.
Please note: Some deposits require no reserve, but for my example, I am using a mandatory 10% reserve on all deposits.
In the first fractional transaction, $100 immediately becomes $190 ($100 original deposit + $90 in new loans that will be deposited somewhere), but the bank is only required to keep 10% (maximum) of the new $90 in reserve, so $190 quickly becomes $271 ($100 + $90 + $81).
After just ten fractional transactions, $100 becomes $686.19. By the time we reach 115 fractional transactions, $100 becomes $1,000.
As you can see, however, each step of money creation creates more debt, causing the need to create more money. See, built-in inflation, which just so happens to be one of the mandates of the Federal Reserve. Funny how that works…
Don’t be fooled by the false security of FDIC protection, either, which is a farce (if not for fiat money creation) that would take too much time to fully dissect. Nonetheless, here’s the short example of the FDIC’s false security.
The FDIC was insolvent while 278 banks failed between July 1, 2009 to March 31, 2011 (see graphic below), and if not for a $500 Billion line of credit from the (virtually insolvent) U.S. Treasury, millions of depositors would have lost billions of dollars.
Let that sink in for a moment…
At the height of its insolvency December 31, 2009, the FDIC insured $5.4 Trillion in deposits, but they were $20.8 Billion in the hole. Their “insurance” was worthless, and they had to be rescued by the U.S. Treasury.
Imagine what would have happened if people panicked and tried to withdraw all their money? How much money would the U.S. Treasury/Federal Reserve had to print out of thin air?
To answer that question, we need to review the Federal Reserve H3 reports from the end of 2009. On December 31, 2009, total domestic deposits in U.S. banks totaled $7.7 Trillion, according to the FDIC (page 17 of the 12-31-2009 FDIC Quarterly). As you can see below, the Federal Reserve recorded $970.5 Billion in reserves, with only $55.2 Billion in physical vault cash.
Banks only had $12.60 in reserve for every $100 on deposit, and the FDIC had no money to back them up. Worse, banks only had 72 cents in physical vault cash for every $100 on deposit.
If the U.S. Treasury and Federal Reserve had to accommodate the withdrawal of every deposit, they would have had to create over $6.7 Trillion out of thin air. That never would have happened. Instead, the system would have been shut down just like Cyprus.
That’s why you often hear about the importance of liquidity in conversations about monetary policy.
That fragile balancing act is the very reason $700 Billion in 2008 TARP funds was required to keep the Ponzi scheme from imploding. The choice was between paying billions to prevent the pending implosion of the shadow banking system (i.e. money markets, etc.), or trillions later when the system actually imploded.
Unfortunately, it wound up being both (billions then and trillions later) as the Fed expanded the money supply to keep up the charade.
Banks failed because they were undercapitalized due, in part, to the fractional reserve system itself, but primarily due to poor speculation, issuing questionable loans and investing in derivatives (Mortgage-Backed Securities, Credit Default Swaps, and more).
Since the FDIC had no money in its insurance fund, (fiat) money was created out of thin air and given to the banks to insure deposits that were already created out of thin air and put at risk by the speculative practices of the banks.
While the U.S. Treasury and Fed were creating these phony billions, the big primary-dealer institutions (the too-big-to-fail) made money on every side of that transaction; from the markup on the initial creation of the money, to the loan revenue they collected, to the speculative gains (when they were profitable), to the bail-outs, to the funds received as FDIC insurance when their bets didn’t pay off, and even the markup on the bail-out and FDIC funds that were created.
What a spectacular racket…
So, how do we fix the problem?
First, we should conduct a forensic audit of the Federal Reserve to determine how much fiat currency has been created, what assets were exchanged for the fiat currency, and where the fiat currency is today (foreign and domestic).
Second, wherever fraud is discovered, the funds involved need to be repatriated and all the parties involved (inside and outside the government) need to be jailed without the possibility of parole.
Here’s an example of (probable) government fraud: According to Catherine Austin Fitts, former Assistant Secretary of Housing, and Dr. Mark Skidmore, a professor at Michigan State University, $21 Trillion is missing from the Department of Defense and the Department of Housing and Urban Development, based on a year-to-year study from agency reports audited between 1998 to 2015.
Here are a few more examples of fraud and manipulation by the trustees of our money outside the government: Treasury Auction Scandal, LIBOR Scandal, ICAP’s ISDAfix Scandal, Currency Exchange Rate Scandal, and Precious Metals Price-Fixing Scandal.
If you do the due diligence, you’ll find the same big banks involved in all these scandals.
Third, we should abolish the Federal Reserve and return the power to coin money to Congress, as prescribed in Article 1, Section 8 of the U.S. Constitution: “To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures.”
That would eliminate the usury of the Federal Reserve and the markup profits of the primary dealers.
Fourth, we should establish a new equity-based currency, backed by tangible assets like silver, gold, and real estate (based on free-market values) to replace our current currency backed by debt. In effect, the government would capitalize its operations, so that its profitability, or lack thereof, would be reflected as a component the currency’s value because each note would represent fractional ownership in the government and its assets.
This system would be very different than the debt-based, but gold-backed, currency we had until August 15, 1971.
Done properly, an equity-based currency could only be created as new physical assets were placed as collateral. A profitable government could purchase new assets to create more money, or it could simply increase the value of its existing currency.
If each country had an asset-based, market-valued currency with no artificial valuation pegs (even to another nation’s currency value), the value of a country’s currency would fluctuate according to universally measurable benchmarks, which would eliminate currency manipulation and valuation issues. It would also solve most trade imbalances because the current incentive of trade arbitrage mechanisms would greatly diminish.
If import/export taxes and tariffs were fair (or abolished), trade arbitrage incentives would disappear altogether, but that’s a topic for another Five Steps segment.
Fifth, we should restructure bank charters and the way they’re allowed to operate. No more speculation. And, they should be required to have dollar-for-dollar assets backing every deposit, either in physical cash or in easily convertible collateral assets.
If a bank authorizes a loan, the depositor(s) (not the bank) should become the lienholder of the property, or the bank should be responsible to collateralize an unsecured loan, effectively acting as a co-signer to protect the depositor(s). The bank should simply be a trustee of the funds.
In addition, instead of loans being based on interest rates that can be manipulated, they should be negotiated contracts with the total lending price of the transaction built-in. That way banks (as fiduciaries) and depositors (as the investors) become real partners in the success of a bank, so when a depositor borrows money from his own bank, he would essentially be repaying himself.
I know this was a lot of information to digest, but done properly, these steps would create a much more stable currency and economic system.
What say you?