Every dollar in existence is loaned into circulation by a bank. The process begins at the Federal Reserve when they loan out money to the US government and other industries. However, the FED is not actually loaning out money that it has, they are simply entering those numbers into existence on a computer. Furthermore this money is not based by any physical backing such as gold, in fact the FED has not owned any gold since 1934. When the federal reserve lends money to the United States government, the government issues out government bonds. This bond is nothing more than written promise to pay back the loans at a future time with interest. It is estimated that only 3% of all of Americas currency exists in physical form.
Government Bonds are instruments of debt. Lets say for example that the United States asks the FED to print 10 Billion dollars in new money. Based on the fractional reserve system after the bonds are transferred and the money deposited, it becomes part of a banks reserves. According to reserve requirements banks must maintain a certain percentage of this 10 billion dollars; the amount is just 10%. This means that with a 10 billion deposit, 1 billion is held in reserve (principle) and the other 9 billion is considered “excessive reserve” and can be used as the basis for creating new loans. Now, it is logical to assume that this 9 billion in new loans will come directly out of the original 10 billion deposit, but this is not the case. Based on fractional reserve laws banks are not required to loan money based on the deposits they have received but instead give loans out in the form of promissory notes (loan contracts) in exchange for credit (money). This is how the monetary system is expanded to create more money. To put it a more direct way, these laws allow banks to lend out money that they do not physically have. This is called fractional reserve banking. But there are restrictions.........banks are "only" allowed to lend out up to 10x the money they actually have. Meaning 9 billion dollars can be created out of thin air because there is a demand for this loan from consumers (seeking loan contracts) and there is a 1 billion dollar deposit needed to satisfy the banks legal reserve requirements.
Lets take it another step. Lets assume someone walks into this bank and wishes to borrow this 9 billion dollars. One will assume they will then most likely take this money and deposit it into their own bank account. The entire process I explained above now begins to repeat, for this money now becomes part of a different banks reserves. As you remember the bank only needs to hold 10% of this 9 billion to legally satisfy reserve requirements. This means another 8.1 billion dollars becomes available as newly created money which can be loaned out by the new bank as credit. This 8.1 can then be loaned out and re-deposited creating another 7.29, which can then be loaned out and deposited creating another 6.5 billion. So on and so forth. This deposit/money creation cycle can theoretically go on until infinity. When you do the math, this means that 90 billion dollars of money can be created from the original 10 billion dollars printed by the FED. Again, this is not real money. This is money transferred from computer to computer, created out of thin air and loaned out into existence as credit. We may have created 100 billion dollars into the marketplace but only 10 billion is principle (actual money) and 90 billion is nothing but debt promised to be paid back at a future time.
You may then ask yourself, but if this is true and money is created out of thin air and technically does not exist, what gives this money any actual value? The answer is found in the money that already exists. The newly created money essentially steals money from the existing monetary supply. Using the analogy from above we just added 100 million dollars to the economy but in doing so did nothing respective to increasing the goods and services being produced. As the new money saturates the market it devalues the existing money, we call this phenomenon inflation. As supply and demand reaches equilibrium this causes prices to now rise, diminishing the purchasing power as each individual dollar in existence. When you look at the broader picture, inflation in essence is a tax upon the citizens of the country. The more money is borrowed from the central bank, the less purchasing power consumers have with their existing money. The fractional reserve system/monetary creation system we have in place is inherently inflationary. Very simply, the act of expanding the money supply without increasing the goods and services produced will always result in inflation. A fact from Americas recent history......... one dollar in 1913 is now equal to 21.67 in 2007. This is a 96% devaluation of the dollar since the FED began in 1913.
Keeping this in mind, if the reality of inflation seems absurd and economically self-defeating to you........ you are right. In the financial system the FED has created, money is debt and debt is money. If you look at the national debt compared to the total national monetary supply you will see a direct correlation. The more money created the more debt is created; the more debt created the more money there is. Basically every dollar you have is owed to somebody by somebody. Remember the only way money can come into existence is through loans, therefore if everyone in the country was magically able to pay off all their loans or debts there would actually not be one dollar left in existence in circulation.......
“If there were no debts in out monetary system, there would not be any money” – Marriner Eccles Govenor of the federal reserve 1941
This brings me to interest. When the government borrows money from the FED or when a customer borrows money from a bank, this money always has to be paid back with interest. This means every dollar that is borrowed must be paid back at a future time with interest. Again using the example from above: If all money is originally being borrowed from a central bank by commercial banks through loans, only something called the principle (10 billion) was being created within the actual/physical monetary supply. So then, where is all of the money to cover the debts and interests charged to cover the 90 billion we created? The answer is that it is nowhere, it does not exist. Think of it this way: The amount of money loaned out will always exceed the amount of money available in circulation. This makes inflation a constant in the Federal Reserve economy. Money will always be needed to cover the perpetual deficit built into the system caused by the need to pay the interest. This means that mathematically aspects such as bankruptcy and defaults are literally built into the system and there will always be poor pockets of society left to shoulder the burden. This type of central banking system inevitably transfers true wealth and prosperity from the people of the country and into the hands of the banks.
70% of our total national debt has been created within just the past 6 years. We have been struggling through something known as the “great recession” which required a federal bailout (money printed from the FED) to originally endure through. You may here that the stock markets are reaching all time highs, but this literally means nothing. As I have explained you realize that we can make 90 billion dollars out of a 10 billion dollar loan. With 70% of our national debt created through money printed through the FED of course will be seeing monetary totals soaring. But this is meaningless, hyper inflation will soon become a reality turning this “great recession” into something much worse.