Chapter 1 - Where Does Money Come From?

To operate a money system, we need to know how money is created. I have used various ways to explain the origin of new money. The explanation most easily understood is a consideration of the figures from the Federal Reserve Bank of the USA. In October 2016, the total Cash Currency in circulation was $1480 billion. [3] This is represented by the circle.

This $1480 billion is the folding notes that are to be found in wallets and buried in back gardens. This $1480 billion is the total of all Legal Tender Cash Currency created by the Federal Reserve Bank. The Federal Reserve Bank never created more than this.

I use the term cash in its defined way meaning coins or notes, as distinct from cheques, money orders, or credit.

Much of the Cash Currency is in circulation overseas. The Federal Reserve estimates that between 50% and 67% of Cash Currency is held abroad. [5] Some of this foreign held currency is held as a store of value, and some is used as a medium of exchange. [5] This means that there is about $740 billion of Cash Currency circulating in the USA itself. [12] I have visited two countries where US notes are used as the daily currency. East Timor operates on US dollar notes. Transactions below one dollar are conducted in local currency and transactions above one dollar are in US folding notes. Cambodia was similar. The ATMs in the street dispense fresh crisp US dollars.

Incomplete Money Supply figures are issued by the Federal Reserve. M2 is listed as $13 100 billion. [4] The best figure for Money Supply has to be calculated due to Federal Reserve intransigence. M3 is calculated to be $18000 billion.

Of the $18000 billion money in the USA, only $740 billion came from the Federal Reserve. (With another $740 billion in Cash Currency held by people in foreign countries.) Thus only 4% of the money in circulation in the USA originated from the Federal Reserve. [8] The rest is numbers written in accounts. If you wish to include Cash Currency held by citizens in foreign countries, the figure is 8%.

Very little money originates from the Federal Reserve.

Most money is virtual numbers in bank accounts that did not originate from the Federal Reserve.

The US Debt Clock lists the US Total Debt as $66800 billion [2016-11][6].

In 2016, the Federal Debt was $19900. [7] State debt was $1194 billion. [3] Most of the debt in the graph is Private Debt which is Mortgages and car loans etc. Trading Economics lists the Private Debt as $35535 billion. The Bank for International Settlement states the Private Sector Debt as $25470 billion[2014]. The Debt Clock has a slightly different calculation. Irrespective of the source, the result is similar. The debt vastly exceeds the capacity to pay. An impossible contract has occurred.

USA diagram of debt and money. Creative Commons Attribute - Andy Chalkley.

In the above diagram, it is clear that a small volume of Federal Reserve created Cash Currency is used as a base to create vast quantities of Bank Credit. This Bank Credit creates an equal quantity of debt. The debt magnifies with interest to become unpayable.

The green circle represents the total of Cash Currency and all the money in bank accounts. Yet only $1460 billion was created by the Federal Reserve Bank as Cash Currency Legal Tender. The other $17540 billion clearly did not originate from the Federal Reserve Bank as Cash Currency legal Tender. The $18000 billion less $1460 billion came from somewhere that was not the Reserve Bank. This ~$17540 billion appears in bank accounts but did not come from the Federal Reserve Bank. From where did this money come? I shall explain in a while. The next surprising figure is the sum of government debt and private debt. The sum of the total Government Debt and the Private Debt equals $66000 billion. [3] The United States has ‘more debt than money’. The volume of debt exceeds the volume of money by a factor greater than three. [$66000 billion divided by $18000 billion = 3.7] I originally thought that I had made a gross error, so I checked in numerous ways, but could find no error. I developed various models to demonstrate that it was possible to have ‘more debt than money’. To explain this to those that look puzzled, I suggest that ‘me and thee’ own all the gold in the world. You and I lend it out. After one year, we want gold plus ten percent. This is not possible. It is not possible to pay back more gold than there is gold. We have an impossible contract. After two years, we are owed gold plus ten plus ten and so on. Within a few years, we own everything in sight. This is how there is ‘more debt than money’. To confirm my findings for the United States, I checked the figures for other countries. Australia has a debt exceeding money by a factor of three. Europe has debt exceeding money by a factor of about 2.6. Greece is about three. The UK is about 2.6. The USA is above three and a half. When I sum the figures for all countries for which figures are available, (which is most of them) I arrive at a worldwide figure of two times as ‘much debt as money’. There is twice as much debt in the world as there is money.

I created this fascinating graph for your amusement. Notice the fall in lending at 2008 causing a hiccup in Money Supply. Not shown is that the fall in Money Supply causes a fall in Circulating Money that hampers business which causes a fall in Government Revenue (sometimes greater than the fall in Circulating Money that caused the slow-down) which drives up government expenditure leading to increased government debt. A whole string of problems occur when the Money Supply falls:

USA graph of debt and money. Creative Commons Attribute - Andy Chalkley.

If credit to the private sector is curtailed, the Money Supply falls and government revenue falls. The Government loads up on debt. The debt continues its rise as before.

Contraction of the Money Supply at the collapse of the Roman Era. Creative Commons Attribute - Andy Chalkley.

The Dark Ages were a dismal time in Europe. The society reverted to a very basic state. Famines and plagues affected the reduced population. The skills of bricklaying disappeared. Few stone buildings except cathedrals were built for almost ten centuries. [11] The missing component was a money token system. The money system disappeared at the end of the Roman era. Although one may hate the machinations of those that control a money system, any money system is better than no money system.

A small volume of Federal Reserve created Cash Currency is used as a base to create vast quantities of Bank Credit. This Bank Credit creates an equal quantity of debt. The debt magnifies with interest to become unpayable.

Graph of World Money Supply and Debt. Creative Commons Attribute - Andy Chalkley.

The Cash Currency component is a somewhat insignificant component of the Money Supply. The bulk of the Money Supply is Bank Credit.

The Phone Card?

I invite you to join my mobile phone company credit system. You can use your phone provided you have deposited money with me to build up credit on your phone account. The deposits are non-refundable. As soon as you give me $1000, I spend it on staff wages and other expenses including my interest to the bank. However, you still have $1000 credit, even if the money no longer exists. I allow you to transfer credit to other clients using an app on your phone. There is no money but you can pay people with non-existent money and they can pay you with non-existent money. My phone company has created a money and payment system with absolutely no money in it. My phone company owes you $1000 but you cannot have it as money, only as phone calls.

I change my policy and allow you to convert phone credit to cash provided you do not request more than $100 per day and are prepared to pay a fee of $2.50 for each withdrawal. My phone credit system is now acting the same as a bank account. My phone credit system becomes popular and I decide to loan phone credit, provided that you do not want it as Cash Legal Tender. I charge a fee of 10% per annum. Your friend, Jim, wishes to borrows $1000 in phone credit from me at 10% interest so that he can buy a parachute from Patrick, who is another one of my clients. On the appointed day, I write $1000 with a plus sign next to it in the account of Patrick the Parachute Maker. In your friend, Jim’s account, I write $1000 with a negative sign. I did not need any Legal Tender to conduct this loan. I did not use any customer phone credit. I simply wrote $1000 with a plus sign and $1000 with a minus sign and made $100 profit. Lending phone credit is as easy as writing numbers in accounts. Fresh phone credit is created at will.

I have regularly added interest to Jim’s account. First year was $100, then increasing amounts each year following this series: Amount owed: 1100, 1210, 1331, 1464.10, 1610.51, 1771.56, 1948.72, 2143.59, 2357.95, 2593.74, 2853.12, 3138.43, 3452.27, 3797.50, 4177.25, 4594.97, 5054.47, 5559.92, 6115.91, 6727.50. So at the end of 20 years, there is 6727.50 owing to the money lenders of which 5727.50 is interest.

My next innovation is an arrangement with other phone companies. They have identical phone credit lending arrangements. I arrange that phone credit can be transferred between clients in different phone companies. The phone companies thought this was impossible because they thought they would be giving away money to other companies. I explained that the volume of phone credit passed between companies would be approximately equal on any particular day.

My system rivalled the high street banks who wanted to maintain their monopoly on the creation of virtual credit. They banned my phone credit system.

What is Bank Credit?

It turns out that the so-called money that we have listed in our bank accounts, is not money as we think of it. It is credit. It is the amount that the bank owes you in Cash Currency, payable at some date in the future. It is a credit on the bank’s books which you can transfer to others as a means of payment. It is Bank Credit that is equal in value to the Cash Currency created by the central bank and is (in theory) freely converted to Cash Currency. It did not come from the central bank. The banks of the United States do not have $18000 billion of cash sitting in vaults. $18000 billion of cash does not exist. Only $1460 billion of cash exists of which $730 billion is in foreigner’s hands. Most or the remaining $730 billion is in people’s back pockets. $1460 billion is the sum total of all the currency created by the Federal Reserve Bank. Now we sniff out where the money listed in bank accounts originated. The Federal Reserve Bank has created $1460 billion of Cash Currency. The government does not pay its bills using cash. The government pays its expenses using bank accounts. This is significant. The government has the authority to make money which is may make in discrete units called Cash Currency. It uses Bank Credit (which is not in discrete units). It has to obtained by other means as the Government has no ability to create Bank Credit unless it owns a government-owned Public Bank. Guess what, it borrows it. It borrows bank Credit. It does so in an elaborate scheme which involves the issuing of Government Bonds.

Consider what you do if you want money. For little items, you pay with cash or from a bank account. For large items, you will borrow the money. And that is the clue. If you want more money, you borrow it. Money is available if you borrow it. Almost all money in use is borrowed money that is being passed from citizen to citizen. The money in your bank account probably came to life as a mortgage loan and the positive book entry is getting passed from person to person as a means of payment. The proceeds of the loan are transferable. Banks seem to have a never-ending supply of money to lend. It appears to come from nowhere. But they are lending you credit, not currency.

The Money Supply rises constantly, but the new money is not coming from the Federal Reserve. In 2015, the calculated M3 rose by $460 billion. [18090.49-17631.19=459.3] The Federal Reserve issued $82 billion in new Cash Currency. [1305.8-1223.3=82]

It is not as though this has not been noticed before. Here are a few of many comments from the past on the creation of money:

Robert Hemphill 1934, Credit Manager of Federal Reserve Bank, Atlanta, Georgia: “This is a staggering thought. We are completely dependent on the Commercial Banks. Someone has to borrow every dollar we have in circulation, cash or credit. If the Banks create ample synthetic money we are prosperous; if not, we starve. We are absolutely without a permanent money system. When one gets a complete grasp of the picture, the tragic absurdity of our hopeless position is almost incredible, but there it is. It is the most important subject intelligent persons can investigate and reflect upon. It is so important that our present civilization may collapse unless it becomes widely understood and the defects remedied very soon.”

Federal Reserve Bank of Chicago: “The actual process of money creation takes place in commercial banks.” [2]

Bank of England 2014: “Creating money in the form of cash notes is illegal and called counterfeiting, however, creating money that is equivalent to cash and lending it to people is apparently legal.” [1]

Federal Reserve Bank of Chicago: “Commercial banks create checkbook money whenever they grant a loan, simply by adding new deposit dollars in accounts on their books in exchange for a borrower’s IOU.” [2]

Bankers know the secret of banking. Banks create the ‘money’ that they lend by writing accounting entries into the accounts of borrowers and recipients. They write a positive amount into the recipient’s account and a negative amount into the borrower’s account. From the bank’s position, it is a zero sum transaction. It is a quirk of ‘Double Entry Accounting’.

The Right Honorable Reginald McKenna was a former Chancellor of the Exchequer. He told the shareholders of the Midland Bank on 25 January 1924:

“I am afraid the ordinary citizen will not like to be told that the banks can, and do, create and destroy money. The amount of money in existence varies only with the action of the banks in increasing or decreasing deposits and bank purchases. We know how this is effected. Every loan, overdraft or bank purchase creates a deposit, and every repayment of a loan, overdraft or bank sale destroys a deposit.”

Dr. Coombs was a former Governor of the Reserve Bank of Australia. He said in an address at Queensland University on 15 September 1954:

“[W]hen money is lent by a bank it passes into the hands of the person who borrows it without anybody having less. Whenever a bank lends money there is therefore, an increase in the total amount of money available.”

Ralph Hawtrey was Assistant Under Secretary to the British Treasury in the 1930s. He wrote in ‘Trade Depression and the Way Out’:

“When a bank lends, it creates money out of nothing.”

Ralph Hawtrey expanded this in another book ‘The Art of Central Banking’:

“When a bank lends, it creates credit. Against the advance which it enters amongst its assets, there is a deposit entered in its liabilities. But other lenders have not the mystical power of creating the means of payment out of nothing. What they lend must be money that they have acquired through their economic activities.”

Denison Miller had set up the Commonwealth Bank of Australia. Melbourne Board of Works borrowed £3 million and asked Denison Miller where he had raised all that money. He replied:

“On the credit of the nation. It is unlimited.”

Fresh credit is created as accounting entries in ledgers. Fresh money is nothing more than numbers in a bank account. Money is a freely created commodity. It can be created in any quantity at no cost. All that is needed for fresh money to be created is something to buy. The act of creating a new product gives the opportunity of creating fresh money with which to purchase it. Humans exist by exchanging goods and services. Fresh money gets its value from the goods that it can purchase. If money can buy goods, it has value. If money cannot buy goods, it is has no value. The act of creating money makes a call on part of the GDP. Thus the act of creating money needs to match the magnitude of economic activity. When a bank lends money, it does not have less money after it makes the loan. The loans are merely pen and ink entries in the debit and credit columns of a bank’s ledger.

At the 1937 Australian Royal Commission into Banking, part of a report was clarified by the Chairman, with this statement:

“The Commonwealth Bank can make money available to governments or to others on such terms as it chooses even by way of a loan without interest or even without requiring either interest or repayment of principal...”

It is by this straightforward procedure that has enabled China to become a world leading manufacturer. The China National bank ensures that all entrepreneurial activity has access to freely created credit at all levels of society. Their on-demand money creation is so successful that they can purchase vast quantities of overseas assets.

Professor Soddy, a prominent Oxford University physicist, wrote: “Is it possible in these days of disbelief in physical miracles really to caricature institutions which pretend to lend money, and do not lend it, but create it? And when it is repaid them, de-create it? And who have achieved the physically impossible miracle thereby, not only of getting something for nothing, but also of getting perennial interest from it?”

The banks created money where none existed and lent it out at interest.

The Chicago Plan Revisited, IMF Working Paper. 2012: “under the present system banks do not have to wait for depositors to appear and make funds available before they can on-lend, or intermediate, those funds. Rather, they create their own funds, deposits, in the act of lending. This fact can be verified in the description of the money creation system in many central bank statements, and it is obvious to anybody who has ever lent money and created the resulting book entries...”

In 1938, an English Bankers’ Journal, with the name ‘Branch Banking’, stated:

“There is no more unprofitable subject under the sun than to argue any banking or credit points, since there are enough substantial quotations in existence to prove to the initiated that banks do create credit without restraint.”

“There is just one restraint. ‘Sound banking practice’ limits the creation of credit to nine or ten times the amount of cash or legal tender which a bank holds.”

The late Sir Edward Holden, an eminent British banker, said:

“Banking is little more than bookkeeping. It is a transfer of credit from one person to another. The transfer is by cheque. Cheques are currency (not legal tender). Currency is money.”

The Judicial Committee of the Privy Council, in the famous Bank Nationalisation Case, gave this definition of banking:

“The business of banking, consisting of the creation and transfer of credit, and making of loans, the purchase and disposal of investments and other kindred activities, is part of the trade, commerce and intercourse of a modern society ...” [10]

Notice that they say “creation of credit”. The business of banking consists of the “creation of credit”.

Bank Credit is the lifeblood of commerce. Businesses cannot function without Bank Credit. Every person is a modern society is also dependent upon Bank Credit. If the banks stop credit for a few days, there would be a nation-wide crisis. If the restriction on the issue of credit continues for months, an enormous depression would ensue, leading to unemployment for millions and bankruptcy for thousands.

Industry, in all its forms, cannot function on its own resources. It needs the bank overdraft to operate. This industry is the backbone of the nation and industry relies on credit provided by banks.

When one borrows money to buy a house, the bank creates fresh credit through register entries. The backing for the money is your own asset. At the stroke of the pen on the appointed day, your name gets written on the title deeds but a caveat cedes ownership if you do not pay. The bank becomes the virtual owner of the property until such time as you have paid them approximately twice the value of the property. The bank did not lay a single brick nor hammer a nail. A stroke of a pen and they created the money to purchase. The bank monetized the asset value of the house.

As almost all money is created as credit by banks which they lend out and all assets and property are purchased by money that originated as a loan to someone, one can assume that the banks effectively own the assets of the nation. If there are no banks in a new nation, land is given away or purchased with small change from the meagre supply minted by the Treasury. When the banks arrive in the new nation, there is plentiful money that can be borrowed to purchase property, but the money is borrowed and the property is mortgaged to the bank. At the stroke of a pen from the new banks, they can set about being de facto owners of the land and property of the nation. They certainly have call on all the properties that are mortgaged to them. By maintaining immigration and strict land use laws, the limited availability of land plays into the hand of the lenders. Carefully crafted tax laws ensure business is always in need of loans.

Take a visit to Cambodia to see the effect of banks arriving in an impoverished country.

Mr. H. G. Wells about 1940

“Unexpected consequences of banking convenience have appeared. The idea of the cheque was a very obvious and a simple one, yet its working out leads us to quite a remarkable kind. The opening nineteenth century saw the rise of the cheque to an importance far exceeding that of the restrained and regulated bank note. If cheques were forbidden to-morrow, all the money in the country, even if no one held any for more than a day, would scarce suffice for half the needs of the very slackest working of our economic life. An enormous amount of business of the English speaking communities is now transacted by cheque without the moving of a bank note or the shifting of a coin. The clearing house has become an organ of primary importance in our economic life. The experience of the century is making it clear that, except for the convenience of paper and coins for small immediate transactions, it would be possible to dispense with actual concrete money altogether; it would be possible to sustain the general working of an entire economic system by clearing house bookkeeping by the continual transfer of money on account, of crude purchasing power, that is from one account to another.” [13]

Mr. MorganRees, Professor of Economics in the University of Wales about 1940:

“So far is this control being attained that since 1914 it is increasingly clear that the grip of the financiers and the bankers over the credit machine therefore over industry is becoming stronger.” [13]

Professor Soddy, Oxford University.

“The cheque system, itself a beneficent invention, has, by a mere incidental consequence, enabled the banks continuously to create and destroy money at will. If it had been understood from the first, that what hitherto had been a bank, was by this invention made a private mint, the practice would have been prevented as subversive to the continued existence of the State - for it is just as much high treason as uttering coins. Though known to students of the subject (and the “City” which thrives on it) from long before the war, it is only since the war that the fact has become obvious to everyone able to think for themselves and capable of interested denial. It is this power of the private mint which imperils the future of scientific civilization, which makes politics a sorry farce, and reduces Parliament to a sham. Destroy it, and the nation would be free to pursue its peaceful avocation in peace.” [13]

Abraham Lincoln

“Government, possessing the power to create and issue currency and credit as money, and enjoying the right to withdraw both currency and credit by means of taxation, and otherwise, need not and should not borrow capital at interest as the means of financing government and public enterprise. The Government should create, issue and circulate all the currency and credit needed to satisfy the spending-power of the Government and the buying-power of the consumers. The privilege of creating and issuing money is not only the supreme prerogative of the Government but it is the Government’s greatest creative opportunity.” [13]