Under the "fractional reserve" lending system, banks are allowed to extend credit (create money as loans) in a sum equal to many times their deposit base. Congressman Jerry Voorhis, writing in 1973, explained it like this:
"[F]or every $1 or $1.50 which people - or the government - deposit in a bank, the banking system can create out of thin air and by the stroke of a pen some $10 of checkbook money or demand deposits. It can lend all that $10 into circulation at interest just so long as it has the $1 or a little more in reserve to back it up."3
That banks actually create money with accounting entries was confirmed in a revealing booklet published by the Chicago Federal Reserve titled Modern Money Mechanics.2 The booklet was periodically revised until 1992, when it had reached 50 pages long. On page 49 of the 1992 edition, it states:
"With a uniform 10 percent reserve requirement, a $1 increase in reserves would support $10 of additional transaction accounts [loans created as deposits in borrowers' accounts]."4
The 10 percent reserve requirement is now largely obsolete, in part because banks have figured out how to get around it with such devices as "overnight sweeps". What chiefly limits bank lending today is the 8 percent capital requirement imposed by the Bank for International Settlements, the head of the private global central banking system in Basel, Switzerland. With an 8 percent capital requirement, a state with its own bank could fan its revenues into 12.5 times their face value in loans (100 ÷ 8 = 12.5). And since the state would actually own the bank, it would not have to worry about shareholders or profits. It could lend to creditworthy borrowers at very low interest, perhaps limited only to a service charge covering its costs; and it could lend to itself or to its municipal governments at as low as zero percent interest. If these loans were rolled over indefinitely, the effect would be the same as creating new, debt-free money.
Dangerously inflationary? Not if the money were used to create new goods and services. Price inflation results only when "demand" (money) exceeds "supply" (goods and services). When they increase together, prices remain stable.
Today we are in a dangerous deflationary spiral, as lending has dried up and asset values have plummeted. The monopoly on the creation of money and credit by a private banking fraternity has resulted in a malfunctioning credit system and monetary collapse. Credit markets have been frozen by the wildly speculative derivatives gambles of a few big Wall Street banks, bets that not only destroyed those banks' balance sheets but are infecting the whole private banking system with toxic debris. To get out of this deflationary debt trap requires an injection of new, debt-free money into the economy, something that can best be done through a system of public banks dedicated to serving the public interest, administering credit as a public utility.
Some experts insist that we must tighten our belts and start saving again, in order to rebuild the "capital" necessary for functioning markets; but our markets actually functioned quite well so long as the credit system was working. We have the same real assets (raw materials, oil, technical knowledge, productive capacity, labor force, etc.) that we had before the crisis began. Our workers and factories are sitting idle because the private credit system has failed. A system of public credit could put them back to work again. The notion that "money" is something that has to be "saved" before it can be "borrowed" misconstrues the nature of money and credit. Credit is merely a legal agreement, a "monetization" of future proceeds, a promise to pay later from the fruits of the advance. Banks have created credit on their books for hundreds of years, and this system would have worked quite well had it not been for the enormous tribute siphoned off to private coffers in the form of interest. A public banking system could overcome that problem by returning the interest to the public purse. This is the sort of banking system that was pioneered in the colony of Pennsylvania, where it worked brilliantly well.
Restoring Michigan to Solvency
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