I love conspiracy theories. The detailed and convoluted tales of faked moon landings, dissected aliens at Area 51, Illuminati treasures secreted under national monuments and dire warnings of a nearing Armageddon fire my imagination with their entertaining renditions of world events. I revel in the thought of Elvis giving up his rock n roll career to fight crime with the FBI and the like, but there are instances where I believe that the tag of “conspiracy theory” is misplaced or perhaps applied to a topic just so that people will not take it seriously. One instance of this, in my opinion, is fiat money, or fractional reserve currency.
If you were to ask most people about where their cash comes from they will tell you that the Treasury holds a certain amount of gold upon which they base the value of the currency that they issue. Yet, this is an urban myth and when the truth about how banks produce money is revealed the same people still do not believe the facts- essentially, the banks just print money as they need it. In fact, the production of currency is directly linked to the way that banks handle their deposit and loan accounts.
Originally, banks were mainly places where, for a small fee, people could deposit their money for safekeeping. Eventually the bankers holding these funds determined that they could increase their profits if they then loaned out some (or all) of these stored funds whilst they were holding them. This scheme is fine until the original depositors want their money back before the bank has recovered their loan and the money isn’t in the vault. In practice though this eventuality isn’t very likely as it is rare for all of the banks depositors to want all of their money at once meaning that most of the time a depositors funds can be returned on demand. But, on those rare occasions that it does happen, the result is always the same- financial collapse.
In order to circumvent circumstances of this nature banks developed a cunning plan. When a bank has loaned out its reserve the common practice (amongst banks) is to bundle up all of those loans, or more accurately, the income calculated to come from those loans, and to sell off these new “assets” in the form of bonds, thus monetizing the debts that are owing to them and allowing the bank to loan out the money again. Of course, when the new money is loaned out the whole process can be repeated again, more bonds are created and sold and the banks then make more loans and so on. In this way the banks can continue to manufacture money endlessly, in theory. Of course, if, for some reason the bank cannot recoup the money that it has loaned out, the bonds lose value and the scheme collapses. And, of course, the banks must retain a fraction of its reserve to satisfy the demands that are made by the depositors for their cash at any given time. This amount is determined by what the bankers think is prudent and which in practice is about 10%. So most banks, operating on a fractional reserve of 10% can inflate their cash at the rate of 9:1, that is, every dollar that the bank holds can be (legally) turned into $10. And, as most Western countries have a central bank (like the Reserve Bank of Australia or the US Federal Reserve) there is always a customer ready to buy bonds from the banks and as a consequence the loans that they back then become guaranteed by the government and any fiduciary collapse will be covered by the public purse- tax dollars.
So why does this matter? After all, how likely is it that enough people will want their cash, or that enough loans will tank to cause the bond markets to crash? So long as these institutions of banking are stable it doesn’t matter- right? Wrong! Every time the banks add to the circulating currency there is an increase in the amount of money yet there is no corresponding increase in goods to that value, making the spending power of all money less. This is called inflation, which generally appears to consumers as price increases and makes a hidden tax that we all pay with every purchase that we make. In the end only the first people to get their hands on newly printed fiat money receive the benefit of it- the banks. The more hands that it passes through the less spending power that new fiat money actually has.
Of course banks and governments (that pay their way in this fiat money) make a lot of arguments in favor of this system- they are the main beneficiaries of it, but the true results of using debt based currency are now so apparent that even the political spin can no longer hide the truth. Now we are reaping the rewards of a century of fractional reserve banking.
Photo: A Cool Friday (http://www.acf-fr.org/)