How Fractional Reserve Lending - Destroys the Value of Your Money

​Inflation and Fractional Reserve Lending

Inflation is one of the least understood economic principles. Most people think they understand it, but few actually do. Most confuse it with the supply – demand dynamic, not realizing that inflation is a deliberately engineered distortion of supply and demand. This lack of understanding is bad for the people, but it’s great for the political class.  This ignorance by the citizenry, is allowing the corrupt oligarchy running our government, to continue getting away with the most egregious theft of middle-class property we’ve ever known – with our consent.

For this reason, I am posting this article – an excerpt from the book “Chase The Rabbit,” in a feeble yet well-intentioned attempt to enlighten as many as possible.

Inflation—The Hidden Tax
Most people in the modern industrialized world have been conditioned to believe that inflation (demonstrated as rising prices) is a naturally occurring and unavoidable phenomenon. This is absolutely false.
It is important to understand that rising prices is not the cause but instead the consequence of inflation. Most people intuitively understand how supply and demand affects prices, but what escapes them is how inflation enters into the supply and demand dynamic. The word inflation refers to an expansion of the supply of money. The increased amount of money in circulation causes each unit of money to be devalued in terms of its purchasing power, so more dollars are required to buy the same goods, giving the appearance of higher prices.

Inflation Is Not a Naturally Occurring Phenomenon

The Oxford English Dictionary defines inflation as follows:

• An increase in the amount of currency in circulation, resulting in a relatively sharp and sudden fall in its value, with a consequent rise in prices due to the currency’s reduced purchasing power. It is caused by an increase in the volume of paper [fiat] money issued.
• A persistent increase in the level of consumer prices resulting from a persistent decline in the purchasing power of money, caused by an increase in the amount of available currency and/or credit beyond the proportion of available goods and services.
  
  

These conditions indicate that inflation is not defined as the increase in prices but as the increase in the supply of money causing its reduced purchasing power. When your money has been devalued, you need more of it to purchase the same things as before giving the appearance of higher prices (in spite of the intrinsic value of those things remaining unchanged). Inflation is the cause while rising prices are the effect and not the other way around. In a FIAT monetary system such as the Federal Reserve system, all money is issued as debt. Therefore, monetary expansion also constitutes an increase in the amount of available credit (such as mortgages). Therefore, printing money is nothing more than a euphemism for expanding credit (debt). The many other euphemisms used by the Federal Reserve and banking industry to describe this include: quantitative easing (QE); active policy responses; accommodative monetary policy; adding liquidity; adding to bank reserves; asset swap; creating excess reserves; currency intervention; deficit accommodation; easing credit; debasing the currency; expansionary monetary policy; expanding The Fed’s balance sheet; Fed purchasing debt; securities purchase program; funding the deficit; helicopter drop; liquidity enhancement; monetizing debt—all of these are bankers’ code names for exactly the same thing—creating money from nothing.

The reader should note that the word credit is used by the banking industry in place of the word debt. This is because when you take on a debt, the bank has issued you credit. Bankers use the words credit and debt interchangeably because the choice of words expanding credit sounds much kinder than the words expanding debt, although they mean exactly the same thing.

In summary, the most important aspect of this to remember is that inflation or expansion of the money supply is the cause, while the rising prices are the effect, and not the other way around.

​Money for Nothing

Most people believe that the total money supply is created by The Federal Reserve through its money creation power – granted it by the US Congress in the 1913 Federal Reserve Act – a direct violation of the US Constitution. However this is not the only source of inflationary monetary expansion. The lion’s share of inflationary monetary expansion is created by commercial banks and we the people who borrow and spend, continually living beyond our means. As such, we are the arbiters of our own ruin – which suits the political class and elites just fine.

Commercial banks create money from thin air when they engage in fractional reserve lending. This is a principle whereby banks are only required to retain a fraction of their total depositors’ funds on hand while they are permitted to loan out the rest at interest. In fact, the lion’s share of the total money supply is created in this way.

Money is the prime motive of human labor. If you want food, clothing, and shelter, you must have money. Unless you are fortunate enough to be part of the tiny minority that has inherited more money than you could spend in your lifetime, you must work for, beg for, borrow, or steal it. Only one of the aforementioned provides for self-reliance. Stealing is unethical and a crime. Begging depends upon the charity of others. Borrowing makes you beholden to the lender. Laboring--earning your money—is the one and only means of obtaining wealth that allows you to become self-reliant and therefore free. Therefore, those who wish to control society must ensure that the people have no choice but to either beg for or borrow money, whether they want to or not. Fiat money provides this feature since it is created as debt—from nothing. Since all fiat money is debt—when you are paid for your labor you are forced to accept money that is actually owed to someone else. It is through this system that rulers are able to make self-reliance unachievable. Their purpose is to expand social and economic dependency in order to ensure their status and permanence as rulers. Thus, the archenemy of any ruling class is a sound monetary system.

Since the value of every transaction and every asset is based upon the monetary system under which the economy functions, the one who controls the monetary system controls the value of everything. This includes the value of our time and therefore our labor.

Section 8, clause 5 of the US Constitution states, “The Congress shall have the power to coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures.” This clause guaranteed the United States a system of sound money. This means that money must be created only as coin—a precious metal commodity—as opposed to fiat (paper notes), and that its unit of value should be fixed in terms of a standard of weight of that precious metal.

Gold and silver cannot be created out of thin air. Under a sound money system based on gold or silver, the overall supply of money remains stable, and therefore, prices are stable over time. Prices of all goods and services as well as the value of all real assets are then based solely on the market forces of supply and demand. These market forces result from the daily actions of the whole of the people. Under such a system there is no inflation. If prices rise, it is solely due to the demand for something increasing relative to its supply. When that occurs, suppliers increase production to meet the increasing demand, and prices then re-stabilize on that basis. Suppliers do so out of self-interest just as those who demand more of their products also act in their self-interest. It is an economy in symbiotic, albeit dynamic equilibrium. It is perfectly natural.

Fiat money is unnatural. Its value is not defined in terms of any weight or measure of anything. We have already seen how fiat money is used as the instrument of inflation and how central bankers are able to create market-specific inflations—market bubbles. We also demonstrated how they deliberately destabilize the economy by deciding into which markets to loan the most money (expanding credit) and at which interest rates—thus allowing them to distort supply and demand differentially across markets. The last and more important piece of this insidious puzzle, however, is that central bankers conduct their monetary manipulations in secret. Therefore, they are in a position to pick and choose which of their corporate and political cronies will benefit from having foregone knowledge of their actions, while the general public is kept in the dark.

This is why the cost of virtually everything that we in the middle class depend on for our daily lives is increasing at a disproportionately faster rate than our individual incomes. It is also one of the reasons that average middle-class citizens continually get poorer and poorer, while certain privileged individuals get richer and richer regardless of how the overall economy is doing.

How Fractional Reserve Lending Creates Money Out of Thin Air

Most of the total money supply (in US dollars) is created by commercial banks. Commercial banks are required to keep a certain amount of depositors’ cash in their vaults at any given time. This is called the reserve requirement. In the United States the reserve requirement is 10 percent. This means that if the bank has one million dollars in deposits, it can loan out $900 thousand of that amount at interest, even though it belongs to the depositors. The new money creation process takes place from this point forward. When the eventual borrowers of that $900 thousand then deposit that money into their own bank, their receiving bank considers that as part of its reserve and can then re-loan all but 10 percent of that amount—another $810 thousand. The bank that in turn receives this $810 thousand then adds this money to its reserve and can again loan out 90 percent of that—another $729 thousand—and so on and so forth. The banking industry calls this the money-multiplier effect. This is a misnomer, however, since it is in truth a debt-multiplier. In effect, this same $729 thousand is owed to more than three different depositors. The last dollar of the original million is owed to 132 different depositors. Therefore, banks collectively earn interest on the same money loaned out to multiple borrowers. When all is said and done, this initial one-million-dollar deposit yields a total of nine million dollars in new virtual money, every penny of which is debt, and all of which is earning interest for the banks.

Banks are allowed to create virtual money in this way because every borrower who signs a loan application pledges their future labor and earnings as the means to pay it back (while also pledging assets as collateral to be seized in the event of nonpayment). In other words, your signature on a loan agreement authorizes the bank to create the money you are borrowing out of thin air (or more correctly – to loan you money that is already owed to 131 other banks). In effect, that newly created money is infused with new purchasing power by virtue of the future labor that every one of those 131 prior borrowers has promised to exchange for it upon repayment of the debt.

We the People Are Complicit in Our Own Fleecing

Although it is commercial banks that create most of the money supply through fractional reserve lending (expanding credit), there are always two parties involved in a loan agreement—the lender and the borrower. Monetary expansion is created by the people themselves, people who either refuse to live within their means or have no choice but to use debt just to survive. Most of the government’s monetary and tax policies are designed to impose this latter condition upon the people. The more debt you use to fund your lifestyle, the more you contribute to monetary expansion and the further you devalue every single US dollar in existence. Every time you use debt to finance a purchase, you increase the money supply, create inflation and devalue your own savings. With every dollar you borrow you further impoverish yourself, your neighbors, and your children. As the basic standard of living in this country becomes less and less affordable because of the resultant inflation, more people are driven more deeply into debt just to survive. The system has entered a death spiral toward self-destruction. This is one of the reasons that the rate at which the number of people who are descending from the middle class into the ranks of poverty is increasing.

During the run up to the 2008 housing collapse—banks offered home equity loans of up to 125% of the value of the home. This is a called a 125-LTV (loan-to-value) mortgage or a “no-equity home loan.” These mortgage products continue to be offered even today, in spite of what happened during the housing bubble, and they allow borrowers to deliberately put their homes underwater in debt. Once the housing bubble burst, many of the same borrowers who knowingly took on these absurd levels of debt were then complaining that they should be bailed out by the government.

Unless you pay cash for your house—in full—it is not your house and your neighbors and other American taxpayers don’t owe you one.

The Infinite Bubble
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Credit card debt is also created through fractional reserve lending. Every time you swipe your credit card, whether it is to fill your gas tank, buy groceries, or take a vacation with your family, you have created new virtual money that did not exist before. The banking industry encourages people to use revolving credit to fuel their consumerism because the average interest rates they can charge for this is more than 20 percent annually. This does not even include the transaction fees levied against the merchant, which can be as much as 4 percent of the amount charged. While banks are paying on average about 0.5 percent interest on depositors’ savings, those same banks are earning more than 20 percent annually on credit card debt. This represents a more than 4,000 percent rate of return for the bank by lending money that doesn’t actually exist until you swipe the card.

With every credit card swipe, you expand the money supply, devaluing your real-money assets, your savings, and your retirement. Therefore, with every credit card swipe, you enrich the bank and impoverish yourself and your neighbors. This is why the banking industry is trying to drive the financial system away from using cash for most transactions. They instead want people to use credit cards for just about everything. When consumers use cash, the bank doesn’t get a piece of the action. For this reason the banking industry and the government are intent on moving us toward a cashless society, based entirely on digital fiat money.
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Finally the most important aspect of this is that all fractional reserve institutions are simply bankruptcies waiting to happen. It takes only a relatively small number of depositors all withdrawing their money at the same time to put any bank out of business. Such an event is what is known as a run on the banks.

The Puppet Masters
 
Take careful note of the following graph, which compares the inflation in median home prices to the median per-capita income. This demonstrated clearly that the ratio of the median price of a home relative to per-capita income has increased more than sixfold between 1977 and today. This condition has been deliberately created by the money manipulators in the Federal Reserve system by differentially targeting the housing market versus the labor market with different levels of liquidity and different interest rates on the debt offered in each market category. At the same time the federal government distorts individual income further through taxes.

It is the Fed’s board of governors and open market committee who determine how much capital to deploy, the interbank interest rates, and what the reserve requirements for the member banks shall be. Therefore, the rate of monetary expansion and thus the rate of inflation is under the direct control of the Federal Reserve. While inflation decimates the purchasing power of your money, you are taxed on your earnings and property. This ensures that you are unable to earn enough to keep up with the rising cost of living without using increasing levels of debt. The system is intended to drive you further and further into debt and keep you there. This enriches both the banking aristocracy and the political class with the fruits of your labor. This is the essence of chasing the rabbit—a prize that has been deliberately made uncatchable.

If the Federal Government truly wanted to reduce inflation, the most immediate and effective means to do so would be to simply order the Fed to increase the reserve requirement for Commercial banks.  By raising the reserve requirement from 10% to say ... 35%, the rate of monetary expansion by fractional reserve lending (and thus the rate of inflation), would be cut by 2/3 - essentially over night.

In a free market economy based on sound money, the forces of supply and demand are a consequence of the actions of the whole of the people. In contrast, in a centrally controlled economy based on fiat money, the forces of inflation are a consequence of the actions of a few very powerful men and women—the people who run the Federal Reserve system. They use inflation to pervert the natural forces of supply and demand in order to achieve certain ends that are known only to them. In other words, they attempt to centrally plan our entire economy through the authority they have been granted to create and issue our money (all of which is debt) and to manipulate its purchasing power.
 
Central Planning’s Fatal Flaw

In practice, central economic planning is deeply flawed. No central planner can possibly possess enough knowledge about local changes in the economy and localized supply and demand as experienced by the entire US population going about their daily lives. It is the billions of daily choices made from moment to moment by the more than 320 million American citizens that should determine the real value and the price of everything. This is why a free market is the most efficient and honest system. Money and investment flows through transactions made by the whole of the people based upon each and every individual’s unique knowledge about their particular part of the macroeconomic landscape. A small boardroom of central bankers sitting in Washington could never have the collective knowledge about market dynamics driven by 320 million or more people. However, central economic planning via a central bank has been the principal objective of those seeking to rule society for centuries. It is one of the foundations of Marxist-Socialist dogma.

Fiat Money—The Cornerstone of Socialism

Central Banking and Socialism are inextricably linked - forever. It is well known that Socialism is a shortage economy. It is the economy of inefficiency and corruption, of indifferent workers and "bigwigs," of lacking funds, of failure, of needing perpetual reforms, reforms which are constantly unsuccessful.

Among those who are devoted to socialism many are well-intentioned idealists believing that it has the possibility to improve society as a whole and to provide for the poor. They believe this only because they have been misinformed by more than a century of relentless propaganda. They have been spoon-fed that propaganda by those who are devoted to socialism for a different reason. These are the people who recognize socialism’s ability to centralize power in the hands of a few with the consent of the masses. Their goal is to be among those few who gain that power over other men so that they can abuse it. These people have long understood that having authority over the creation of a nation’s fiat money system is the main catalyst to acquiring absolute power over society. It gives the issuer control over all property, natural resources, and especially labor. Consider the alarming consequences of this fact when the idea of a single global currency is raised during public discourse.

In 1919, Austrian Otto Bauer, a lawyer, social democrat, and “father of Euro-communism” wrote, “If all banks are amalgamated into a single central bank, then its administrative board becomes the supreme economic authority, the chief administrative organ of the whole economy.”

He went on to say, “Only by nationalization [centralization] of the banks and monetary powers does society obtain the power to regulate its labor according to a plan, and to distribute its resources rationally among the various branches of production, so as to adapt them to the nation’s needs.”

In his book Der Weg Zum Sozialismus (The Way to Socialism), Bauer’s premise, nationalization of the banks, is to centralize the fiat money-creation powers under the sole control of a central bank.

Central banking is the essence of central economic planning with the intent to control the means of production through financial manipulation. This idea’s practical failure is the inability for central planners to possess the collective knowledge of hundreds of millions of people who make market decisions every waking hour of every day. This is why central planning does not work for the benefit of the citizenry and never will.

It can, however, be employed to work for the benefit of a corrupt few who have been granted the control authority.
In 1920, the economist Ludwig von Mises demonstrated that since a socialist economy destroys price information through government intervention, the innumerable participants in the economy are unable to make a rational calculation about value or about profit and loss.[1] Any economic activity that operates at a loss cannot be sustainable. Furthermore, Nobel Prize-winning economist Friedrich A. Hayek demonstrated that a national economy has such an immense number of dynamic economic relationships that no single committee or bureaucracy, no matter how intellectually gifted or well-staffed could ever know enough to direct prices or production levels. He referred to this as socialism’s fatal flaw.[2]
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From an economic perspective there is no difference between Socialism and Communism. It is more correct to understand Socialism as an economic model, and Communism as a form of governance. The latter, to maintain its power, depends upon the former to deprive the people of their property rights. Both terms denote central control of the means of production. Planning consists in the plans of the government being substituted for the plans of individual citizens. The result is that entrepreneurs and businessmen will be deprived of the discretion to employ their capital in accordance with their own vision. They must instead comply unconditionally with the central planners’ whims. In America it is by taxation and our debt-based fiat system of capital through which control of the means of production has been transferred from entrepreneurs and businessmen to the government.[3]

From the ethical perspective socialism is morally bankrupt. Its premise is that we can each live at the expense of others in spite of the fact that this violates both natural law and the biblical commandments that forbid coveting and theft. Indeed, socialism in practice depends upon the use of force applied by one group of people over others. It is the essence of human parasitism. The use of force by one man against another except in self-defense is unjust and immoral. Nevertheless, this reality has never stopped the statists from attempting to centralize their power over the economy.

Now consider for a moment the following hypothetical: A corrupt, power-mongering sociopath bent on dominating society reads Otto Bauer’s previous passage. Such a person would see the following:

“Only by centralizing the banks and the monetary powers under my control can I obtain the power to regulate labor, according to a plan, and then distribute society’s resources to myself, my family, my political supporters, and to my own corporate institutions, so as to adapt them to my own needs.”

If one seriously considers the ramifications of this hypothetical statement, it sheds an ominous light on the following well-known quotation made by Mayer Amschel Bauer Rothschild:

“Give me the power to issue and control a nation’s money, and I care not who makes its laws.”

Rothschild understood that a fiat monetary system controlled by a few privileged men (preferably he and his family) would enable the issuer to “make the nation’s laws.” In other words, it would give him control of the government as well as the economy, effectively placing him above the law. Whoever controls the issuance of a nation’s fiat money system controls the government, the economy, and therefore the people.

Karl Marx’s idea was that the government would control the central bank. Rothschild’s idea was that the central bank would control the government. The former yields a system of state socialism (or Communism). The latter yields a model of corporate socialism. MIT professor Noam Chomsky calls this ‘state capitalism,’ but it is actually fascism (the merger of state and corporate financial power). Both models are the antithesis of the concept of self-governance as espoused in the US Constitution. Both models depend upon a central bank-controlled fiat monetary system, a system that is explicitly prohibited by the US Constitution.
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Therefore, the clear distinction between a sound currency and a fiat currency represents the difference between a nation of free individuals with the possibility of self-governance—and one that is ruled by a totalitarian oligarchy that absolutely prohibits self-governance and has few or no property rights. Which would you prefer to live under?
The United States was founded as the former. Since 1913, we have devolved into the latter.
 


[1] Mises, Ludwig Von. Economic Calculation in the Soviet Commonwealth. 1920.

[2] Hayek, F.A. The Fatal Conceit, The Errors of Socialism. University of Chicago Press. 1991.

[3] Mises, Ludwig Von. The Anti-Capitalistic Mentality, Ludwig Von Mises Institute.