The U.S. Fiat Currency System

A Discourse on the Federal Reserve System
October 25, 2011

Many politicians and economists always talk about ridding America of its debt.  But the truth is, the system depends on debt to sustain itself.  There wouldn’t be any currency for people to spend unless there was debt that inspired the creation of it in the first place. If the debt is reduced, there will be a corresponding reduction in the currency supply. And if the debt is erased completely, there wouldn’t be any currency at all.  It’s amazing, but true – the system traps its users in a perpetual debt cycle. It’s a scam of epic proportions and only a tiny percentage of the population have grasped the significance of what that means.

Every dollar represents no more than simple debt. A dollar is an IOU from the Federal Reserve.  That’s why every bill actually says “Federal Reserve Note” – a piece of paper which represents a promise by the Federal Reserve to pay you a quantity of dollars. It’s not a promise to pay in gold, silver or anything else of any value.  It only promises the reimbursement of dollars.  The obvious question, then, is why would someone turn in such a note in order to receive back exactly the same note?  It’s a good question, but most people don’t know enough about the currency system in order to pose that question.

The Creature from Jekyll IslandThe following is an explanation of the way the Federal Reserve System works in the United States. It’s a crazy system indeed.  For verification of these facts and a history of central banking in America, the reader is urged to read G. Edward Griffin’s book, The Creature from Jekyll Island.

1. U.S. Treasury creates Bills, Notes & Bonds

The United States Government needs money to operate.  So, the U.S. Treasury sells Bills, Bonds & Notes.  All of these are debt instruments which promise to pay back to the buyer the original purchase price, plus interest, at some time in the future.

2. Federal Reserve buys the U.S. Treasury Debt

Certain banks, known as Primary Dealers, buy the U.S. Treasury’s debt instruments during Treasury auctions. But these Primary Dealers are really only “middle-men” because through Open Market Operations (OMO), the Federal Reserve ends up holding the Treasury’s debt and writes a Federal Reserve Check to cover the cost.

But here’s the important thing to remember – the Federal Reserve doesn’t have any money to cover this check.  The check represents money created out of thin air!!! This is what prompted Griffin to refer to this system as the “Mandrake Mechanism,” referring to a magician of the early 1900’s who was famous for making things appear from nothing.

3. Federal Government gets the Cash & Spends

The Federal Reserve’s check is credited toward the Federal Government in a Federal Reserve Bank account.  From this account, the Federal Government is able to disburse funds as necessary among the various branches of government in order to pay for all the deficit spending, welfare programs and wars.

4. People & Contractors get the Cash & Make Deposits

Government employees and soldiers in the military receive their paychecks.  Contractors get paid for their crony-acquired government projects. The employees, soldiers and contractors then make deposits into their personal bank accounts across the nation. Now the currency creation starts to happen in the commercial banks.

5. Banks Take Deposits & Practice Fractional Reserve Banking

Once the commercial banks get these deposits from their customers, they employ Fractional Reserve Banking to create yet more currency into existence. In Fractional Reserve Banking, the banks are able make loans to other people in amounts much greater than the sum they actually have in their reserves.  For example, if a bank gets a deposit of $1000 from someone, it only needs to keep $100 for its reserve base. The bank is therefore able to multiply that original deposit by 90% and make a new loan to someone else for $900 (90% more currency created out of thin air).  The bank now has reserve assets made up of the $100 from the original deposit plus a $900 loan that generates monthly income from the new borrower. But the original depositor still has a claim on the entire $1000.

6. New Loans are Re-Deposited

All the people receiving these new loans take the money and re-deposit it into their banks. And again, those banks take the deposits and turn them into even more currency by re-employing the fractional reserve banking concept and loaning out more to others.  Following the example used above, the new $900 deposit becomes a source for a new loan by taking 90% of that – a new loan of $810 for someone, generating yet another blast of currency out of thin air.

The above steps are repeated over and over again.  Repetitive iterations of steps 5 & 6 produce slightly less currency in the system than the previous iteration, but in the end, the commercial banking system has been able to create almost 10 times the amount of currency that was created by the Federal Reserve in the first place.

The really interesting point here is not the mere currency creation out of thin air, because many people are already familiar with the printing press concept. What’s really amazing is that all this currency creation cannot happen unless someone borrows it into existence. Our government takes the original loan from the Fed in the first step. All subsequent steps depend on the public to take on debt.  It’s truly a perpetual debt system.

Here’s Mike Maloney explaining all this at the Casey Summit, When Money Dies

There are two more ways which the Fed creates debt currency, which are just additional ways of creating money out of thin air.  These are the following:

  1. The Discount Window. The Federal Reserve uses the Discount Window to allow banks to borrow money to increase their own base supply.  Sometimes banks run short of money because they experience temporary surges in customer withdrawals.  Additionallly, bad loans become problematic for the bank – the underlying assets sometimes need to be written off.  In these cases, the bank’s currency reserve is reduced, placing in jeopardy their ability to maintain their miminum fractional reserve base.
    The Federal Reserve is the “banker’s bank.” The Discount Window allows the banks to increase their currency reserve by simply taking a loan from the Fed. But remember, the Fed doesn’t have any money, so this is just more currency creation out of nothing!
  2. Reserve Ratios. In the examples above and in Mike Maloney’s discussion, a reserve ratio of 10 to 1 (or 90%) was used as the fractional reserve base. But the Fed can alter this ratio specification at any time depending on what it deems necessary.  Essentially, this allows them to increase or decrease the rate at which the currency supply grows at any time by simply re-defining the rules for banks keeping a certain percentage of reserves in relation to their loans.

So the Federal Reserve System is quite a remarkable thing indeed. One wonders how long it will be before the populous wakes up to the scam!

Here are a couple of videos discussing the Federal Reserve and central banking concepts.

Money, Banking, and the Federal Reserve from Mises Media on Vimeo.

Here’s a comprehensive video discussing the details of the Federal Reserve and an in-depth historical account of the evolution of central banking.  Very Interesting!

Contact the author of this article by sending an email to Jonk.