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Magic Money- Fractional Reserve Banking

November 4, 2009

Magic Money- Fractional Reserve Banking

Global Dollars“Money is such a routine part of everyday living that its existence and acceptance are ordinarily taken for granted. A user may sense that money must come into being either automatically as a result of economic activity or as an outgrowth of some government operation. But just how this happens all too often remains a mystery”.

-Federal Reserve Bank of Chicago, “Modern Money Mechanics”

In this article, we are going to lift the veil of mystery surrounding the subject of money creation. Have you ever thought about how money is created and placed into circulation? I’m not referring to the actual manufacturing process when for example the United Sates Treasury has the U.S. Mint print Federal Reserve Notes or stamp coinage. Far from it, money creation is way more interesting than that, here we will layout the actual source.

We need to go back a step in the process in order really appreciate the truth about money creation. If you can honestly answer “no” I don’t know how money or for that matter how credit is created, then what you will learn may fascinate or even shock you as it has others.

For a story about the history of money/currencies, take a look at this post- Just what is money?

With all the economic upheaval engulfing the globe, now is a great time to get schooled on modern money mechanics. Hold on, and don’t run off now! This subject affects everyone and is pretty easy to comprehend once you get the fundamentals and will be beneficial to you now and for years to come.  Our economic future is being reshaped very quickly and it involves you. The more you know the less fearful you become and money certainly should not be on the exclusionary list of subjects. We will also expose how the staggering billions and billions of credit-money is being created by the Central Banks of the world including here in the USA.

Each step of this process is purposefully orchestrated through “bail-out” monetary policies to inject massive credit into the financial system (read- giant, New York money-center banks) in an effort to ward-off their total ruin and financial collapse. If any of them fail, we pick up the tab because of how the financing is structured. Although this has been done before in the U.S., it has never been on the magnitude witnessed today. But before we get into that, back to the related subject at hand: credit-money creation.

This is about money, credit, debt and you- all engines of today’s commerce and life. Let’s have a little refresher course and start with a few definitions. This mini resource lays a foundation for understanding some basic concepts and terminology we will use in this article.


Note: Please skip ahead of this mini finance-dictionary if familiar with the terms.

Money- A medium that can be exchanged for goods and services and is used as a measure of their values on the market, including among its forms a commodity such as gold, an officially issued coin or note, or a deposit in a checking account or other readily liquefiable account. The official currency, coins, and negotiable paper notes issued by a government. (See: Federal Reserve)

Legal tender- Money recognized by law as acceptable payment for debts owed to creditors. In the United States, legal tender (also called lawful money) is all forms of circulating paper money, mostly Federal Reserve Notes, and coins. The term means that money offered as payment has the backing of the government and must be accepted by a creditor, unless a contract calls for another method of payment. (See: fiat currencies)

Credit- An arrangement for deferred payment of a loan or purchase.

Credit-money- Money backed by the full faith and credit of the issuing country as opposed to hard currency such as gold. Most currencies in circulation today are credit money. (Also called fiat money, see: fiat currencies)

Fiat currencies- Legal tender, especially paper currency, authorized by a government but not based on or convertible into gold or silver.

United States Treasury- the U.S. Treasury is responsible for the revenue of the U.S. government. Also responsible for Printing of bills, postage, Federal Reserve notes, minting of coins, collection of taxes, enforcement of tax laws (through the IRS)
management of all government accounts and debt (bonds) issues and overseeing U.S. banks

US Treasury bond- A long-term debt obligation of the U.S. Treasury having a maturity period of more than ten years and paying interest to the purchasers of US bonds semiannually.

Federal Reserve- A privately held central bank created by an act of Congress in 1913. Duties include some of the following: lending money to commercial (member) banks, issues the national currency, sets key interest rates effecting supply of credit-money in circulation.

Federal Reserve Banks- These privately held banks are the operating arms of the central bank. They implement the policies of the Federal Reserve.

Fractional reserve- The portion (expressed as a percent) of depositors’ balances banks must have on hand as cash. This is a requirement determined by the country’s central bank, which in the U.S. is the Federal Reserve.

Promissory note- is a written promise to repay a loan or debt under specific terms – usually at a stated time, through a specified series of payments, or upon demand.

Interest- a charge for a loan, usually a percentage of the amount loaned.

Debt- An obligation or liability to pay back typically a loan, to the issuing bank. (See: Interest)


The Government’s Bank of Choice

U.S. Treasury sealStep one: When the US Government needs money a request is placed through the US Treasury with the Federal Reserve Bank. Upon the Governments request, the Federal Reserve agrees to purchase from the US Government, US Treasury Bonds of the same dollar value in exchange for creating the amount of money requested. Once this exchange is complete, instantly money is created! Of course today this is facilitated through electronic transfer deposit entries into a bank account. Approximately 3% of the total money supply of physical currency is in circulation; the remaining balance 97% or so, is digital money.

Step two: Here is when it gets more interesting. Just as when you request money which you do not have (or choose not to use your cash reserves/savings) to purchase a home or other large purchase like an automobile, you request a loan usually from a lending institution such as a bank. This exact process is what the U.S. Government does through the Treasury when they go to their bank, the Federal Reserve Bank. Keep in mind a key point- just like your bank, the Federal Reserve is a privately held bank. You will not find them listed in the Government section of the phone book. They are listed close to Federal Express, another privately held company.

Fed ReserveNow that the U.S. Treasury has sold U.S. bonds to the Federal Reserve they have created a debt obligation in exchange for the money created by the Federal Reserve Bank. This new debt is now required to be paid back including borrowing costs; interest is added to the amount owed. The U.S. government, like you and I have to pay interest to the Federal Reserve Bank on their loans. Kind of a paradox emerges here as “we the people” are the debtors of our government’s debt, referred to as the public debt. So, it is you and I who must bear the costs for this money creation either directly or indirectly. Every dollar created under the present monetary system does not represent a real, tangible asset. Of recent, all the “bail-out” funding going to Wall Street if not paid back by the benefiiaries of these funds, still represents an I.O.U., a promissory note from the government and therefore the people, to the Federal Reserve Central Bank.

An instrumental point of understanding in this article is that money is created out of- Debt.

Fractional Reserve Banking- Modern Money Mechanics

Step three: Now the money-magic begins. At this point in time, you can substitute the U.S. Government as the one who requests money with any other entity including yourself, the process is identical from here forward. To better explain how this magic actually works, using a visual example is good way to see how this unfolds. Below we look at a hypothetical million dollar loan that is deposited into a bank. Keep in mind, the following example can be done using any money on deposit in a bank. This is also the primary mechanism utilized to create additional money in circulation called the “Money Supply” as soon you will see. Now watch how more money is created beyond this single deposit example.

  • Bank deposit = $1,000,000 (The bank now has a million dollars in “reserves”)
  • Required amount of deposit to keep on reserve= $100,000 (10% is the normal reserve requirement)
  • Amount available to make more loans= $900,000 ($900K available as the basis of new loans since they are “excessive reserves”)

Let’s now play this process out in a real-world situation to show how money is initially created from a debt and most importantly right out of thin air. Money-Magic!

Someone applies and is approved for a $900,000 loan at the bank where the initial $1,000,000 deposit was made. (Keep in mind that initial $1,000,000 deposit could have been a loan itself) The bank then makes a $900,000 deposit (digital dollars, bookkeeping entry) into the customer’s account at the bank. Shockingly, the first process as shown above repeats.

  • Bank deposit = $900,000 (The bank now has a 900 thousand dollars in “reserves”)
  • Required amount of deposit to keep on reserve= $90,000 (10% is the normal reserve requirement)
  • Amount available to make more loans= $810,000 ($810K available as the basis of new loans since they are “excessive reserves”)


By the time the bank has made the second loan, they have created $1,710,000 in addition to the $1,000,000 initially deposited. And on and on this process can go on, and it in fact does. This deposit money creation / loan cycle can theoretically go on into infinity. The average mathematical result is that about nine times the initial deposit or $9,000.000 (Nine million) can be created out of thin air on top of the $1,000,000! Unlike you and me, when a bank loans money, their assets actually increase. If I loan you money, my available assets decline in direct proportion to what I lend out. Not so with our modern banking system. The new money doesn’t come out of the banks existing assets; the bank is simply inventing it, putting up nothing of its own, except for a theoretical liability on paper. To put fractional reserve banking in perspective, a bank could have outstanding loans totaling $50,000,000 with only $5,000,000 actually on deposit (reserves).

As shown above and contrary to popular belief, banks do not use depositor’s money as the source of funds to make new loans. The money is only created from acquiring new debt. Every dollar in your wallet is a debt owed by somebody to somebody, remember- the only way the money can come into existence is by loans/debts. Take a look at any denomination of US currency and notice that it says: “Federal Reserve Note” then go back and read the  “Promissory note” definition above.

What they (banks) do when they make loans is to accept promissory notes (loans) in exchange for credits (money) to the borrowers’ transaction accounts. Loans (assets) and deposits (liabilities) both rise by the amount of the loan.”

-Federal Reserve Bank of Chicago, publication- “Modern Money Mechanics”

“If there where no debts in our money system, there wouldn’t be any money”.

-Marriner Eccies, Governor Federal Reserve Bank of San Francisco, September 30, 1941.

“The process by which banks create money is so simple that the mind is repelled.”

– Economist John Kenneth Galbraith


A real by-product of creating money in such a fashion is what we refer to as inflation. Inflation (price increases on goods & services) happens when you have more money available in circulation chasing after a limited amount goods or services that cannot be created out of thin air. While is it not the point of this article to discuss inflation or its partner deflation, I would point out that since this banking and money creation process of Fractional Reserve Banking started, inflation has risen dramatically. One dollar in 1913 required $21 in 2007 to match value. That represents a whopping 96% devaluation in 94 years. Virtually each year our purchasing power has decreased by 1%. One must question what or who is ultimately responsible for this and who benefits the most under this current system? 

For a great review done on what you have just read and more, watch this short video-

Exposing for Change, the Mystery of Money

In what has become an ever-increasing hot-topic centered on economic policies and credit-money creation from Capital Hill to conversations across America and the world, gratefully these are rapidly gaining attention and momentum. This will not abate as we have seen infusion of money-out-of-thin-air created through debt obligations placed upon the public which finance continuation of the status quo. A wonderful by-product caused by all the turmoil is forcing a revolutionary redesign of economic models and policy reform to emerge. As we together expose the mystery of money its problems and promise, we can with ingenuity solve our pressing dilemma which all facts point to now being the time ripe for renovation.

“He that will not apply new remedies must expect new evils; for time is the greatest innovator.”
– Francis Bacon

The current system from privately held central banks like The Federal Reserve, to the Fractional Reserve banking model for private banks are all suspect. Having perpetuation of debt every time money is created is economic insanity unless of course you are the beneficiaries of the profits generated. On the issue of Fractional Reserve banking, this practice borders on criminality. What business should be able to generate out of thin air assets they don’t have, lend them out and charge interest on top of that? Banks should only be able to loan on a ratio of 1/1, loaning out only what they actually have verified on deposit. The monetary reformers have many more reasonable and fair solutions to generate equitable prosperity.

Monetary reformers all agree on one central point-

The U.S. government should regain the power of money creation. Eliminate the banking cartel by taking it back from the private banks and the Federal Reserve System through a repeal of the Federal Reserve Act from December 23, 1913. The Federal Reserve is a legalized cartel allowed by law, to provide the money supply through private national banks, operating for the benefit of the few under the guise of protecting and promoting public interests.

In a close scrutiny of their monetary policy and responsibilities, the Federal Reserve Bank’s history reveals they have been derelict in many of their duties and have not succeeded in their publically proclaimed objectives. While they should not be entirely abolished, the Federal Reserve should be rolled into the U.S. Treasury and become a true bank for the benefit and well-being of “we the people”.

Federal Reserve Act

Section 2a. Monetary Policy Objectives

The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.

[12 USC 225a. As added by act of November 16, 1977 (91 Stat. 1387) and amended by acts of October 27, 1978 (92 Stat. 1897); Aug. 23, 1988 (102 Stat. 1375); and Dec. 27, 2000 (114 Stat. 3028).]


Reformers also argue that letting banks create credit and money and then charge high interest rates creates massive levels of debt for states and taxpayers in a never-ending vicious cycle of economic slavery. Another great idea and one already in existence for 90 years with great success are state-owned banks like the Bank of North Dakota. Unlike California and a growing list of other states, with their massive budget deficits, North Dakota for 2009, will have a surplus of about 1.2 billion. The primary cause is due to their low borrowing costs facilitated through their state bank. Reason- they are not paying out billions in interest payments to private banks. Watch the only state in the US with it own bank,  becoming a beacon of hope for other states to emulate very soon. Why? Because it works!

Yes, now is the time America’s banking system must be reformed, and we have begun that process through our desire for fairness, truth and transparency and a future filled with more promise and certainty.

Wisdom Quotes of the Wise

thomas-jefferson “I believe that banking institutions are more dangerous to our liberties than standing armies … If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.”

-Thomas Jefferson, 1743-1826

“If all the bank loans were paid, no one could have a bank deposit, and there would not be a dollar of coin or currency in circulation. 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.”

-Robert H. Hemphill, Credit Manager of the Federal Reserve Bank of Atlanta

“By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens…There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

-John Maynard Keynes

As always- your comments are welcomed and encouraged. If you like what you see and read here at Shift of The Age, be apart of the awareness- share! Be sure to forward, subscribe via RSS feed or email direct to your inbox. Thanks!
6 Comments leave one →
  1. December 2, 2009 5:53 PM

    Dear Author !
    Like attentively would read, but has not understood

    • December 2, 2009 11:35 PM

      Hopefully, the translator was helpful in bridging the language barrier. If not, seek out how money is actually created in the Soviet Union and you may better understand the process which occurs in all developed nations.


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