Politics Magazine

Our Debt-Based Monetary System

Posted on the 31 May 2016 by Adask

The Rules of a Debt-Based Monetary System [courtesy Google Images]

The Rules for a Debt-Based Monetary System
[courtesy Google Images]

What follows is mostly speculation.

I’m going to explore several premises and, using my version of “logic,” build on those premises.

I’m not claiming that my premises are necessarily true. I’m not claiming that my “logic” is necessarily logical.

I am claiming that these premises and my “logic” lead to some hypothetical conclusions about our debt-based monetary system that are at least interesting and perhaps surprising.

Money & Banks

Throughout most of recorded history, whenever there was a monetary system, it was asset-based. The “money” was some sort of tangible asset that had already been produced and/or already existed. These assets weren’t promises; they were facts like like bushels of wheat, buck skins, jugs of corn liquor, beads, iron ingots, heads of cattle, and gold or silver coins.

Mankind’s concept of money (an asset) evolved to the point where “money” was gold or silver and, unlike cattle or other forms of “money,” was sufficiently “concentrated” to be easily stored, hidden, or stolen.

Banks sprang up which would store and protect a depositor’s wealth in the safety of a banker’s strong box or vault. Bankers weren’t necessarily the smartest guys in town, but they were the biggest, meanest thugs that could be found. If anyone wanted to steal your money from the banker’s strong box, they’d have to first fight the banker—not an easy task.


Bank customers would deposit their gold or silver into the banker’s strong box, and the banker would issue a paper certificate (a debt-instrument) which promised to repay the deposited gold (an asset) to the depositor whenever he presented the paper certificate (a debt-instrument) to the banker for redemption.

Depositors quickly learned that, instead of going to the bank to withdraw one ounce of gold to buy a new burro, the depositor could simply trade a paper certificate (debt instrument) denominated as worth one ounce of gold to the burro salesman. Then the burro salesman could redeem the paper debt-instrument by going to the bank to exchange the paper debt-instrument for an asset (one ounce of gold).

Discharging debts with paper debt-instruments was far more convenient than paying with gold.

Note that, in return for the burro, the burro salesman accepted a paper debt-instrument rather than an asset (gold). Also, the burro salesman accepted the inconvenience of having to walk to the banker, present the debt-instrument and receive an actual asset (one ounce of gold) as the actual payment for the burro.

(Principle: You’re not “paid” when you receive a debt-instrument. You’re only paid when you trade a debt-instrument for some tangible good, service or other asset.)

But if, on his way to the banker to exchange his paper debt-instrument for an asset (gold), the burro salesman sees a stack of mud bricks for sale for one ounce of gold, he could purchase those bricks with the same debt-instrument he’d received from the guy who bought the burro. Then, the brick salesman could spend the debt instrument with the local goat-herder to purchase four goats. Pretty soon, the whole community could be trading their labor and property (assets) for paper debt-instruments. Only rarely would anyone actually bring a paper-certificate/debt-instrument issued by the banker to the banker for redemption.

Counterfeit paper debt-instruments

Bankers began to realize that they could issue paper debt-instruments that were “counterfeit” because they weren’t issued in trade for an actual deposit of gold into the banker’s strongbox. There was no gold to “back” these counterfeit debt-instruments.

Bankers could still spend these counterfeit notes knowing that they’d almost never be redeemed by people coming to the bank to demand an asset (gold) in return for the counterfeit paper debt-instrument issued by the banker. Soon, by using counterfeit paper debt-instruments, the banker began to buy up all of burros, all of the mud bricks and just about everything else—until he literally owned the whole community, purchased with nothing but paper debt-instruments with no intrinsic value (they weren’t backed by gold or silver assets).

Rise of the Debt-Based Monetary System

Then, seeing that the people so seldom redeemed their paper debt-instruments for assets (gold or silver), government and/or bankers (is there really a difference?) reduced and eventually eliminated the requirement that their “currency” (counterfeit debt-instruments) be backed by an assets (gold/silver). In doing so, they established a monetary system based solely on debt—mere, intangible “promises to pay”—issued by the bankers and/or government.

In these debt-based monetary systems, debt (a mere promise to someday pay with an asset) is treated as wealth—a payment and asset.

In theory, under this debt-is-wealth system, if I merely promised to pay you $1 million, you’d be suddenly wealthy. Based on my mere promise to pay, you could become an “instant” millionaire. Of course, in practice, you wouldn’t accept my promise to pay $1 million, but you would usually accept the government’s promise to pay $1 million.

Governments like debt-based monetary systems because they never have to actually pay (exchange some tangible product/asset like food or gold) for their debt-instruments—they need only promise to pay their debts.

Because promises (debts) can be easily created with the stroke of a pen, the debt-based monetary system allows government to “spin” currency (counterfeit debt-instruments) “out of thin air”. In a debt-based monetary system, to “make money,” you don’t need to make tangible “things” (which require real effort, investment and hard work to produce)—you need only make intangible promises to pay. I love you, the check is in the mail, etc.. Promises—which usually turn out to be lies—are sufficient collateral for a debt-based monetary system.

When debt is deemed to be wealth, government creates more “wealth” by issuing more bonds (promises to pay) and going deeper into debt.

Fractional Reserve Banking

Fractional reserve banking is a sensible and necessary banking policy which allows banks to lend out some maximum percentage of its customers’ total deposits while keeping some minimum “fraction” of the customers’ deposits in the bank vault.

For example, suppose customers had deposited $1 million into a bank and, by law, the maximum percentage the bank could lend out was 90% of those deposits ($900,000) and had to keep at least 10% ($100,000) in the vault just in case any of the depositors wanted to withdraw some of their funds or close their accounts. In essence, banks could lend $9 out of every $10 deposited into the bank. But, viewed from another perspective, banks could lend $9 for every $1 they held in their vaults.

The difference between these two perspectives (lending 90% of whatever was deposited and lending $9 dollars for every dollar held in the bank vault) may not seem insignificant significant. However, I suspect that this “other perspective” (that banks could lend $9 dollars for every dollar held in the vault) may be the key to understanding modern banking practices. I’ll soon show you why.

Bank Runs

Banks knew from long experience that, statistically, depositors would (almost) never seek to withdraw more than 10% of total deposits on the same day. Thus, banks could safely loan 90% of deposits and collect enough interest on that those loans to allow the bank to profit and stay solvent.

In the unlikely event of an emergency that drove all of the depositors to want to suddenly withdraw all of their bank deposits, that would be a “panic” or “run on the bank”. As explained by George Bailey in It’s a Wonderful Life, the bank couldn’t pay all of the deposits to all of its depositors because 90% of their deposits were loaned out.

If forced by depositors’ demands to admit it was unable to redeem their deposits with assets, a bank might be forced to declare insolvency and be closed or sold off to the highest bidder.

Bank runs were dangerous but unlikely.

The Mother of Invention

Fractional reserve banking was necessary since, if banks couldn’t or wouldn’t lend out any of its deposits, banks couldn’t entice customers to deposit their assets into the bank to earn interest nor could banks prosper by charging interest on loans to borrowers. Worse, without those deposited assets circulating as loans into the local economy, that economy would tend to wither.

Without fractional reserve banking (lending 90% of deposits and keeping a 10% “fraction” in the bank vault), banks would instead have to generate profits by charging fees (negative interest rates) on deposits. I.e., if customers deposited $1 million into the bank, the bank would hold 100% of those deposits in the bank vault, but would be forced to deduct, say, 2% ($20,000) as an annual “deposit fee” on those deposits.

As I said, fractional reserve banking is reasonable and necessary—provided that it’s applied only to the deposits made by the banks’ depositors.

Legalizing Debt as an Asset

Government/bankers passed laws that allowed fractional reserve banks to purchase government bonds (debt-instruments; mere promises to pay) and use those bonds as collateral (“assets”) in their bank vaults. That’s when the “fun” began.

Let’s suppose that a bank had collected $1 million in deposits from depositors. The bank could lend 90% ($900,000) of that $1 million to borrowers. If the bank charged 10% interest on those loans, it could profit by 10% of the $900,000 loaned = $90,000 per year based on the $1 million deposited by private customers.

But again, note that, from a different perspective, it might be said that, under fractional reserve banking, banks can lend $9 for every $1 held as collateral in the bank vault. From that perspective, by adding more collateral to its vault, a bank could make more loans and charge more interest, and generate higher profits.

For example, if banks purchased U.S. bonds and held them in their vaults as collateral, banks might be able lend up to 9 times the face value of the government bonds (debt-instruments). Do you see the distinction?

I.e., if ordinary depositors deposited $1 million into the bank, the bank could lend 90% of those deposits ($900,000) at say, 10% interest, and earn $90,000 in income.

However, I suspect that if the bank itself purchased and deposited a $1 million U.S. bond into its vault, it could lend out 9 times the face value of that bond. That would be $9 million in loans at 10% interest—which would equal $900,000 in bank income based on an original investment of a mere $1 million to buy the bond.

This policy wouldn’t mean that banks could lend out 90% of the the total $1 million in deposited U.S. bonds. It would mean that banks could lend up to 9 times of the face value of the U.S. bonds.

If this suspicion were correct and you were a banker, what would you rather do? Lend $900,000 of bank depositors’ deposits to earn $90,000? Or lend $9 million based on your purchase of a $1 million U.S. bond and earn $900,000?

Irresistible Incentive

This hypothetical 9X multiplier would provide an irresistible incentive for banks to purchase U.S. Bonds.

For example, suppose a bank spent $1 million purchasing a $1 million U.S. bond. Suppose that the bank could use that $1 million bond as collateral to lend another previously non-existent $9 million in the form of consumer loans to the public. Suppose the bank could charge 10% interest on those $9 million in consumer loans. That would allow the banks to potentially collect $900,000 in annual interest on an initial investment of $1 million used to purchase the government’s bond. That’s a potential 90% annual rate of Return On Investment (“ROI”) on the bank’s purchase of government bonds!

If banks charged only 5% interest on its $9 million in consumer loans (derived from the $1 million U.S. bond), that would still result in a 45% annual ROI on the original $1 million expenditure!

Where can you hope to get a legal 45% annual return on your investments?

That hypothetically-huge ROI under fractional reserve banking would provide an irresistible lure for banks to purchase government’s intangible, intrinsically-worthless, promises to pay (a/k/a U.S. bonds). That potential ROI would also guarantee that the U.S. government would (almost) always have creditors willing to purchase its “counterfeit” bonds that weren’t backed by gold or silver assets.

The Real Source of Monetary Stimulation

Thanks to the 9X multiplier that hypothetically attaches to U.S. bonds, private banks—not the government, per se, or even the Federal Reserve—would be the primary source of new currency and economic “stimulation”.

The government and/or Federal Reserve would provide the “seed capital” by printing and selling a $1 million bond, but it would the private banks that “stimulated” the economy by issuing easy-credit to the public worth up to 9 times the face value of the $1 million bond held as legal collateral in the banks’ vaults.

The local banks would be the greatest source of currency “spun out of thin air”.

Confidence Lost

However, if private banks wouldn’t lend to “consumers” because the economy was in shambles and the banks had lost confidence in the public’s capacity to repay their debts, the debt-based monetary system could break down. Without more lending (debt-creation), the debt-based monetary system would fail.

Similarly, if consumers wouldn’t borrow from the private banks because the economy was in shambles and consumers had lost confidence in their own ability to repay additional debt, the debt-based monetary system would break down. Without more borrowing (debt-creation), the debt-based monetary system would fail.

Consumers might also refuse to borrow if they lost confidence in government’s ability to create more inflation that allows consumers to repay their debts with “cheaper” dollars. I.e., low inflation rates—or worse, deflation—inhibits borrowing (debt-creation) and causes the debt-based monetary system to fail.

Most importantly, a debt-based monetary system will collapse if private banks lose confidence in the U.S. government’s ability to repay its debts (U.S. bonds) and therefore stop buying government bonds.

For example, suppose the National Debt grew so large that everyone knew that government could never redeem its existing debt instruments (U.S. bonds). Potential creditors would refuse to purchase more government bonds. If private banks refused to purchase more government bonds, they wouldn’t have more collateral to warrant lending 9 times the face value of new bonds to the public. Without the “stimulation” of 9X lending, the economy could fail.

Helicopter Currency

I suspect that circa A.D. 2000-2007, banks issued “liars loans” because competent consumers were no longer borrowing enough to sustain the debt-based Ponzi scheme. The “liar’s loans” were intended to induce incompetent borrowers (those clearly incapable of repaying their debts) to borrow and create debt-instruments (mortgages).

Why? Because the mortgages could be bundled into mortgage-backed “securities” that could be sold to banks around the world to be used as collateral to lend up to 9 times their face value as consumer loans.

Once the Great Recession began in A.D. 2007-2008, private banks (burned by liars’ loans?) refused to lend more to consumers and/or consumers (burned by home foreclosures?) refused to borrow more.

Then, maybe . . . maybe . . . government countered by essentially giving trillions of free, “helicopter” dollars to major, “too-big-to-fail” banks.

Why? Because government expected those banks to lend those “free” trillions to consumers and thereby stimulate the economy.

Unfortunately, the bankers just sat on their windfalls and either refused to lend free currency to consumers and/or consumers refused to borrow the “easy credit” from the bankers.

Result? Without public confidence in the government’s and/or public’ ability to repay their debts, public confidence in the debt-based monetary system waned. Without that essential confidence (as in “con-game”), government’s ability to borrow new funds (go deeper into debt) and spend more currency into the economy was inhibited, leaving the economy stagnant and the “recovery” illusory.

No Balanced Budget Laws

If this line of conjecture is roughly correct, it explains why both major political parties refuse to pass balanced budget laws.

I.e., if the budget had to be “balanced,” government could spend only as much as it received in tax revenues. Thus, under a balanced budget amendment, government couldn’t borrow more funds and thereby create more debt instruments that are deemed to be “assets” and are the lifeblood of the debt-based monetary system. With an exact balance between tax revenue and spending, government couldn’t create more bonds for bankers to use as collateral in the 9X fractional reserve banking scheme that seems to “stimulate” the economy.

Result? The whole, debt-based monetary system would collapse.

Presuming that both major political parties know that a balanced budget amendment would kill the debt-based economy, it follows that neither party will truly support such amendment.

Big, Bigger Government

Similarly, this conjecture could explain why everyone in the Congress, Senate and White House believes in ever-bigger government programs. Democrats want bigger programs for the poor. Republicans want bigger programs for the military. Government grows like topsy.

Why? Because bigger programs mean bigger debts. A constantly-growing government generates the increased debt that appears to be vital to sustain the debt-based economy.

Yes, Republicans still promise to be “fiscal conservatives,” but they can’t keep that promise. In a debt-based monetary system, any attempt to significantly reduce government borrowing could collapse the economy. So long as we have a debt-based monetary system, fiscal conservatism is the economic equivalent of a cup of hemlock. Drink it and die.

Implication? Big government is the not merely the driving force behind a debt-based monetary system, big government is a principle consequence of a debt-based monetary system.

The moment we Americans gave up our gold- and silver-backed money, we guaranteed that our government would grow like a cancer until it consumed us all, destroyed our productivity, and collapsed our economy and perhaps, our nation.

The Way of All Ponzi-Schemes

If our debt-based monetary system is truly based on the banks capacity to lend $9 for every $1 in U.S. bonds that they holds in their vaults, and the whole system depends on ever-increasing debt—then our monetary system is a Ponzi scheme no different from the one that got Bernie Madoff to spend the rest of his life in the slammer.

If our loss of prosperity and liberty is the consequence of big government, and big government is a consequence of a debt-based monetary system—then it follows that America cannot see a real recovery of our former economic prosperity or of our former liberties lost to big government—until we abandon our debt-based Ponzi scheme and return to an asset-based (gold and silver) monetary system.

As long as we have a debt-based monetary system, government is no more able to fully repay the National Debt or voluntarily stop going deeper into debt than Bernie Madoff was able to repay his debts or stop selling more “promises to pay” to new customers.

In a debt-based monetary system, debt (mere promises to pay) is government’s most important—and only—product. Those promises can’t be kept.

Those who buy or rely on government debt (promises to pay) are investing their hopes and wealth in debt-instruments that, for the most part, won’t ever be repaid and are not only intrinsically worthless but also dangerous to the point of self-destruction.

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