Money and Banking

By: Socred - B.A., SCMP

If the public is unfamiliar with the techniques of money and banking, then they will never understand how the current monetary system governs them. Further,if a monetary system governs individuals, then we have a system controlling men, and since men are above all systems, it is essential that we, as individuals, control the monetary system. In order to control a system, we must understand its techniques. Before trying to understand the techniques of money creation, we must first ask ourselves what is money, and what is its purpose?

"It is absolutely vital to realize that the essential part of money is the belief that through its agency you can satisfy your demands. (C.H. Douglas, "The Control and Distribution of Production")

Money is essentially effective demand. We place our money down in the faith that another will depart with a good or service in exchange for it. It allows us to carry on trade without barter. Money makes it possible for men to associate together in a manner which is beneficial to everyone. Therefore; money is essential to our economy. But, our demands can only be satisfied if money delivers goods and services. Therefore; the basis for the quantity of money, or the limit to our demand, is the ability of the productive system to deliver goods and services when and where they are needed. What does this mean? For one, it means that the basis upon which the quantity of money is determined has nothing to do with any of the physical properties of money itself.

"The best definition of money with which I am acquainted is that of Professor Walker, which is that "money is any medium which has reached such a degree of acceptablility that, no matter what it is made of, and no matter why people want it, no one will refuse it in exchange for his product." You will see that this definition rules out any physical properties in respect of money. The properties that are left, therefore, are not physical. They can be summed up in the word "credit," which is, of course, derived from "credere," to believe. The essential quality of money, therefore, is that a man shall believe that he can get what he wants by the aid of it. This is absolutely the only quality that it is required to possess, although, of course, certain minor attributes, such as convenience, have a bearing on the decision as to what particular description of money, if it fulfils the major requirements, is likely to come into the most general use. The cheque, no doubt, owes its popularity to this latter attribute." (C.H. Douglas, "Warning Democracy")

Money's value does not derive from its composition, but by the capacity of the economy to produce goods and services. This automatically rules out gold as an appropriate determination for the quantity of money. There is no real resemblance between the quantity of gold in existence, and the economy's ability to produce. Reality must reign supreme lest an abstraction have precedence over it, and money is an abstraction. Money should be a measure of wealth, and should never control our creation of it. Whatever is physically possible is financially possible.

"Money is nothing whatever but a ticket system which has nothing whatever to do with all these abstract descriptions of it such as a medium of exchange, or a storehouse of values or any of these other things. It is a ticket system and nothing else." (C.H. Douglas, Testimony before the Alberta Agricultural Commission)

Douglas compared money to a ticketing system, because it is a means of distributing production. The only real limit to the amount of railway tickets issued is the number of seats on the train. The number of railway tickets should never be a limit on the number of people who board the train, for the latter is an inversion of reality. In other words, money should never be a limiting factor on production: production should be a limiting factor on money.

"There is also a nebulous idea involved, I think, to the effect that the man who grows, e.g. a ton of potatoes, also grows the purchasing-power of a ton of potatoes. The facts are far otherwise, as no doubt large numbers of potato-growers could testify. Given a fixed amount of legal tender, and assuming legal tender to be the only purchasing-power, no amount of production would increase it. Probably a minimum of nine-tenths of the immediately available purchasing-power in the world arises out of bank loans or their equivalent in bills discounted. These loans and the purchasing-power which they create have no automatic relation to either production or consumption. " (C.H. Douglas, "Social Credit")

Many people have a vague conception that the production system somehow manufactures money, and in so doing, create enough money to liquidate all costs of production. This idea is perpetuated by the belief that firms "make money" when they earn a profit. Of course, if companies literally "made money", they would be engaged in counterfeiting. The truth is money is not created by production, but is created by the banking system. Central banks are responsible for creating cash, and commercial banks create the majority of the assets used as money. The amount of cash in existence is determined by people's desire to hold cash. As Douglas states above, probably 90% of the money supply is created by commercial banks in the forms of loans to businesses and individuals. This money is called bank credit. Below are some quotes about banks and their ability to create money:

"In the normal course of their operations, banks create money" (Blomqvist, Wonnacott, and Wonnacott, "Economics First Canadian Edition"pge. 201)

"The actual process of money creation takes place primarily in banks." (Federal Reserve, "Modern Money Mechanics")

"Commercial banks and other financial institutions provide the greater part of assets used as money through loans made to individuals and businesses. In that sense, financial institutions are creating money. " (Bank of Canada, "Bank in Brief")

"The process by which banks create money is so simple that the mind is repelled." (John Kenneth Galbraith)

This idea may be novel to some, so it is important to understand exactly how banks create deposits. The process is known as deposit expansion. Many mistakenly believe that banks loan deposits. They believe that when they deposit their money in a bank, the bank somehow loans all, or part, of their deposit to another. This would only be true if a bank debited the depositor's account when they made a loan. Sceptics should ask themselves if they have ever had their bank account debited by any bank because the bank loaned their deposit to someone else. In reality, banks do not loan deposits but create them. Or, as Mr. McKenna, Chairman of the Midland bank, said, "every bank loan and every purchase of securities by a bank creates a deposit, and the withdrawal of every bank loan, and the sale of securities by a bank, destroys a deposit (AGM Midland Bank, January 25, 1924.) The process is explained by the Federal Reserve below assuming that the Fed's open market operations create $10,000 in cash reserves:


"How the Multiple Expansion Process Works
If the process ended here, there would be no "multiple" expansion, i.e., deposits and bank reserves would have changed by the same amount. However, banks are required to maintain reserves equal to only a fraction of their deposits. Reserves in excess of this amount may be used to increase earning assets - loans and investments. Unused or excess reserves earn no interest. Under current regulations, the reserve requirement against most transaction accounts is 10 percent.(5) Assuming, for simplicity, a uniform 10 percent reserve requirement against all transaction deposits, and further assuming that all banks attempt to remain fully invested, we can now trace the process of expansion in deposits which can take place on the basis of the additional reserves provided by the Federal Reserve System's purchase of U. S. government securities.

The expansion process may or may not begin with Bank A, depending on what the dealer does with the money received from the sale of securities. If the dealer immediately writes checks for $10,000 and all of them are deposited in other banks, Bank A loses both deposits and reserves and shows no net change as a result of the System's open market purchase. However, other banks have received them. Most likely, a part of the initial deposit will remain with Bank A, and a part will be shifted to other banks as the dealer's checks clear.

It does not really matter where this money is at any given time. The important fact is that these deposits do not disappear. They are in some deposit accounts at all times. All banks together have $10,000 of deposits and reserves that they did not have before. However, they are not required to keep $10,000 of reserves against the $10,000 of deposits. All they need to retain, under a 10 percent reserve requirement, is $1000. The remaining $9,000 is "excess reserves." This amount can be loaned or invested. See illustration 2.

If business is active, the banks with excess reserves probably will have opportunities to loan the $9,000. Of course, they do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers' transaction accounts. Loans (assets) and deposits (liabilities) both rise by $9,000. Reserves are unchanged by the loan transactions. But the deposit credits constitute new additions to the total deposits of the banking system. See illustration 3.


Expansion - Stage 1
3.Expansion takes place only if the banks that hold these excess reserves (Stage 1 banks) increase their loans or investments. Loans are made by crediting the borrower's account, i.e., by creating additional deposit money. back
STAGE 1 BANKS


Assets Liabilities
Loans....... +9,000 Borrower deposits.... +9,000

This is the beginning of the deposit expansion process. In the first stage of the process, total loans and deposits of the banks rise by an amount equal to the excess reserves existing before any loans were made (90 percent of the initial deposit increase). At the end of Stage 1, deposits have risen a total of $19,000 (the initial $10,000 provided by the Federal Reserve's action plus the $9,000 in deposits created by Stage 1 banks). See illustration 4. However, only $900 (10 percent of $9000) of excess reserves have been absorbed by the additional deposit growth at Stage 1 banks. See illustration 5.

The lending banks, however, do not expect to retain the deposits they create through their loan operations. Borrowers write checks that probably will be deposited in other banks. As these checks move through the collection process, the Federal Reserve Banks debit the reserve accounts of the paying banks (Stage 1 banks) and credit those of the receiving banks. See illustration 6.

Whether Stage 1 banks actually do lose the deposits to other banks or whether any or all of the borrowers' checks are redeposited in these same banks makes no difference in the expansion process. If the lending banks expect to lose these deposits - and an equal amount of reserves - as the borrowers' checks are paid, they will not lend more than their excess reserves. Like the original $10,000 deposit, the loan-credited deposits may be transferred to other banks, but they remain somewhere in the banking system. Whichever banks receive them also acquire equal amounts of reserves, of which all but 10 percent will be "excess."

Assuming that the banks holding the $9,000 of deposits created in Stage 1 in turn make loans equal to their excess reserves, then loans and deposits will rise by a further $8,100 in the second stage of expansion. This process can continue until deposits have risen to the point where all the reserves provided by the initial purchase of government securities by the Federal Reserve System are just sufficient to satisfy reserve requirements against the newly created deposits.(See pages10 and 11.)

The individual bank, of course, is not concerned as to the stages of expansion in which it may be participating. Inflows and outflows of deposits occur continuously. Any deposit received is new money, regardless of its ultimate source. But if bank policy is to make loans and investments equal to whatever reserves are in excess of legal requirements, the expansion process will be carried on." (Modern Money Mechanics, U.S. Federal Reserve)

Any individual bank is not concerned with what stage in the process of deposit expansion they exist when making loans, because the inflows and outflows of deposits occur continuously. The important point to note is that bank loans create deposits/money. The loan is an asset to the bank because the borrower owes the bank the amount of the loan, plus interest. The deposit is a liability to the bank because the bank must now be able to supply cash for the deposit upon demand. Commercial banks cannot create cash, but have to borrow it from the Central Bank, so there is a limit to how much money, or how many deposits, a commercial bank can create, and that limit is based upon the ratio of reserves to deposits. As to the banking system as a whole, including Central Banks, there is absolutely no limit to the amount of money, or credit, that can be created. Cash is an asset to the bank, and along with its securities, forms the banks reserves. In most nations, the government mandates, through law, the amount of reserves a bank must keep in ratio to its deposits. In Canada, changes to the Bank Act in 1992 did away with any legal obligation of Chartered Banks to hold reserves in ratio to their deposits. However; all banks keep a certain amount of reserves in ratio to their deposits for liquidity purposes. When banks are unable to meet their clients' demand for cash, this is known as a "bank run". Because of the possibility of bank runs, the Canadian Deposit Insurance Corporation, and the Federal Deposit Insurance Corporation in the United States, insure deposits up to a certain limit. In order to understand how banks obtained the power to create money, we must understand the history of fractional reserve banking.

"It started with goldsmiths. As early bankers, they initially provided safekeeping services, making a profit from vault storage fees for gold and coins deposited with them. People would redeem their "deposit receipts" whenever they needed gold or coins to purchase something, and physically take the gold or coins to the seller who, in turn, would deposit them for safekeeping, often with the same banker. Everyone soon found that it was a lot easier simply to use the deposit receipts directly as a means of payment. These receipts, which became known as notes, were acceptable as money since whoever held them could go to the banker and exchange them for metallic money.

Then, bankers discovered that they could make loans merely by giving their promises to pay, or bank notes, to borrowers. In this way, banks began to create money. More notes could be issued than the gold and coin on hand because only a portion of the notes outstanding would be presented for payment at any one time. Enough metallic money had to be kept on hand, of course, to redeem whatever volume of notes was presented for payment.

Transaction deposits are the modern counterpart of bank notes. It was a small step from printing notes to making book entries crediting deposits of borrowers, which the borrowers in turn could "spend" by writing checks, thereby "printing" their own money." (Modern Money Mechanics, U.S. Federal Reserve)

The goldsmiths realized they could issue more notes than the amount of gold coin they had on deposit, because only a portion of the notes they had outstanding would be redeemed for gold coins at any point in time. This is also true with cash today. The banks realize that only a portion of the money that people have on deposit with the bank will be redeemed for cash at any point in time, so they create more deposits than they have cash. This works so long as everyone does not demand cash for their deposit.

We see from above that the productive system, and the banking system, are two distinct factors in the economy. The productive system is responsible for producing goods and services, and the banking system is responsible for creating the money necessary to act as effective demand to mobilize those goods and services. The banking system is the distributive system, and far from money originating from the productive system, like the scent from a rose; money originates from a completely separate system; as such, there is often no correspondence between these two systems. Therefore, " it is necessary to transform the basis of the credit-system entirely away from currency on which it now rests, to useful productive capacity." (C.H. Douglas, "The Control and Distribution of Production")

Money's role is to distribute the goods and services that people demand. It's an order system. Since there is no limit to the ability of banks to create money, the only limitation that should be imposed on the amount of money in existence should be the ability of the economy to deliver goods and services when and where they are required - i.e. the real credit of the community. Our ability to produce is based on the physical assets of our nation. Money's role is the monetization of those assets in order that they can be mobilized for production. Douglas created a hypothetical balance sheet for Great Britain in the "Monopoly of Credit", which is reproduced below:

Great Britain Limited

Assets:

(Population. Education Morale) i.e. Human potential

Policy

Organization

Natural Resources

Developed Power

Plant (Railways, Buildings, Tools, etc.)

Public Services

Goodwill (Tradition, reputation etc.)

Work in Progress

Consumable Goods

Liabilities:

National Debt

Bankers (Potential creators of effective demand)

Insurance Companies (Mortgage and Bondholders)

Cash at Call

Taxation for Public Services

Notice that cash is a liability, so the amount of credit created by the current banking system is based on a liability, not on the assets of the nation. However; the amount of credit created should be based on the real credit of the community, which is reflected in the nation's assets.

"We know quite well that the core of this problem is in the disparity between the real wealth available and the monetization of that wealth; that it is within the power of monetization of real wealth that this power of credit lies." (C.H. Douglas, Testimony before the Alberta Agricultural Commission)

The power of credit creation, or the monetization or wealth, has been appropriated by a monopoly of credit - the banking system - which is a body of unelected people responsible solely to their shareholders, and who have been centralizing their power since the creation of the Bank of England in 1694. This centralization process continued with the creation of Central banks around the world including the Federal Reserve Bank in 1913, the Bank of Canada in 1934, and culminating with supranational banks like the IMF and World Bank, which were created in 1944. Not only is the basis of our current money system fundamentally flawed because it is not based on the real credit of the community, but the system itself has become a form of government which has been centralizing its power to the point of being above any national power. Therefore; the real government is not the one that is elected by ballot box every few years, but is a centralized body of unelected officials which dictate monetary policy from organizations which are beyond any national law.