Remember the joke about the old fish who asks, “How’s the water?” To which the young fish responds, “What the heck is water?” 

When it comes to money, we are the young fish. Our financial system is so pervasive that we accept it without question as natural and immutable.  But it is actually a deliberate construct that can be changed, if we understand it and have the will to change it.

With each passing year, more of the world’s wealth is being transferred to an elite few. That is no accident, as the current system was designed by those same beneficiaries to favor themselves.

Those privileged few did so only around 300 years ago, and although money has been with us for millennia, the system they designed is now so omnipresent that it can be difficult to get out of the water and see it for what it is:  a system designed to serve a small, wealthy elite.

We do not realize how nearly everything we touch is influenced and dominated by that system, including how politicians view money and how that influences how they allocate it. Most people take it for granted that the system is the way it is and that there is essentially nothing that can be done about it. Fortunately, they are wrong! We can indeed do something about it. We can educate ourselves as to how the system was designed, and we can choose to supplement it, or even someday replace it, with one that serves the many and not just the few.

The secret to the existing system has to do with the creation of money that we use in everyday life. Bank owners convinced the majority of the world’s governments to let them “create” our money. In essence, they got the government to privatize the creation of money.

“Let me issue and control a nation’s money and I care not who writes the laws.” — Mayer Amschel Rothschild (1744-1812), founder of the House of Rothschild.

It was this simple “sleight of hand” that put in motion the factors dominating our society today and established the foundations that inevitably lead to scarcity in the midst of abundance, and a mindset that assumes scarcity and the need for austerity are just the way things are and cannot be changed.

“It is well that the people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.” — Henry Ford

Not only can something be done, but it can be done relatively easily and quickly. Scarcity and poverty can become a thing of the past. And the secret will be out. That is, if the rich can create money – so can everybody else.

“The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.” — Thomas Jefferson

So, let’s see how they do it and then how we can too.

Money Creation in Modern Times

Ask anyone where money comes from and most will say “the Mint” or “the U.S. Treasury” or even more generally, “the government.” But if that were true, why does the government tax us and borrow money? If the government created the money, then it would have to do neither.

Most national governments actually do create some money – about 3% of all the money in circulation. The other 97% comes from private commercial banks!

How? All commercial banks, large and small, create money every time they issue a loan. That is, the money a bank hands over to us when they provide us with a loan is actually created by the bank in the process of making the loan. Banks do not lend us money that they already have (i.e., money on deposit), as is the common assumption, but rather create new money with each loan. And also contrary to popular belief, banks have no real limit to the amount of money that they can create, given that they are not lending someone else’s money, but creating it out of thin air.

This reality, known to a limited few over the years, has only been made public in recent times. The fact that commercial banks actually create money was confirmed by the Bank of England in this video,  which states that the main way in which money is created “runs contrary to the view sometimes put forward that banks can only lend out depositions that they already have. In fact, loans create deposits, not the other way around.”

They describe that process in greater detail in this bulletin and in this 2015 Working Paper. And while these items focus on the Bank of England and U.K. banks, the principles apply worldwide.

“It proved extraordinarily difficult for economists to recognise that bank loans and bank investments do create deposits.” — Joseph Schumpeter, Economist, 1954

Part of the problem for society is that money created by banks fiat currency  starts off as debt, and debt and money are often conflated.

“Given the near identity of deposits and bank lending, Money and Credit are often used almost inseparably, even interchangeably…” — Bank of England, 2008

In his article, The truth is out: money is just an IOU, and the banks are rolling in it, David Graeber, a professor at the London School of Economics, states that, “The Bank of England’s dose of honesty throws the theoretical basis for austerity out the window.”  We would agree.

The book Where Does Money Come From? published by The New Economics Foundation, further explores the ramifications of this Bank of England disclosure. They pose the question, “Of all the possible alternative ways in which we could create new money and allocate purchasing power, is this really the best?” We would argue no and offer another way.

Money has frequently been created by means other than debt. The fact that the bulk of the modern money supply is created that way doesn’t mean we have to accept that as the only means to get money into circulation. And therein lies a clue to bringing about change.

How Do Banks Actually Create Money?

To understand how banks create money, we need to look at something very familiar to every business person – the balance sheet.

When a borrower signs loan documents, he or she actually gives the bank a new asset that the bank adds to its balance sheet. That asset is based on the borrower’s commitment to pay back the loan and their individual creditworthiness. That means it is the borrower who is giving the bank the assets it needs to create the loan and not the bank putting up its own assets to make the loan.

Is that signed loan document actually worth something? You bet. Most people have heard of banks selling a mortgage, car loan, etc. That proves that loan documents have real value to the bank, value based on the borrower’s creditworthiness, not the bank’s assets. Yet the bank can sell that loan document, capitalizing itself with its borrower’s own creditworthiness.

So, back to the process. Once the bank adds that loan document onto the asset side of their balance sheet, it then creates the balancing entry on the liability side by creating a deposit on behalf of the borrower in the amount of the principal of the loan. Thus, the bank creates money as a new deposit, out of thin air with just a few strokes of a keyboard. In essence the bank is giving us back the asset we just gave them, only in a different form – cash.

This is just simply double entry accounting, but in the process, the bank legally creates money.

“The process by which banks create money is so simple that the mind is repelled.” — John Kenneth Galbraith, economist

The Consequences of Bank-Created Money

If we are to entertain any kind of alternative complementary or replacement monetary system, we need to first understand the impact of the current system and then ask the question that the folks at the New Economics Foundation did – is this really the best? The fact that banks are the primary source of money in our society does have far reaching consequences. Let’s explore those first.

First and foremost, the goal of money creation on the part of the commercial banks is to make a profit. That means that all the actions taken by those banks will be viewed through the lens of profit making and whether any action they might take enhances or detracts from that.

This profit motive is tied to the fact that modern banking is largely a product of capitalism. And the accepted norm in capitalism is that the owners (shareholders) are the stakeholders who are prioritized above all others, whether employees, suppliers, consumers or the community at large.

Thus, we see that the needs of the owners would be placed before all others, favoring a small few over the many. If humanity were to design a system today, it certainly would not choose the needs of a small minority over all others. Yet that is at the heart of the current monetary system.

What are the ramifications of the current system?

  • Profit in any business is traditionally tied to risk. The greater the risk, the less probable the profit. In the case of lending risk on the part of banks, risk rises when the economy is down and diminishes when the economy is strong. Therefore, banks are less inclined to lend when the economy is down and more inclined when things are good. Yet more money should be injected into the society when the economy is down, because that is when society needs it the most. Thus, banks lend counter-cyclically to the needs of society.
  • Banks are more inclined to lend money to those who already have it. The very people who need it the most, get the least, resulting in scarcity and increasing the spread between the haves and have nots.
  • When it comes to lending, banks, like casinos, have a condition where the odds favor the house. That works in a number of ways:
  • When a loan is made, the borrower usually pledges some form of collateral. Should the borrower default, the bank can seize that collateral. And yet the bank, as explained above, did not put up any of its own assets to make the loan, but in the event of a default, it receives an asset in the form of the collateral, for which it paid nothing. Heads I win, tails you lose.
  • Even if the borrower does not default, the bank still wins. Banks collect interest on loans that cost the bank virtually nothing to create. How many manufacturers would love to have a product that costs them nothing to produce and yet have the purchaser pay them interest on that no-cost product? Effectively the bank is being paid by the borrower for the privilege of letting the bank monetize the borrower’s own creditworthiness.
  • Banks don’t create the interest to pay for the loan, only the principal. That means that the borrower has to get the interest from the money in general circulation. And that money originated as a loan to someone else. Thus, the bank winds up being paid back not only the principal it created out of thin air, but also interest that is pulled from society in a musical chairs fashion where someone, somewhere loses out and more of society’s wealth is transferred to the banks and thus to their wealthy owners.
  • In all of these cases, mathematically the banks take assets off the table that belong to someone else, and the commonwealth of a nation is inexorably transferred from everyone else to the banks and their owners. At the meta level, this is one of the chief drivers behind the ever-increasing spread between the financial elite and the rest of humanity.
  • Finally, because governments don’t create money (they can and have done so in the past, and many argue they should again) they have to tax and borrow to get the funds they need to carry out the functions of government. The borrowed funds have to be paid back plus interest and thus the government, like all other borrowers, transfers some of the wealth of society to the banks owners. The government pays for borrowed funds via tax revenue, and therefore taxation is the key driver to funding government. And therein lies a fundamental problem. Almost nobody wants to be taxed and the wealthy (those most capable of paying taxes) succeed in getting laws passed that reduce their tax bill in their favor and against almost everyone else, thereby starving government of its needed resources. Politicians are loath to raise taxes and struggle to make ends meet with what they have. This results in an ever-growing call for austerity, especially to programs that benefit the poor, thereby further hurting those already at the bottom of the financial heap. The common assumption is that there is not enough money to go around and somebody has to come up short. Under the current monetary system that is a reasonable conclusion. But it does not have to be that way.

The current monetary system, where money is injected into society nearly exclusively by loans from the banks, produces a number of systemic problems that hurt the majority of society and benefit the few. Should society wish to create a new monetary system today, it is likely that the only group that would favor the current system would once again be the financial elite.

Rising Income & Wealth Inequality

According to the 2020 Rand Corporation study Trends in Income From 1975 to 2018, the last four decades have seen an acceleration in the spread between the haves and have nots in the United States.  For the first three decades following World War II, the growth in income between the top 10% and the bottom 90% grew at approximately the same rate. Beginning in the 70s they began to diverge at an increasing rate, where the vast majority of the growth went to the top 10%.

That study estimates that had the bottom 90% continue to grow at the same rate that they did in the three decades following World War II, their cumulative taxable income would have been $47 trillion more than what they actually received and that would have resulted in an additional $2.5 trillion in net income in 2018 alone, a rate 67% higher than it was.

To put that in perspective, a low-income worker earning $25,000 per year today would be making almost $42,000 and a college graduate earning $60,000 would be making $100,000! That difference is costing the median wage earner in the U.S. approximately $42,000 per year.

That trend is unsustainable, yet as explained above, the rules “favor the house” – i.e., the wealthy. The easiest way we can circumvent the house rules is to not play on their home court. The next section provides such a pathway.

Next: Part 2 – Creating Successful Alternatives