how does fractional reserve system make it impossible to pay off debt?
Our fractional-reserve, fiat financial system is built upon
debt-based money. In this perverse arrangement, new dollars come into existence through the creation of government and private debt. Going the other way, if the private sector and the federal government ever began seriously paying down their debts, the supply of US dollars would shrink.
Money is loaned into existence. Put simply, under a fractional reserve banking system all money is created out of debt.
Not all money. Inside money is debt, outside money isn't. But your post makes no sense anyway. In aggregate, if there were no debt that would mean the stock of inside money would be zero, but there's still outside money. Currency isn't money as debt. So it doesn't matter anyway, even if there were no debt. But individual actors, like you, me or the government, can completely pay down our debt without impacting the money supply. Inside money grows endogenously. If Treasury debt stops getting created, other debt will expand automatically to fill the demand for money. Fractional Reserve has
nothing to do with paying down debt.
If ALL debts were paid, public and private, there would be no money in circulation. When money is created under the fractional reserve system it is loaned into existence
at interest by the banks. That money has to be paid back
at interest, but the interest is never created.So, the fractional reserve system makes it inherently impossible to pay off ALL debts, public or private and to still have money in circulation.
The American dollar is a Federal Reserve note and it is loaned into existence by the FED at interest to the government and commercial banks in the beginning. The commercial banks after getting this money (fiat currency) from the private central bank, the Federal Reserve, then can loan out 9$ dollars,
at interest, for every 1$ dollar it has in
capital reserve. This is the fractional reserve banking system.
This is how all money in the United States is created. When the government spends more than what it gets in tax revenue, it either has to raise taxes and/or cut spending or borrow it from the private central and/or by selling treasuries (debt obligations) at interest. The Treasury Dept. creates treasuries, T-bills, Notes, and 30 yr. bond and participating banks auction off these treasuries every Monday. Interest/yields are paid to the purchasers of these treasuries. When there aren't enough purchasers of treasuries to cover the governments debt. The Federal Reserve will monetize the debt by exchanging the government treasuries (debt obligations) for federal reserve notes (check book money).The Federal Reserve doesn't print all this money of course, it's checkbook money made by key strokes on a computer at the FED... ledger book entries.
The federal government will never pay off the debt. As it has been for a very long time, the federal government has been only paying the
interest on the debt. This
interest is paid out to the purchasers of the treasuries and it is part of the annual budget. The amount of interest paid out is determined by the Federal Reserves'
interest rates. If the Federal Reserve raises it's interest rate more money will have to be allocated out of the government's annual budget just to pay the interest.
To expand on this, Borrowing from wikipedia:
"In monetary economics, a money multiplier is one of various closely related ratios of commercial bank money to central bank money under a fractional-reserve banking system. Most often, it measures the maximum amount of commercial bank money that can be created by a given unit of central bank money. That is, in a fractional-reserve banking system, the total amount of LOANS (at interest) that commercial banks are allowed to extend (the commercial bank money that they can legally CREATE) is a multiple of reserves; this multiple is the reciprocal of the reserve ratio, and it is an economic multiplier."
"If banks LEND OUT (at interest) close to the maximum allowed by their reserves, then the inequality becomes an approximate equality, and commercial bank money is central bank money times the multiplier (i.e.10:1). If banks instead LEND LESS than the maximum, accumulating excess reserves, then commercial bank money will be less than central bank money times the theoretical multiplier." End of wikipedia quote
So you see money is created at interest in the form of loans by the commercial banks by maintaining a minimum reserve requirement. The money created is checkbook money, a ledger book entry. This money is created by creating debt to a borrower, who must pay it back
at interest, which again, is not created. There are inherent problems with a fractional reserve banking system and having a private central bank creating money out of thin air (fiat currency).
Example:
The 1929 stock market crash was caused by foolish investors who had BORROWED money from the BANKS to invest in the markets when times were good expecting to make a hefty return, but, the markets slowed down, there were bank runs and bank failures the stocks dipped instead of climbing, there were margin calls and along with that, the investors defaulted heavily on their loans. The stock market crash and the subsequent Depression were actually caused by tight monetary policies that the Federal Reserve instituted at that time. The Fed began raising the FED FUNDS rate in the spring of 1928, and kept raising it through a recession that began in August 1929. This led to the stock market crash in October 1929. When the stock market crashed, investors turned to the currency markets. At that time, dollars were backed by gold held by the U.S. Government. Speculators began selling dollars for gold in September 1931, which caused a run on the dollar.
The FED raised interest rates again to preserve the value of the dollar.
This further restricted the availability of money for businesses, causing more bankruptcies.
The Fed did not increase the supply of money to combat deflation. As investors withdrew all their dollars from banks, the banks failed, causing more panic. The FED ignored the banks' plight, thus destroying any remaining consumersÂ’ confidence in banks. Most people withdrew their cash and put it under the mattress, which further decreased the money supply. Bottom line...thanks to the FED, there was just not enough money in circulation to get the economy going again. Instead of pumping money into the economy, and increasing the money supply, the FED ( Federal Reserve bank)allowed the money supply to fall 30%.
