FAQs
Here is the trick. Take, for example, a year like this year in which the government runs a $400 billion dollar deficit. The Treasury Department has to sell $400 billion in US Treasury bills, bonds and notes (government IOUs) to buyers at a rate of interest sufficient to attract their money (and beat the interest competition of other banks’ CDs and other governments’ bills, bonds and notes). To avoid a credit squeeze, the Federal Reserve System Open Market Committee in Washington directs the NY Federal Reserve Bank to purchase roughly 10% of that total (or $40 billion in our example) in existing US bills, bonds, and notes from the current holders. To pay for them it creates the $40 billion out of nothing, merely with keystrokes on a computer. Through more keystrokes, this new $40 billion is deposited into the banks of the various bill, bond, and note sellers, thereby increasing the reserves of those banks by $40 billion.
Pursuant to the Federal Reserve Act of 1913 those banks must keep only 10% of those new deposits on “reserve.” (Because these banks do not have to keep 100% on reserve, this banking system is called a “fractional reserve” system.). So of the $40 billion deposited, the banks must keep 10% on reserve ($4 billion) and may loan out $36 billion (90%), for business loans, mortgages, credit card loans, to purchase government bonds – for whatever borrowers want. Those loans (and payments) are in turn deposited in banks (very few folks put their money in mattresses). So of the $36 billion loaned out and then re-deposited, the banks receiving the new deposits can then loan out 90% or $32.4 billion, retaining 10% or $3.6 billion as reserves.
Banks repeat this redeposit-reloan process, reduced 10% each time, until the 10% reserves retained have reduced the funds available for loan to zero. This cunning process allows the banks to create out of nothing nine times the original $40 billion in new deposits received from the Federal Reserve (the “Fed”), or $360 billion dollars. This total is concealed from the public by the only partial expansion of the loan total at each repetitive step.
We can easily see that even by the second re-loan step mentioned above, the banks have loaned out $68.4 billion based on the original $40 billion deposited. The end result of the process is that the banks receiving the deposits and re-deposits collectively have loaned out $360 billion dollars, which they created out of nothing, and have retained $40 billion in reserve. The Fed created the first $40 billion, the banks $360 billion, equaling $400 billion dollars. Thus the credit markets are stabilized even though the US government has borrowed $400 billion.
But notice, the Fed only created the initial 10% ($40 billion). Privately owned banks created 90% ($360 billion) out of nothing, and loaned it out at interest. At even 6% that is $21.6 billion dollars per year in interest. Some of this profit goes to the private stockholders of the banks. However, the banks conceal much of this vast profit from the public as undistributed or retained earnings. Five banks hold over 50% of all deposits in the United States. This means that in a year with a $400 billion deficit (such as FY 2007-2008), those five banks will receive over 50% of approximately 6% interest on the newly created $360 billion: over $10 billion per year, from now on, for creating money out of nothing. This is profoundly unjust, and dangerous to any government, especially in a country that prides itself on being a democracy.
