In an address to the stockholders in 1924, the Chairman of Midland Bank, Reginald McKenna said “I am afraid that the ordinary citizen will not like to be told that the banks can and do create money.And they who control the credit of the nation direct the policy of Governments and hold in the hollow of their hand the destiny of the people”.
To understand the paradigm of money, we must understand this ﬁnancial jargon “ﬁat money”,which means that the modern money is not backed by any physical asset. In the pre-industrial period, the pound sterling literally meant a pound of sterling silver. There was only so much silver out of the ground, it was something tangible and you couldn’t print silver. It was something real and one could not print any more money than there is silver or gold to back it up. The logic of today’s money is very simple, it is just a promissory note, just another bill to pay the debt. In other words,if one draws out note from his or her wallet and chew it, their appetite would not be fulﬁlled; or if you crumple the paper currency and throw it in the fuel tank, the car is not going to move.
Most of us believe that money is being created by government but the truth is that in the world’s economies, money is created by private corporations called BANKS through loans, mortgages and other debt. Most of us feel that banks lend out money that has been deposited by people. But the fact is that banks create money not from earnings and deposits, instead it is created directly from borrowers promise to repay. Borrower’s signature on the loan paper says that it’s an obligation to pay the bank, the amount of loan plus interest or else lose house, car or whatever assets pledged as collateral. It’s a big commitment from borrower’s side. Today, money is literally created as debt. New money is created whenever somebody takes loan from bank. As a result the total money that can be created has only one real limit the total level of debt. Economist and author Mr. Irving Fisher had once rightly pointed that “the national circulating medium is now at the mercy of loan transactions of banks, which lend not money, but promises to supply money they do not posses”.
Central banks around the world place an additional statutory limit on the creation of money by enforcing a rule known as fractional reserve requirement. It varies from country to country and from time to time. Let’s understand further about fractional reserve system and how banks make money out of thin air. The most common reserve requirement ratio is 9:1 wherein banks need to have at least Rs.10 in the vault for every Rs.100 money being created. Banks have 10% more on deposits than it has on loans. It’s misleading information that loans come out of deposits. This illustration will give broader idea. If a customer deposits Rs.10 into a bank, the bank is free to loan out Rs.90, on the premise that not everybody is going to come in and withdraw all at once. In reality, banks do not have so much money which they actually lend out. If everybody withdraws at the same time, then banks will collapse, in fact great recessions in US contained run on several banks. Former Chairman of the Federal Reserve, Marriner Stoddard Eccles was quoted saying “If there were no
debts in our money system, there wouldn’t be any money”.
This leaves us plenty of room to research, analyse and understand the nature of what really is money. Former US President, Woodrow Wilson left us with a mysterious quote that has led to several conspiracy theories on how big banks control the global economy, politics and industry. He said “Some of the biggest men in the United States, in the ﬁeld of commerce and manufacture are afraid of something. They know that there is a power somewhere so organised, so subtle, so watchful, so interlocked, so complete, so pervasive that they had better not speak above their breath when they speak in condemnation of it”.