Wednesday, July 30, 2008

Even Steven

by Paul Hein

Exclusive to STR

July 30, 2008

As the economy predictably crumbles, bankruptcies and business closings will increase, and businesses and individuals will find themselves in financial straits, with little hope of economic salvation. Many families are in danger of losing their homes, and there seems little, short of a miracle, that can be done about it.

It seems to me that this isn’t necessary, presuming logic and truth play any role in our financial system--which may be debatable.

Why do we read daily of businesses failing, or on the brink of failure? Why do we see ad after ad on TV for firms offering financial assistance and guidance for individuals faced with economic disaster? Because people and companies are neck-high in debt, which they can no longer expect to repay. And to whom are they indebted? Generally, to banks, but ultimately, all debt is to banks, since banks are the sole source of our “money,” which is created for borrowers with the stroke of a pen, and requires the borrower to repay more than was borrowed. Since banks are the only source of money, the situation is analogous to returning to the only well in town more water than was taken from it, year after year. That’s obviously impossible in the case of a well, but it works--at least for a while--with banking, because money, unlike water, is intangible, and banks can create it in unlimited amounts, to enable borrowers to return more than they borrowed, with the money loaned to pay interest provided--at interest! You can see that the situation, once embarked upon, is bound to end in catastrophe.

Let’s look at bank borrowing. Do banks lend the funds they have on deposit from their customers? Heavens, no! If they did that, the money supply wouldn’t be increasing exponentially. When they lend, they simply create the funds. The Federal Reserve Bank of New York puts it succinctly: “Commercial banks create checkbook money whenever they grant a loan, simply by adding new deposit dollars to accounts on their books in exchange for a borrower’s IOU.” It’s a staggering admission that, I suspect, the bank was only willing to make because it realized that few would read it, (in its little booklet “I Bet You Thought,”) and fewer still would consider what it really meant. The bank tells us that WHENEVER (no exceptions noted) banks “grant” a loan, they simply create checkbook money—i.e., a bank deposit--to the borrower’s account. In other words, customer deposits do not create bank funds, but rather, bank funds create customer deposits! Every dime in every bank account got there because, ultimately, in the dim forgotten past, perhaps, someone borrowed it! You may never have borrowed from any bank, but, if you have a bank account, the money in that account was borrowed by somebody.

Now let’s look at those bank deposits. This time we’ll get our information from the Federal Reserve Bank of Chicago , in its booklet Modern Money Mechanics. Here’s what we read on page 3: “The actual process of money creation takes place in commercial banks. As noted early, demand liabilities of commercial banks are money. These liabilities are customers’ accounts. They increase when the customers deposit currency and checks and when the proceeds of loans made by the banks are credited to borrowers’ accounts.” Did you get that? The bank is telling us that your bank account consists of the bank’s liabilities. The bank’s liabilities increase when you deposit cash or checks, or “when the proceeds of loans--are credited to borrowers’ accounts.”

Let’s put it all together. You go into the bank to borrow a million dollars. The bank agrees to make the loan. As a result, the number 1,000,000.00 is added to your account. Where did the million come from? It’s just a number! Some clerk added it to your account. What is the nature of this number? It is a liability of the lending bank. In other words, the bank has created a liability on itself, in your favor. Simply put, in granting you the loan, the bank has obligated itself to you for one million dollars, as evidenced by the bank’s addition, of 1,000,000.00 to your account. It does this, as the Chicago Fed told us (I Bet You Thought, p. 19) “in exchange for a borrower’s IOU.” So: the bank loaned you its liabilities totaling 1,000,000.00. It may not be technically correct to refer to bank liabilities (i.e., checkbook money) as “IOU’s,” but close enough. You, in return, tendered your IOU for a million. You know, that looks like a pretty even swap, doesn’t it?

Of course, the bank, as well as common (non) sense, asserts that the bank’s liabilities are “money.” Your own liabilities, of course, are simply--liabilities. But by what law is bank credit money? How can the liabilities of one private firm be “money,” while those of another (Chrysler Corporation, for instance) be simply evidence of debt? Is there some definition of “money” somewhere that defines bank credit as money? Maybe, but I haven’t found it. And if bank credit is, by some permutation of law, actual money, then by what law may a private firm, such as your local bank, create a nation’s money? Questions abound, although it seems to me that they’re rarely, if ever, asked, and when they are, never answered.

If the bank actually paid off its liabilities, by tendering you a million units of whatever is defined as a dollar quantity of money, that would be another matter altogether. You would then have an obligation to repay. But that hasn’t happened, and won’t happen, because if money were to be some tangible substance, banking would be little more than warehousing, and where’s the profit in that? ( I calculated a few years ago that the interest earned on the national debt is about a billion dollars per working day). The actual transaction was, in effect and, I believe, in fact, an exchange of IOUs. So who owes whom anything? You should lose your home to such a transaction?

A final note: bank deposits constitute a bank’s liabilities. As you can see in the quote above, from the Federal Reserve of Chicago, increasing your bank deposits increases the bank’s liabilities. So if, in the example we’ve been discussing, you managed to accumulate a million dollars to deposit with the bank (of course, the interest would still be due, but you could borrow that!!) you would be increasing the bank’s liabilities. Are there many companies that will sue you if you fail to increase their liabilities?

If modern banking is an abomination, it is because modern money is an abomination. Of course, the law (i.e., the Constitution) doesn’t permit modern “money,” but who pays any attention to that old anachronism? Give up your home, your automobile, go on the dole, and quit complaining!

Paul Hein is semi-retired from the practice of medicine (ophthalmology) in St. Louis. His book All Work and No Pay should be available soon from

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