In school, we do not learn about money. That is why many people do not understand the basic concepts of money, let alone how money works. Stepping back and looking at our monetary system as a whole gives us the ability to get an overview and a sense of how money works.
Our monetary system is a complex shell game mixed with smoke and mirrors that are hardly ever discussed, let alone taught. In this article, we will do our best to describe how the United States’ and many other countries’ monetary system works.
The US Monetary System
The current monetary system in the U.S. starts at the United States Treasury. The Treasury creates bonds and sells them. A treasury bond essentially is an IOU (debt statement) that states, “If you (buyer) gives me X dollars, I (treasury) will give you Y% interest on that money over Z years, plus the full X dollars in principal.”
If the U.S. treasury says, “We would like to sell $1 trillion in bonds,” who steps up and buys them? Banks. Then those banks look for buyers of the bonds at a premium. Here is where the Federal Reserve comes in. The Federal Reserve will buy the bonds from the big banks and wire them a nice payday of electronic money. You may wonder where the Fed got all that money from. They created it out of thin air not by printing, but by simply doing an electronic credit to the big banks’ account at the Fed.
So, if the US wants to borrow the cash they need to issue bonds that big banks buy. Those banks sell them at a premium to the Fed that creates (or prints) money to buy those bonds. Why does the treasury not directly sell to the Fed? Because that is illegal.
So now magically Big Bank X has all this money in its account at the Fed. What will Big Bank X do with all this new money in its accounts? Well, Big Bank X just did pretty well in buying treasury bonds, so why not go buy some more? They go back to the bond auction, buy more bonds, and yet again, the Fed buys the bonds by crediting their account. This leaves the Treasury with a bunch of electronic money the bankers paid them. Big Bank X is nice and rich from the premiums. And the Fed is unaffected because all they did was enter a transaction on the computer to make it happen, and now they start collecting the Y% interest on the bonds they own.
But wait! Now the treasury has a whole bunch of money. What do they do with it? They spend it! They give it out to different parts of the government, and they spend it on roads, bridges, social programs, and the military.
The Fractional Reserve Banking System
Because we and many other countries use a fractional reserve banking system, banks can now lend a percentage of its total deposits. Although reserve ratios can change, in many cases banks are allowed to lend out 90% of all deposits and keep 10% on reserve for account holders to withdraw if they want their money. This means 90% of the money the workers in our example earned and put into their bank ends up getting lent out. But that money goes somewhere, right? Yes. I’ll give a specific example to explain where it goes.
For a specific but very basic example of fractional reserve banking and what it does to our currency supply, we’ll look at a school teacher. Let’s say a teacher makes $50,000 and has it direct deposited into her bank account. The bank then can and does lends out $45,000, or 90%, of her deposits. Let’s say that bank decides to lend $45,000 to a company to buy a work truck. The truck dealer who sold the truck then takes the $45,000 payment and deposits it into their bank account. The bank then lends out 90% of that, or $40,500, to someone who wants a boat. The buyer of the boat then hands $40,500 to the seller, and the boat seller deposits it into his/her account. And then boat sellers bank lends out 90%. This goes on and on until the $50,000 that the teacher deposited is expanded to $500,000 in bank loans.
When you hear that there isn’t any money being printed, they are not lying. The printers might not be running, but the currency is being stretched through our banking system. The reality is 92%-96% of all currency created is formed in this exact banking system.
When the Dollar is Worth Less, it Makes Paying Off Existing Debt Easier
What does this all mean? This means the U.S. Treasury is taking on trillions and trillions of debt. They are doing this by borrowing dollars into creation from the Fed, which increases the currency supply and inevitably causes inflation.
The government understands this. Their debt is easier to pay as the dollar’s purchasing power becomes diluted through inflation. On top of this, the increased inflation helps slide income levels up, pushing individuals into higher tax brackets, which makes it easier to collect more taxes to pay for all that interest on the debt.
There is one piece of the puzzle that we haven’t covered. Do you remember way back in the beginning when the Fed did some computer entries to buy bonds that pay Y% interest? Well, that means the Treasury, who issued the bonds, owes the Fed Y% interest plus the principal. That has to come from somewhere. Ah, yes, the IRS will collect that money for the treasury through income taxes. Yep, our hard-earned money that is taxed goes to paying off debt rather than fixing our schools, roads, or anything else useful.
How This Relates to You
If you made it this far, you may be thinking, “How in the heck does this relate to me?” It greatly does, and understanding how our money works gives you the ability to see things differently. Not only will it show you how our monetary system is a scam, it will enlighten you to align yourself with the inevitable outcome of this madness.
The amount of money created and injected into our economy during the past years of quantitative easing making its way through the banking system will result in inflation. It may take a few years and a few events to happen because much of that money is roosting overseas at this point. But when you increase the amount of currency in the system like our government has, we are bound to see the purchasing power of the dollar go down. This is why debt is powerful, bookmarking in time the purchasing power prior to seeing the inflationary results of our government’s actions. By getting some debt yourself (at a fair rate), you are simply aligning your interest with those in charge.
It is so important to understand how our monetary system works and understand why the government does things it does. Having that understanding will allow you the ability to look at investments through a full lens perspective. If you can understand, you can position your own investments in a way that align with the interests of those who call the shots, while also protecting yourself if things crash and burn from the madness.
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Last modified: January 15, 2021
