Money creation in a fractional reserve banking system (beginner's question)

Economics Economics Questions
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21

OK thanks. My country is a bit vague but for accademic purposes any old country will do. I was just listening to http://media.mises.org/mp3/MU2007/49-Garrison.mp3 and the speaker (Garrison?) mentions that M0 in the US has gone from around 27% back in 1980 to almost 50% today, as a result of phasing out “Regulation Q”… all of which is quite interesting listenning.

In any event, as notes, coins and the issuing of debt/credit are merely fuel for the fire, the answer to my question seems to lie in these Open Market Operations, which are described in Wikipedia at http://en.wikipedia.org/wiki/Open_market_operations. That web page mentions three examples: government securities (debt - that won’t help us), foreign exchange (yet more debt - this might help at a national level but if we expand the economic system to include the world at large then that still doesn’t help us) and finally gold. So of the three, gold is basically the only thing that commercial banks and governments can give central banks in order to pay off the interest on loans (or to pay the yeild on bonds).

It’s hinted at http://en.wikipedia.org/wiki/Financial_instrument that financial assets might take the form of securities as well, which could potentially mean stocks and options in the companies that or villagers have created (and subsequently sold to commercial banks to pay off the interest on their loans). I’m not sure whether central banks will purchase securities or not - I suspect the answer to that is no…

So from what I can tell, the long and short of it is that:

  • The villagers are going to have to sell a few widgets to the bankers in order to stay afloat (and they’ll have to do this on a permanent basis because monetary inflation is constantly taxing their wealth and transfering this to the bankers, whether they like it or not)
  • In as much as concerns the exchanges that take place between the central bank and the government/commercial banks, the only non-debt money arround appears to be gold and silver, so gold and silver are still (as always) key strategic resources that the banks need to obtain in order to stay afloat (shouldn’t be too hard, since they have a government created edict that lets them tax the villagers - this should give them ample currency to purchase gold from the miners)
  • There is a net flow of wealth from the villagers to the central bankers, which is proportional to interest rates… something which appears to be rather contradictoray since it’s generally thought that low interest rates cause inflation and it appears to be a form of inflation which is essentially taxing the villagers. Yet you can’t deny the mathematics - higher interest rates means the villagers have to do more work for the bankers. My only explanation for this is that perhaps when interest rates are low the villager’s existing deposits/savings are basically devalued/confiscated via inflation (indirect yet instant taxation) wheras when interest rates are high the interest repayments on their loans become greater, increasing their future obligations (direct but delayed taxation)
    All in all quite interesting stuff and the general moral of the story is, “Be a central banker - it’s free money”. Commercial banking looks like a pretty good gig but on the other hand they have to compete with other commercial banks, which no doubt squeezes the spread between their deposit and loan rates - so the commercial banks could be viewed as more of a systemic overhead than anything. Without a doubt, the best place to be is the central bank - since they have a government prescribed monopoly on the creation of money (and thus a government prescribed monopoly on the taxation of savings and investment). It’s unfathomable that the central bank has remained a private institution in the US since the beginning of last century - all the more so since the US exports so much of their currency to the rest of the planet, which quietly accepts what then becomes a more or less global tax that is paid to the private shareholders of the Federal Reserve…
22

Jimmy,

Back in the mid-80’s having been of question on the Fed for about 10 years I ran across some Federal Reserve Bank publications entitled, “I Bet You Thought” published by the NY Fed and “Modern Money Mechanics” published by the Chicago Fed. Now both these documents are no longer in print, many informed minds believe because of it’s content and admissions and that may be true, but thanks to the internet and some heavenly souls you too can read them. But first, I’d like to wet your appetite hopefully on what you’ll find inside.

“What they [banks] do when they make loans is to accept promissory notes in exchange for credits to the borrowers’ transaction accounts. Loans (assets) and deposits (liabilities) both rise by [the amount of the “loan”].” That is from page 6 of Modern Money Mechanics and some speculate this sentence alone is why they stop printing. I’ll let others judge that but in others words, when the bank makes a loan, they create book entry money on both sides of the ledger. The one thing I always found insidous about the fiat money creation is that in order for money to enter our economy (the only way) it must be borrowed in. OK, we are day one of our brand new economy and we have $0 balance in our new economic universe. I decide I’ll get the ball rolling and I walk in and place my security up on the table and in exchange I get a $100 dollar loan at say 3% interest over a 1 year period. Now I walk out with the $100 which is the sum total of everything in our new economy but where will the 3% in interest that I have to pay come from? IMO, if Social Security is a ponzi scheme, what is this? This is also another reason the system is forced and monopolistic as it would fail on his very face if free markets were allowed to reign.

Both publications are chocked full of eye catching pieces of info and it’s surprising what they do say although they don’t openly admit some grand conspiratorial scheme if one is looking for that. They also do a bit of soft selling IMO to try and divert the uneducated reader from asking to much. Hope you find them useful concerning your questions.

Modern Money Mechanics

http://landru.i-link-2.net/monques/mmm2.html

I Bet You Thought (Catchy title is it not?)[;)]

http://www.reallyneatstuffalaska.com/I_Bet_You_Thought

Best of luck!

23

Sorry folks. Just saw where you guys covered the “where does the interest to pay the loan come from” question. Sorry for the echo!

Nice job BTW.

24

Fantastic - thanks. That article gives quite a lot more detail on how the Fed works and how the Open Market Operations work. I still find it quite amazing that the government handed over a monopoly on money creation to a bunch of bankers who receive 6% dividends on profits derived from something they’ve literally pulled out of thin air… but apparently the American public are quite happy with this situation. As a non-US citizen I suppose I’m not really in a position to offer them advice on how they manage their affairs and can only wish them the best of luck.

Jimmy

25

Hey Jimmy,

Offer away on the advice because the folks who run this whole show act like non-americans anyway and we follow them like dumb lemmings!

I’ll willing to risk you’ve got a better idea anyway!

[:D]

26

I think I have an answer to this. You lend without interest. If there’s no growth in the money supply then the creation of wealth from investment will result in deflation, and loaned money will have increased in value upon return. So to turn a profit all the bank would have to do is keep operating costs lower than their real profit from the deflation. I see some potential problems with this. Unless a significant amount of the total money suppy is invested (and producing wealth) it may be impossible for banks to keep overhead low enough to operate profitably (anyone, feel free to correct me on this - I have no banking experience). Secondly, anyone saving, but not investing (they’re hiding it under the mattress I gues[:P]) is benefitting as a kind of - at least as I see it - free rider, although it would seem to me that the most benefit for all would come from all available savings being invested. At least if they could be in a manner where one could expect their money back.

Also, it seems to me that interest is possible - without the insolvency, as long as it is no higher than the rate of monetary expansion. So I suppose the banks would be keeping an eye on those pesky gold miners.

Forgive me if I butchered any terminology etc. I’ll be happy to clarify if desired.

27

Hm, it’s an interesting idea but I have a couple of reservations about such a system. The first problem I can see with such a system is that you effectively get paid to horde your cash, which could certainly have some consequences on the velocity of money in the system. If velocity goes down then this effectively reduces the amount of money available to conduct transactions and you have fewer dollars chasing the same amount of products (either prices go down or production goes down and prices remain stable)… I think such a system will be rather like stocks in a company - with a static number of stocks, as the value of the company increases (or the economy as a whole in the case of your monetary system) those that got a stake early will end up mega rich. In the case of a company, this makes sense since they are typically the ones that took the most risk and thus contributed the most to the company’s eventual success. In the case of this theoretical economy I think they’re just piggybacking on a fault in the system - the same fault as that of inflation in our current system - which is that money is not holding its value… instead, in your monetary system, it’s gaining in value relative to all other products, and not necessarily because the holder of that money is producing more or less - just as inflation taxes people who hold money indiscriminately, such a system would reward such people indiscriminately.

The second problem I have is that such a system effectively takes different interest rates out of the equation totally. All the “banks” in this case would be obliged to lend money at the same rate (i.e. 0%) and thus to make the same loss/return proportional to their loans. In our current market, interest rates that banks charge would typically incorporate:

  1. Some kind of profit which would typically be determined by the availability of “capital stock” as Adam Smith calls it. If capital stock were widely available then bankers would be competing heavily on interest rates and the profit component of the interest rate would tend towards zero. If capital stock were slim then interest rates (the price of money) would go up. Under some kind of gold standard the availability of “capital stock” would likely indicate the equivallent of “number of nuts stored for the winter” in a squirrel economy. In a fiat money system the availability of capital stock really just means the availability of credit and this component of interest rates is determined by the lending rate obtained either from other banks or from the central bank… which doesn’t necessarily imply that our sqirrels have stored any nuts - it could be that their central bank has just dropped interest rates to try to “boost” the economy, effectively confiscating (via inflation) whatever nuts there may be in the economy (even if the economy’s nut reserves are dangerously low and the winter looks like it’s going to be particularly cold).
  2. The risk they might not get their money back. If the bank lends money to customer A to buy a BMW and lends money to customer B to buy the corner store, the two loans obviously represent different risks to the bank. In the case of the BMW there’s a good chance customer A will wrap it round a pole at some stage. In the case of customer B the corner store is an investment so there’s a good chance customer B will be able to pay back the interest on this loan - worst case scenario the bank takes the corner store (more valuable than a BMW crash site).

The system you were proposing of zero interest rates eliminates the possibility that banks charge different rates depending on the risk that the customer in front of them represents. They effectively have two choices: loan at the compulsory 0% interest rate or don’t loan at all. This means that lots of customers who would have found capital for their new ventures (e.g. Google), although having a profile and proposal that represented a relatively high risk, would not find capital in such a system… they would not be offered the possibility of paying higher interest rates - they simply would not be offered money at all. This is to take quite a useful element out of our current lending mechanisms (an element which would exists in the gold standard as well).

I’m not dead set against the system you’re proposing - I’m providing the above arguments as much to play devil’s advocate as much as anything… but I do think that you’d need to at least consider the possible effects of the decreased velocity of money and the inability of banks to effectively price the risk component in the loans they make (this being particularly pertinent now, at a time when many banks are going belly up over sub-prime lending in the US).

Jimmy

28

Well, in principal, I can see the benefit of an elastic money supply. However, from what I’ve been able to understand so far, the basic problem is that currently new money currently gets injected into the wrong end of the system. A simple solution to this problem would be to inject all new money into the other end of the system… so you’d still keep track of inflation and try to target a figure which is approximately 0% inflation (which ensures enough new money to cope with any growth in the economy) but if you ever do need to inject new money into the system you don’t inject it in the form of a loan at the banking end of the system. Instead you’d inject it in the form of savings at the other end.

For example, if the guys controlling the money (let’s say some kind of public central bank, run out of tax payer’s money) witnessed deflation of 0.2% they might say, “OK - we need some extra cash”. They’d then inject the new money into the system simply by modifying the account balances of anyone who had savings in the economy, in a manor which was proportional to the savings they had. So it would be kind of like a “central bank interest” that would accumulate on people’s savings (but not be charged on loans). If you needed to contract the money supply then you could do so by charging a similar “central bank interest”, this time on loans but not on savings.

I’m not sure if such a system would work or not - it’s just something I made up as I was writing this post - I’d be interested to hear any [constructive] criticism though.

Jimmy

29

I don’t see any benefit of an elastic money supply.

30

So you favour a system of deflation in the wake of economic growth and inflation in the wake of recession?

Surely the principal function of money, and it’s most important function, is that it should hold it’s value between the time that you accept it as payment for goods/services you provide and the time that you spend it on whatever it was you actually wanted for yourself. If money supply is inelastic then it’s pretty much impossible to achieve this since the quantity of goods and services in any economy constantly changes - so only monetary systems that use an elastic money supply will be able to maintain anything close to 0% inflation… even the gold standard has some elasticity built into it’s design in that you can dig new gold out of the ground (which is useful in times when the economy is expanding at around the same rate as the supply of gold - as it turns out I think that’s probably the most common case but I doubt that it’s always the case).

Do you disagree with any of the above for any particular reason or are you just being contrary for the sake of it?

31

Businesses cycles are caused by the FED, therefore economic growth and recession should not happen in a free market. All goods and services do not inflate at the same level during inflation. Houses and gasoline inflate the most, technology DEFLATES during times of inflation, and some other goods stays the same. Therefore, there is no method to determine an “overall” level of inflation. Not all goods inflate proportionally, so credit expansion is not a method of maintaining a stable price index.

People are forced to use government-created money because they have to use that money to pay taxes. If taxes were dismantled, then they would look for alternative currencies.

Credit expansion subsidizes unproductive business methods at the expense of the poor. Credit expansion increases income inequality. The rich has more money to invest than the poor. Therefore, the rich would benefit from larger returns, even if the poor does the same amount of labor as the rich.

Humans would switch to alternative currencies (such as gold) because you want fiat money to increase supply. The people that use alternative currencies BENEFIT from increased money supply, and the expense of the poor, no matter if it is inflation or not.

Setting a stable price index, even if it is effective in maintaing all prices stable, is worser than deflation. It is always possible to invest in an inelastic alternative currency, such as gold, silver, housing, gasoline, etc.

32

Woah, I’m not even sure where to begin here. You’re got rather a dogmatic style of writing, but I think I get where you’re coming from and I’ll try my best.

OK - so you’ve started with a completely unfounded statement and then used this leap to a completely unrelated and rather backward conclusion. None the less, the idea that growth and recessions don’t happen in a free market is pretty much ridiculous. The Easter Islands, for example, experienced what is more often termed a collapse (not just a recession) after they chopped down all their trees… And one could hardly argue that the discovery of combustion and the industrial revolution didn’t contribute to relative economic growth.

Indeed.

Erm… I’m not too sure about that one. I think the people paying for credit expansion are anyone with savings (not necessarily or specifically poor people). And the subsidies generally get injected into the system at the banking end of the system. Admittedly one result of these subsidies will be lower interest rates (easier access to credit) than you’d probably find under a gold standard, but the people benefiting from the system are primarily the central and commercial banks.

??? There’s no logic here to refute, so I’m really not sure what to say. Once again, your writing style is rather dogmatic.

As I said above, even the gold standard has a degree of elasticity built into it. The question is, is this sufficient to maintain stable prices. By in large I think history proved that it was - so I fully agree that the gold standard would be a preferable monetary system to the fiat money system. However it’s rather fanciful to think that the gold standard doesn’t have it’s own flaws/weaknesses. For a start, if the banks buy the gold mines then you find youself in exactly the same situation as we are currently (i.e. a net transfer of wealth to the bankers).

In any event, I think there’s way too much ground to cover between your relatively inflexible position and my own - so there’s probably not too much point in us continuing this discussion.

33

That was my argument to refute the previous sentence. Unstable prices is not a problem in the market. You would still have the same purchasing power if prices suddenly went high by inflation or prices are low by deflation. If the value of the dollar decreases by half, then you would have twice the number of dollars. One-half times two equals 1.

Why are you against the banks investing gold? It would be benevolent for the banks to invested in gold. If you invest money in these banks, they would compete against each other that would offer you higher returns for the money you invest in the bank. Basically, letting banks buy some gold mines would make them store the gold and invest gold for you, instead of physically storing gold in your own house by yourself.

34

OK, I see what you’re saying. Essentially you’re saying price stability isn’t the holy grail. However imagine an economy that starts out with 100 gold coins and 100 apples. On day one, if you buy an apple it costs you 1 gold coin - and if you sell an apple you earn a gold coin. Now imagine apple production soars due to better growing techniques… We now have 200 apples produced each day. Two apples now cost 1 gold coin and you have to sell a couple of apples to earn a gold coin. That’s all very well and it turns out people in the economy are always improving their growing techniques, making adjustments here and there and managing to make ever more apples with the same number of hours in every day and on the same land. People start to think “if I save the gold coin I earn today, I’ll be able to buy twice as many apples for it tomorrow”… and so they stop spending their gold and start buying less apples. Of course, with less gold in supply and less people buying apples this causes the price of apples to go down even further.

One result of such a system is a decrease in the velocity of money, which contributes to a decrease in the quantity of money available - which I admit I’d only suspected might be a problem (and which lead me to think that an elastic money supply could have some benefits - providing they targetted 0% inflation, which they certainly don’t and couldn’t in our current fiat money system).

On second thoughts, I think I made this statement a little too quickly. The first post on the second page of posts for this thread explains why this wouldn’t be a problem.

In any event, can you see any problem with the monetary system I proposed which targetted 0% inflation and didn’t require vast amounts of effort to dig otherwise useless metal out of the ground?

35

Some commodities would inflate or deflate more or less than others.

  1. If the supply of a good is constant and the supply of money is constant, then the price of that good would stay the same.
  2. If the supply of a good is constant and the supply of money is increasing, then the price of that good would go up.
  3. If the supply of a good is increasing and the supply of money is constant, then the price of that good would go down (like your apple example).
  4. If the supply of a good is increasing and the supply of money is increasing at the same rate, then the price of that good would stay the same.

For example, in the housing market, the prices houses inflate much more quickly than other commodities. That is because the supply of houses is comparably constant (since our population is comparably constant) and the supply of money increases, therefore the prices of houses would go up (according to #2).

The supply of gold is constant. The supply of money increases. If this happened, the price of gold would increase (according to #2).

If the supply of apples is increasing and the supply of money is constant, then the price of apples would go down (according to #3)

The supply of consumer goods (such as toys) is increasing. The supply of money is increasing. If this happened, then the price of toys would stay the same (according to #4).

The “Consumer Price Index” only measures consumer goods (that is, the goods that are increasing in supply). Because the supply of money is increasing, they would cancel each other out so the price of toys (and other goods that are increasing in supply) would remain stable.

The Federal Reserve inflates money to stablize the “Consumer Price Index” (CPI). Therefore, the price of goods that are increasing in supply (consumer goods, suchas toys) would remain constant.

The CPI however, fails to measure the price of goods in constant supply (such as houses, gold). Because of this failure, the prices of houses would inflate (according to #2).

Because of inflation, the price of houses rise. Therefore, some people would want to buy houses so they can sell their house at a higher price later.

For example, the average cost of a house would cost $100,000. Five years later, the average cost of a house will go up to $300,000 (due to inflation). Therefore, people would earn an extra $200,000 if they buy a house for $100,000 and sell it for $300,000 five years later. This is the cause of the housing bubble. People are just buying houses to sell them later at a higher price. People are now loaning from banks to get that money to invest in houses. This results in bank failures, speculation, etc.

Investing in houses is an inefficient allocation of resources. You need lumber, labor, money, energy to build a house. This costs the environment because of cutting down trees and the energy required for the machinery for building houses.

What happens to the old houses? Wouldn’t there would be too much houses because our population is constant but the number of houses are increasing? Yes, the old houses gets abandoned or destroyed.

This are not even “investing”. They are building houses to just circumvent the effects of inflation (the devaluation of their money). This is unproductive investment (or malinvestment) because building and then destroying houses is a waste of resources. Their money could be better spent on more productive activities. In order to give them an incentive to not invest in houses and make productive use of their money, we must end our inflation that raises the cost of houses. In order to do that, we need a constant supply of money. If we have a constant supply of money and a constant supply of houses, the price of houses would be constant, and no more malinvestment (according to #1)!

Therefore, we should adopt a constant supply of money like the gold standard. (anyway our people would always find goods in constant supply, such as gasoline, silver, diamonds, etc.) In that way, our people would not use their money to malinvest in houses, so they would concentrate to spend their money on more productive activities. They don’t need to invest in other unproductive stuff because gold is an investment!

36

Yes but my post made no mention of the CPI. I never suggested using the CPI (I’m well aware of the many ways in which this statistic is fanciful).

They may well do, but my post made no mention of the FED either.

I think perhaps you’ve rather misunderstood the system I was suggesting. You seem to be under the impression that I’m suggesting a system which closely resembles our current system, which is not the case for various reasons:

  1. The central bank would be public and not for profit. Employees would take modest salaries, not dividends (as is the case with the current FED)
  2. The target inflation rate would be 0%. Inflation one year would be countered by deflation the next. The idea is to have money that holds it’s value… Currently governments like high real inflation with pretend low (CPI) inflation so that they can avoid paying more to retirees and unemployed people (yearly increases that are based on the CPI). If target inflation were 0% then the amount they paid these people would be constant and would not require any yearly adjustment. Further, and most important…
  3. New money injected into the system would not be in the form of credit but in the form of savings (a central bank interest paid on your savings). This means new money that gets injected into the system does not result in the devaluation of people’s savings. It is not money that is confiscated from someone else - it is distributed in proportion to existing savings. This means that the central bank would have nothing to gain from misrepresenting inflation statistics either.

Your main objection to our current fiat money system is that the FED effectively confiscates people’s savings via monetary inflation and I’m in whole hearted agreement with this (I’ve be trading precious metals for the past couple of years to avoid loosing the value of my USD savings - a lesson which I learnt the hard way by holding USD savings between 2001 and 2006 which went from 0.85c on the euro to 1.33c on the euro - my solution was not to buy Euros which suffer much the same problem as dollars, but to buy precious metals that hold their value). What I was proposing was an alternative system which would offer a solution to the problem of central bank created inflation.

Gold is an alternative system (your writing makes me think you’re convinced it’s the only possible alternative system and that no other could possibly take it’s place - which seems rather more like blind devotion than reason, although not without some foundation in reality). By in large, I think gold is a far superior system to our current fiat money system since it has built in protection against inflation. If we could pay taxes in gold then I’d go get an eGold account tomorrow. However it does require a massive amount of effort to maintain (you only have to visit the “Big Hole” in South Africa to get an indea of how much) - gold mining consumes substantial physical resources and has a not inconsiderable impact on the environmental (Jarred Diamond’s Collapse makes for interesting reading in this regard). So if it were possible to create a less onerous system that was as effective then that would be a good thing right?

37

Essentially zero price inflation contributed largely to the beginning of the Great Depression. Although consumer prices stayed pretty much the same throughout the '20s, the money supply increased greatly.

If it was not possible to lend money against deposits, prices would have gradually fallen during the '20s as the money supply stayed constant - the liquidity that funded the stock market bubble would also have never came into existence.

While the causes of the Great Depression are a bit more complex than this (price & wage supports, along with New Deal like programs that started under Hoover contributed quite a bit), it is false to think that ‘stable prices’ cannot lead to booms and busts fueled by credit expansion.

However, I agree that if there was some way to keep the money supply the same (not prices, prices fall naturally over time in a system where the money supply is fixed or pegged 100% to gold, with the exception of times of great gold discovery), that such a system would be just as good as a gold backed money system. However, such a system, once put into place, is much easier to manipulate by the powers that be, and doesn’t make much sense to most people. At least gold has a tangible value that can easily convince you that banks that lend out against your gold deposits, which are supposed to be available at any time, are stealing from you.

38

Fair enough. That’s the kind of answer I can relate to. Sounds solid.

PS: Do you have any recommend reading regarding the above (in particular related to the Great Depression)? I’m guessing Hayek had a few words to say about this…

39

Here’s another aspect of the expansion/inflation problem I see with our monetary system, specifically Fractional Reserve Banking henceforth FRB, in the way money is created. Obviously the question, “then where does the money for interest come from?” seems the most looming of questions but I have another. It was proposed to me when I asked the question of what about inflation in respect to the money creation, specifically book entry money rather than real, physical Fed. notes of the mechanism to check rampant inflation. I was told by folks at the Atlanta Federal Reserve during a visit (interesting trip if you ever get the chance to any Fed. Bank) that interest rates were the check to inflation. Now for some time that satisfied me but in time it just never seem to total work the more I learned.

Along these lines in the early 1980’s I became interested in our federal tax system as much out of curosity but also self-preservation. The IRS and I not being drinking buddies at the time and continuing into the mid-90’s [:D] but as I studied not just tax law but through Freedom of Information Act filings of internal IRS workings I came to a personal conviction that the income tax as we know it is also and moreso the actual check on inflation but in an odd kinda way. This I would venture to say or what I’m about to say is not a widely held POV to my knowledge and being that the IRS and I have lived in happy harmony for the last 12 plus years, some aspects of this worked for me so at least from my end I was happy knocking down a few cold ones with the IRS. Most of the documentation I had to convey this point is now gone or buried somewhere in storage boxes and I know the suggestion almost seems conspiratorial in light of common thinking but I still believe there is an inflationary checking relationship between FRB and tax policy. The harvesting of money through debt payments and then the extracting of interest just doesn’t work for me at all. Especially when you consider a debt payment (say a monthly mortgage) becomes a asset on the bank books and therefore a new influx on reserves to which more money can be created and loaned out. On that scenario, where is the inflationary check? I’m not the sharpest knife in the drawer so if there are any sharper I’m all ears.

The only other central mechanism taking money out of the circulation is taxation and now that statement alone doesn’t make it the key to the kingdom. In the 1980’s during his first tenure in Congress, Ron Paul commented about our income tax system and specifically where tax dollars under the income tax went to once collected. At the time Ron made what I thought was an incredible if not unbelievable statement that “Congress has no idea where the money collected by the IRS for income taxes goes too!” Now at first I thought it was a slam to the dummies he worked with in Washington concerning wasteful spending until I got via FOIA all of Chapter 21 or 23 of the Internal Revenue Manual. (Sorry, it’s been years until this conversation and I’ve been playing a good little boy for the master) The IRM is a internal operations manual for the IRS and you can get them fairly easily or at least in the late 80’s you could. Chapter 21 or 23 covers the accouting practices within the agency when tax returns are processed and it was rather eye poping to me. To my shock it seemed to validate what Ron was saying. None of the money goes to Washington and the general fund as we think. There was even a section within Chapter 21/23 (sorry been to long to remember actual citing) where tax recepts collected were paid directly to the Agency for International Development (AID for short). If you just said “What the F----!” join the club, so did I when I read it. What is AID you ask?

AID is know known as USAID and I think it was a reorganization via Congress in 2000’ or 2001’ that did this, I don’t consider that important fact to this so therefore no link to source. Lookup USAID for yourself. Anyway USAID is an independent gov’t agency who’s currency arm is the Export/Import Bank. What is that? A 1934’ Corporation established by FDR http://www.presidency.ucsb.edu/ws/?pid=14772 whose function it was to promote the export of American goods and services through loans to foreign entities to purchase such. My view at this time was FDR saw this as a means of advancing the economy to help pull the country out of depression. Now those here with vast views different to that statement on the FDR Mussolini economic model (hope that makes you feel better) just sit tight. [;)] The point is not that at this time, FDR ain’t my friend either LOL! In 1961, Kennedy reorganized the Foreign Policy Act (Public Law, 87-195.75, codified in 22 USC sec. 2151) set in place in 1945’ and the Marshall Plan in which time AID or now USAID was created.

Here’s my skinny on all of this and obviously I’ve just barely skimmed the surface. 1913’ Federal Reserve created along with the 16th amendment income tax. Tax rate was low and limited as the money supply was also. Economy expanded or I should say money supply but in time it became evident this model like a ponzi scheme needs new blood to further it’s game. Keeping the game confined within national borders meant at some point a saturation point is met and meltdown because you’ve monetized everything. Remember, how is money pulled into being? Via the loan process and security is needed to do this and thus you monetize goods and property. Also gold and silver backing caused a crisis point of where the meltdown would accur so what’s the fix? Remove it from the picture!

Taking this economic model global allowed for 1 basic truism of economics (that’s IMO folks so take it for what’s it’s worth, maybe zero grant you) to be fulfilled. If you have to continue to expand the money supply to meet the interest payments (debt service)for which no money initally was created, over time inflationary pressure builds and you either have to contract to let everything settle at which point the masses will realize the game (gold and silver almost did this)or you expand into other markets which lets the overflow wash out and from which you are able to print more money for the current masses to meet debt payments with while monetizing across the globe.

At this point, I perceive the IRS and income tax as a federal collection plan designed to redistribute excess inflationary dollars within our own economy and thus transfer those dollars globally to monetize global assets to keep the whole thing going. We are the Fed. note factory and the globe our customer although the globe if you will. IMO we’re also into empire but that’s a whole other issue in itself. Now obviously, it would take lots of research and vastly more documentation than was given here to prove this seemingly crazy theory and I’m cool with those who consider it X-Filish and maybe it is. I’ll concede that potential. However, I present it as a means to provoke further thought of the relationship of a managed monetary policy that we completely and wholely accept when it comes to money creation and economic expansion but never, ever consider that taxation is also a part of that larger economic planning process. The 2 really go hand in hand and are not whole seperate entites in and of themselves but in fact left/right arms of the same body. JMO and thanks for listening or even rolling your eyes if you did that!

[;)]

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To start with, I think I basically agree with you - I’m simply going to go about explaining why in a round about way…

So, I’d have difficulty believing payments that you make to commercial banks would be an inflationary check since, as you say, these payments are simply used as reserves to make more loans. However I think there are two points in the system at which higher interest rates could have some effect on inflation - exactly what the magnitude of that effect is I’m not sure but here goes… Firstly the fact that there are higher interest rates means that people will be less inclined to borrow - as such less loans will be made and, as you know, in our current money system loans are the way money is created… so less loans = less money. Second, higher interest rates result in a higher net flow of wealth from commercial banks back to the reserve bank. Now in the US, the FED has a static dividend that it pays out to it’s shareholders of 6%… so if more money is flowing into the FED from the commercial banks then the FED is paying bigger nominal dividends to it’s shareholders (primarily these guys ARE the commercial banks from what I can tell) which is money that flows back into the system, but none the less only 6% of the money that flows in leaks back out… so all in all I think higher interest rates will slow inflation (as compared with lower interest rates that is, in which case loans are made willy nilly and money basically falls out of the sky).

Having said that, I don’t think most of the money that get’s created actually passes between the commercial banks and the central banks any more. From memory, around 90% of the Open Market Operations conducted by the FED concern either the purchase or sale of government bonds. So I suspect government expenditure plays a HUGE role in inflation. Most of the money that gets taken out of the system, it would seem, gets removed by way of the government buying back bonds (and vice versa)… and it’s not always the FED that is buying government bonds when money is being injected into the system - of late it’s often been the Chinese.

None the less, if you were to lump all the central banks in the world together though (the Chinese included), and consider them as the source of all new money creation, I think you’d end up with a picture of the world that more or less revolved around the central banks injecting money into the system as a response to the massive overexpenditure (and the resulting debt) of one or more governments who then “create” bonds which they sell to the central banks and voila - a whole crapload of cash rains down on the economy… all of which, as you noted, can only be financed by taxation.

If the above is true then this would imply that governments can:

a) Tax arbitrarily - someone has to pay back that debt and it’s taxpayers as usual. Even though you might not know it becuase Bush is pretending to give out tax cuts, behind your back he’s taxing at one of the highest rates in US history, he simply hasn’t given you the bill yet.

b) Governments can also create money and inflation, despite the fact that they are not officially the central bank… This is simply a consequence of the fact that they’re the biggest borrowers in existence and no one ever turns them down when they ask for a loan. Banks know that they’re promise to pay is backed by the forced labour of your children and their children after them… children who have the honour of working to pay back debts that were contracted before they were even conceived (which has certain moral implications I won’t go into here).

So essentially all of this is pretty much in agreement with what you were saying, that taxation is one of the primary mechanisms of dealing with inflation… but the only time it actually serves to counter inflation is when the government turns a surplus (e.g. New Zealand or Australia at the moment) and when they don’t spend their windfall (not the case in Australia and New Zealand - which explains their continuing high inflation), but instead use it pay off their debts.