The Federal Reserve Act of 1913 made law a fractional reserve money creation system: private banks create new US money when they exchange their own IOU-future-value notes, called Federal Reserve Notes, for an IOU from either the public or the government.

When the Fed system was first established it was genuinely a reserve system, with gold (and a little silver) as the reserve. The individual banks with the power to create new money had to maintain a reserve of gold bullion equal to 5–18 percent.27 For every one dollar worth of gold they kept on hand, they could issue their own IOUs promising to produce six to twenty dollars’ worth of gold on demand. However, it took only 16 years to go through irrationally exuberant money creation to the crash of 1929 and a decade of tight-money depression. This tells us the gold reserve requirements were not an effective constraint on the banks.

The central Fed maintained a ratio of Gold Certificate reserves to Federal Reserve Notes and deposit liabilities that slowly dwindled from 88 percent in 1914 to 27 percent in 1967. Recording this measure was discontinued at that time, and three years later we went off the gold standard, which had required keeping a percentage of gold on reserve as collateral for bank promises. This shifted the burden of guarantee completely from the private banks to the common wealth of the nation. An over-controlling government did not make this move; it was made under pressure from bankers.

Today, the law has been amended so the system functions more like a no-reserve, no-limits system – particularly for the large banks that control most banking business and money creation. Community banks still have to meet some prudent reserve requirements, making it harder for them to compete and stay in business and pushing us toward an increasingly monopolistic banking sector.

How coins and cash are manufactured and then turned into money by entering them into the economy at their face value is covered in the next section. Here’s how the rest, roughly 97 percent of our money is created under the Federal Reserve Act.

How it works

When you go to the bank for a loan, you pledge the income from your work in the future. You may guarantee you will pay by pledging wealth you have now as collateral (e.g., the equity in your home, your car, or stock or bullion certificates). The bank takes your IOU, and loans you money. It does not have the money it loans to you; it creates it for you. Some economists call this book money or sight money – now it’s on the books; now you see it.

The amount of your loan is its face value. The bank enters the face value of your IOU as an asset on its balance sheet. Then with a few keystrokes, it enters a matching amount into your account. The bank is pledging to produce that amount at any time for you. You give the bank your IOU and the bank gives you its IOUs (Federal Reserve Notes). In the bank’s accounts, there is an IOU from you entered as an asset of the bank. And there is the bank’s IOU of the cash or digital equivalent it must produce on demand entered as a liability. On the bank’s balance sheet it nets out: You Owe Me = IOU.

Assume that you took no other action, and your loan money is just sitting in your deposit account. If you authorized the bank to take the money and pay back the loan, the bank would cancel your IOU and cancel its own IOU to you. Ignoring the interest you owe, the accounts would be back to net zero. The money the bank created for you would vanish and the money supply would shrink by that amount.

But for an individual, taking out a loan and paying it back takes place over time. If we just look at one person’s borrowing and then spending, we lose sight of the overall creation and extinction of the money supply. An individual’s borrowed money is likely out in the economy circulating, returning to the bank as people transfer money or pay back their own loans.

In terms of money creation and destruction by the bank, the system works in aggregate. Banks have IOUs from many, many people on the asset side of their ledgers. They have deposits constantly moving in and out of accounts and between other banks. These deposits are liabilities; the bank has to produce this money on demand. Banks are constantly juggling all these IOUs and you-owe-me’s so that they are able to meet their obligations and make as much money as possible. If everyone paid back their loans at once, there would be no money in the system, and there would be no money to pay interest. But, it doesn’t happen at one time. All the money circulates. And in our system, the banks continuously grow the money supply so that they can extract interest on the money they’ve created. If they did not increase the supply of money, the interest would have to come from the pool of other people’s borrowing that makes up the general money supply, diminishing the amount of money available for general transactions.

Are there limits on money creation?

In practice: no reserve requirements

Fractional reserve bankers have been gaming this system for hundreds of years. They are very good at it. Under The Federal Reserve Act, bankers continue at this game; they’ve just gotten better at hiding their games in nests of companies, derivatives and fancy financial instruments.

The Fed itself says reserve requirements today affect less than 10 percent of the money supply and, “the tight link suggested by the multiplier between reserves and money and bank lending does not exist.” 28 Over several hundred years, bank money creators have successfully convinced lawmakers reserves are excess money that is not being fully utilized in the economy. They call the reserves a waste and inefficiency needing remedy.

Effective January 2018, the law requires no reserve on deposits (bank promises) up to $16 million, 3 percent from $16 million to $122.3 million, and 10 percent for more than $122.3 million.29 But, banks can count the vault deposits they would need anyway to manage their ATM and cash withdrawals, as reserve – because multi-tasking money is efficient. They have used the central banking system, and jiggered the law so they can reduce their reserves even further.

Here’s an example of how banks get around reserve requirements today: under current US law there are different reserve requirements for different kinds of accounts. Ordinary deposit accounts have the highest reserve requirements. Money market accounts do not require any reserves, as they are considered investment accounts even when they are also used as checking accounts.

Bankers have figured out that if a second or two before it is time to do their daily accounting of how much reserve they need to have on hand, they move the balances in their deposit accounts (10 percent reserve) into a money market account (zero percent reserve), then they don’t need to have reserves for that money. After the calculation of reserves and reporting, another accounting entry moves the funds back into the deposit accounts. This is called a daily sweep, and is just one example of the legal capers that virtually eliminate the need for reserves and make a mockery of a reserve requirement.30

In practice: inadequate capital requirements

Capital or equity requirements are still in place. By 2019, bankers must total up their assets, and meet a ratio of $8 in equity for every $100 in new money they have created against IOUs. But, bankers have written our laws so they can weight assets based on their own judgment of risk, or on the judgment of a ratings agency whose services they buy – a conflict of interest that played a role in the 2007 market collapse.


US banks have been slowly stepping up to meet these requirements using US accounting standards. However, using European accounting standards, which do not allow as much off-balance sheet activity, our banks are still closer to 4 percent equity. For example, Forbes reported that by US accounting standards, JPMorgan Chase, the largest commercial bank in the US (2012), had $103 billion in equity for $2,292 billion in assets – a 4.5 percent ratio of capital to assets. However, the $2,292 billion was only what US law requires be reported. JPMorgan had another $1,660 billion in assets that they were keeping off their books.31

If JPMorgan had been required to use recommended international standards, they would have needed to report an additional $1,660 billion in assets. On their books, this $1,660 billion would cut their capital ratio to 2.6 percent – a stunning ratio of reported assets to hidden assets: 2,292 to 1,660. Forty-two percent of their total assets were hidden off their books!

This capital ratio means that if in 2012 JPMorgan’s juggling of incoming and outgoing IOU-future-value promises had been deficient by more than 2.6 percent, the bank would have been insolvent. Hardly prudent in a money system that gives the power to create a nation’s money to these bankers, tying the well-being of the national economy to their choices. That 2.6 percent is pretty close to nothing by any reasonable standard, and is considered representative of most of the big global banks.


Again as noted in Chapter 4.35, in addition to moving assets off balance sheet, banks have a great deal of freedom to define what constitutes an asset to meet this requirement. For example, banks can include goodwill as an asset. JPMorgan Chase in 2014 meets its 8 percent requirement by counting $48 billion in goodwill as part of its $232 billion in common shareholder equity. Goodwill is 21 percent of their equity!32 If they are insolvent and defaulting on their promises, what good will goodwill do? It will evaporate.

Goodwill should not be a bankable asset on the balance sheet of a bank. Imagine going to your banker for a loan and listing goodwill valued at one fifth of your total net assets. You could smile all you want and bring in your membership to Rotary and the PTA, and the bank would dismiss this line item as nonsense. It would be no guarantee you could meet your loan obligations. Yet, bankers have successfully written our laws to allow them to include this as a line item on their own books.

However assets are counted, 2–8 percent skin in the game isn’t much in a system designed to be volatile with routine asset bubbles and busts swinging well beyond 8 percent.

Real limits?

In practice, there are hardly any limits on how much new money bankers create with their lending. They are only limited by their mood. When they are confident, they make more loans; when they are not confident, they stop making loans. This means the supply of money in our economy is the result of the mood swings of bankers. Most decision-makers in the financial sector are men. When they win, their testosterone goes up and they are more inclined to take more and bigger risks. When they lose, their testosterone goes down and they become risk averse. Our economy is jerked around by these hormonal swings (Chapter 6.63).

The privilege and power of money creation gives the banks and the people in positions of power within them an unprecedented edge in the marketplace.

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