“Multiplied Reserve Banking” & a “Promise-Based Monetary System”

“Multiplied Reserve Banking” & a “Promise-Based Monetary System”




Conventional View of Fractional Reserve Banking

This article advances an hypothesis that’s both new and unclear–at least, to me.  The article is overly long (3,700 words) because I’m not only trying to explain my hypothesis to you, I’m also trying to explain it to myself.
In the process, I use numbers in this article, but those numbers aren’t intended to accurately reflect reality—they’re only intended to illustrate principles relevant to my hypothesis.

I’m not claiming that this hypothesis is true. In fact, it might be seriously flawed or even absurd.  I’m only claiming that it might be interesting and even roughly correct.



Most people don’t understand that we live in a financial world characterized by:

1)  “fractional reserve banking”; and,

2)  a “debt-based monetary system”.

Neither of those two concepts are well-understood by most people.  The term “fractional reserve banking” might be vaguely recognized by most people, but seldom understood.  The term “debt-based monetary system” hasn’t even been heard of by most people and isn’t understood by even one in a thousand.

Insofar as we recognize either term, we tend to regard them as two distinctly different, and unrelated concepts.

But I begin to see that those two concepts are no more unrelated than the two sides of a coin.  In fact, I begin to suspect that neither characteristic could exist without the other and that, together, they comprise the backbone for the current financial system of the US, the world, and perhaps even the New World Order.


I’ll try to explain my suspicions in relation to a couple of excerpts from a recent article published by The Fiscal Times (“The Liberal Solution to America’s Big Spending Problem”).

According to that article, Thomas Hungerford, senior economist and director for budget and tax policy at the left-leaning Economic Policy Institute, recently issued a new paper.  In that paper, Hungerford argued that the U.S. government is not “broke” (as claimed by many conservatives) and can raise enough tax revenue to pay for future spending needs, including important additional investments in infrastructure and education—without going deeper into debt.

In this article, I’ll propose the seemingly incredible hypothesis that government doesn’t want to “raise enough tax revenue” to pay all of its bills and instead prefers to fund government programs by going deeper into debt.



Soak The Rich

•  According to Mr. Hungerford,

“While the federal government is projected to run deficits far into the future, the U.S. economy is projected to generate substantial amounts of income growth far into the future. This means the real fiscal challenge is simply the political problem of raising revenues that are sufficient to meet our spending needs.”

Hungerford’s solution is to raise taxes on the super-rich.  However, he believes the super-rich won’t be required to pay higher taxes so long as Republicans control the House and Senate.  According to Hungerford, the problem isn’t a lack of potential revenue; it’s a lack of political will within the Republican-dominated Congress to soak the super-rich.

That argument makes sense, but is it true?

Maybe not.



A Need For Debt?

Maybe government doesn’t need more tax revenue, but instead needs more debt to stimulate our economy.  Maybe government’s refusal to raise taxes isn’t evidence of a lack of political will, but rather evidence of intelligent, political intent.  Maybe debt is more valuable to our economy than tax revenues.

Does that notion sound irrational to you?  Well, it does to me, too.

But under the correlative premises of:

1) a “debt-based monetary system”; and,

2) “fractional reserve banking,”

—it may be entirely logical for government to value debt more highly than tax revenues and therefore seek to restrict tax revenues in order to “force” government to borrow more to fund government programs and thereby maximize the debt.




•  Debt-based monetary system: Before you dismiss my hypothesis as absurd, note that we already have a “debt-based monetary system” wherein debt (a mere promise to pay rather than the actual payment of a tangible asset) is deemed to be an asset.  Under that premise, paper debt-instruments (like stocks, bonds, pension funds, bank accounts, mortgages, invoices, etc.) can be treated as tangible assets and therefore can be used by banks as collateral to justify more loans.
That’s the critical consequence of a “debt-based monetary system”:  being able treat debt (mere promises to pay) as actual assets (payments).

Historically, banks demanded tangible assets (like gold, silver, land or buildings) as collateral to secure loans.  Today, under our “debt-based monetary system,” banks can treat paper debt instruments (mere promises to pay) as if they were tangible assets.

Given that paper debt instruments can now be treated as assets, the idea that government might value debt more than tax revenues may not be so implausible.



Fractional-Reserve Banking

Fractional-reserve banking allows banks to keep only a “fraction” of wealth deposited by depositors as “reserves” in the banks vaults.

If a man deposits $1,000 in a bank, the bank doesn’t need to keep the entire $1,000 in its vault. Instead, the bank is only liable to keep $100 (a “fraction” of the deposit) on hand in the bank vault and can therefore lend the other “fraction” ($900) to consumers who will spend their borrowed currency on flat-screen TVs, automobiles and homes and thereby stimulate the economy.

Fractional reserve banking is justified by the fact that, statistically, only a relatively few people withdraw all of their deposits from a bank on any given day.  I.e., it would be arguably wasteful to deposit $1,000 into a bank account if the entire $1,000 had to be held by the bank and none of it could be loaned to consumers to strengthen the economy.

Without fractional reserve banking, banking would be a drag on the economy.  If 100% of every dime deposited had to be kept in the bank, every deposit would take money out of the economy, shrink the money supply, and thereby help precipitate an economic depression.

More, fractional reserve banking is the antidote to hoarding your cash or gold under your bed or buried out in the backyard.  Fractional reserve banking gets 90% of the money you’ve earned and saved in some hidey-hole out into a bank, and then back out into the economy.

By themselves, a debt-based monetary system and fractional-reserve banking may seem a little strange, but in combination, the two concepts are powerful to the point of being sorcery.



Fighting Waste and Taxes

“Hungerford also blames groups like Citizens Against Government Waste which reject tax increases based on their claim “that waste, fraud and abuse alone east up almost half of every tax dollar.”

Most people would agree that excessive government waste should be stopped before government is allowed to borrow more currency.  If government has some good ideas that should be implemented by legislation, they should fund those good ideas with whatever is saved by cutting waste—right?

In a rational world, excessive waste is stupid, wrong and even ungodly.

But we don’t live in a rational world.  We live in a world where a “debt-based monetary system” and “fractional reserve banking” are deemed normal and wise.

Under fractional-reserve banking, it’s been presumed that the bank’s depositors deposit wealth into banks’ vaults.  The banks need only keep, say, 10% of those deposits on hand to deal with usual withdrawals, and can lend out the other 90% to borrowers and profit from the interest on the bank loans.

But, what if the banks could buy debt-instruments (like US bonds) and add those purchases to their bank vault?  Then, in theory, using those US bonds as collateral, the banks could lend nine times the face value of those bonds.

Why?  Because under fractional reserve banking, there’s a 1 to 9 ratio of assets held in “reserve” in the bank to currency loaned out to borrowers.  The $1,000 deposited by a customer was divided into two fractions on a 1 to 9 basis.  10% stayed in the bank vault; 90% was loaned out to the public.

But today, the banks may still use the 1 to 9 ratio, but they don’t divide deposits on the 1 to 9 ratio—they multiply those deposits.  Where a bank once was allowed to loan $900,000 (90%) of a $1 million deposit, they can now lend $9 million based on a $1 million deposit.



The Profit Motive

Let’s compare how much currency a bank could loan based on customer deposits.

Let’s suppose that the people in a community deposited $1 million into a bank.  Under fractional-reserve banking, the bank would have to keep $100,000 in “reserve” in the bank vault and could lend the other $900,000 to local borrowers.

The bank might charge 10% interest ($90,000) on the $900,000 that was loaned out to consumers.  The bank might pay 5% annual interest ($50,000) to those who deposited the $1 million. Thus, the bank might net $40,000 per year on the $1 million deposit.

Note that no currency is created in this scenario.  Local depositors deposited $1 million; the bank loaned out $900,000.  90% of the $1 million deposited is put to good use, but it’s not multiplied.



Multiplied Reserve Banking

Now, let’s suppose that the bank bought a $1 million US bond (paper debt-instrument) and the bank deposited that bond as an asset into its vault.  In our brave new world of fractional-reserve banking, the bank could lend nine times the $1 million face value of that bond to the public.


Based on that $1 million bond, the bank could now lend $9 million to the public
Get that?  Instead of $900,000 for loans, the $1 million deposit generates $9 million in loans.

If the public deposits $1 million into the bank, the bank can lend 90%—a fraction of that deposit to the public. The public deposits are divided into the 90% fraction hat can be loaned to the public and the 10% that must be held in the bank vault.  That original form of “fractional reserve banking” might more accurately be referred to as “divided reserve banking” since every deposit was divided into 10% and 90% “fractions”.

But, if the bank deposits a $1 million US bond into the bank vault, the bank can then lend $9 million to the public. The $1 million deposit is not divided (10% withheld; 90% loaned), it is multiplied ($1 million withheld; $9 million loaned).

Thanks to this multiplication, the bank will have created 9 million fiat dollars.  This act of monetary multiplication and subsequent lending will both inflate the currency supply and stimulate the local economy.



•  Compare the potential interest income that might be received by the banks:

If the public deposits $1 million, the bank pays $50,000 per year in interest on those deposits and lends $900,000 at 10%, the bank nets about $40,000.

If the bank deposits its own $1million US bond and keeps that $1 million in the vault, it can lend $9 million at 10% annual interest and thereby net $900,000 in interest payments. In theory, that’s a 90% annual return on investment.

If the public deposits $1 million cash into the bank, the bank might make $40,000.  If the bank deposits a $1 million bond into the bank vault, the bank might make $900,000.  Which $1 million do you suppose the bank wants more—your actual cash deposits or the government’s debt instruments?



•  If the bank lends 90% of the $1 million deposited by the public, no currency is created. The $1 million in deposits reflects the real wealth that has been earned by dint of hard work and industry and saved (not created/spun) by local depositors.

Because the local currency supply is not increased, the local economy isn’t “stimulated”.  The bank merely manages the $1 million in deposits to see that they’re wisely invested in the best interests of the local community.

If the bank lends $9 million based on a $1 million US bond deposited into the bank, the bank will have created and added $9 million into the local economy.  The result should be economically “stimulating”.



•  Do you see what the banks have done?

Historically, under “traditional” fractional reserve banking, the banks had a 1 to 9 ratio that said 10% of the public’s deposits had to be “reserved” in the bank’s vault, and 90% of those deposits could be loaned out into the community.  The $1 million in public deposits was divided into two fractions (10% withheld and 90% loaned).  Thus, “fractional reserve banking” might be more accurately described as “divided reserve banking” or even “divided deposit banking”.

But under the new-and-improved “multiplied reserve banking,” they kept the 1 to 9 ratio, but instead of dividing deposits into 90% to 10% “fractions,” banks are now allowed to lend 9 times the face value of their own deposits.  These deposits are no longer divided into fractions, but are multiplied.  The 1:9 ratio no longer applies as a “fraction” of deposits, but is instead a multiplier of deposits.

Instead of describing today’s banking system as “fractional reserve banking,” is might be more accurate to describe it as “multiplied reserve banking” since the banks can apparently multiply its deposits by a factor of nine.



Promise-Based Monetary System


The debt-based monetary system allows banks to treat debt-instruments as collateral.  That capability is essential to “multiplied reserve banking”.  We can deposit debts (mere promises to pay; not real assets) into bank vaults and then multiply the face value of those debts to create (spin) apparent assets of fiat dollars.

Without a debt-based monetary system, the “multiplied reserve system” couldn’t work.  Banks couldn’t create fiat dollars out of thin air unless debts were recognized as assets. But, together, these two concepts allow banks to “spin” apparent wealth out of thin air.  In combination, “debt-based money” and “multiplied reserve banking” allow The Powers That Be to seemingly create wealth (or at least economic “stimulation”) by going into debt.

How can this be?  It’s easy.  Debt is nothing but a promise to pay.  Promises are easily created.  Today’s bank vaults don’t generally contain real assets (like gold, which can’t be artificially created or spun out of thin air) but are instead filled with nothing but promises to pay (which can be “created” with the stroke of a pen).

Thus, our “debt-based monetary system” might more accurately be described as a “promise-based monetary system” which, in conjunction with the “multiplied reserve banking,” allows bankers to “spin” apparent wealth (fiat dollars) out of the “thin air” of mere promises.

How hard would it be for me to earn $1 billion?  Very.

How hard would it be for me to promise to repay $1 billion.  Nothing to it.  Just sign my name to a piece of paper.  “I.O.U. $1 billion”.  Easy.  If the banks could use my $1 billion I.O.U as collateral to justify lending another $9 billion to customers, they’d eagerly accept and validate my $1 billion promise as valuable, even if I had no more chance or keeping that promise than I had of living to be 200 years old.



Liar Loans

Don’t forget that, prior to the Great Recession, banks happily issued “liars loans” to Americans who lied about their incomes in order to get bigger loans and bigger homes—but had no chance to repay their bigger mortgages.

It didn’t matter that these “liars” couldn’t repay their loans.  What mattered was that the “liars” signed on the line to create a debt-instrument (note and mortgage; a promise to pay) for, say, $200,000, that could be used as collateral by US or even foreign banks to justify lending up to $1.8 million to other consumers.

Thanks to “multiplied reserve banking” and “promise-based monetary system,” the banks eagerly sought promises to repay (debt-instruments) from even people who were recognized as never being able to actually keep their promise to repay.  It didn’t matter that the lying borrowers could never actually repay their loans.  All that mattered was that the liars created a paper promise to repay that could be used as collateral to lend nine times the face value of the promise to pay.



•  Today, as with the previous liar-loans, so long as we have a “promise-based monetary system” and “multiplied reserve banking,” it doesn’t matter if government can’t ever repay its bonds. It doesn’t matter if the US government can’t repay its $18 trillion ($200 trillion?) national debt.  It doesn’t matter that Greece can’t repay its $300 billion national debt.

All that matters is that no one repudiates its promises to repay.  So long as Greece continues to promise (even if its promises are obvious lies) to repay its $300 billion in liar-loans . . . so long as the US gov-co continues to promise (even if its promises are obvious lies) to someday, somehow repay the national debt . . . then, those promises are presumed to be valid and all of the billions or trillions of fiat dollars and euros that were “multiplied” into existence based on those promises need not be repudiated.



•  I begin to suspect that, under the twin premises of “promise-based monetary system” and “multiplied reserve banking,” nobody really cares if the debts are paid. It doesn’t matter if government can ever keep its promises to repay the national debt.  But if either of those two premises fails, the whole racket will implode.

What matters is that government goes deeper into debt in order to create and sells its bonds (promises to pay), that those promises be used as collateral by banks under multiplied reserve banking to allow up to nine times as much fiat currency to be created and loaned to the public to stimulate the economy.  Thanks to a promise-based monetary system and multiplied reserve banking, the more bonds (promises to pay; debts) government sells, the “richer” the US becomes.

Thus, we might reasonably conclude that government would rather go into debt than collect more tax revenues.  The tax revenues can’t be multiplied by private banks but the debt-instruments can.

On the one hand, this is a brilliant scheme that’s worked for several generations.

On the other hand, this is a Ponzi scheme that will inevitably implode when the world either stops buying US promises to pay (bonds) or refuses to participate in “multiplied reserve banking”.



Lower Taxes

Hungerford described the U.S. as one of the lowest-taxed developed countries in the world.

In a world of promise-based currency and multiplied reserve banking, taxes that are too low to pay for government spending are not irrational

Low taxes + big government = big debt.

Under the bizarre hypothesis I’ve advanced concerning the “promise-based monetary system” and “multiplied-reserve-banking,” low taxes make sense since the result is more deficits, more government debt, more debt-instruments to be used as collateral by banks to issue up to nine times the face value of the debt-instruments.



Method to the Madness

The public believes that our rising deficits are due to fiscal incompetence and mismanagement by Congress and the Federal Reserve.

But, is the government really “incompetent”?  Or, is it acting logically under the combined premises of a promise-based monetary system and multiplied reserve banking to stimulate the economy by going into ever deeper debt?

To what extent are rising government deficits (debts) truly due to government mismanagement and to what extent are rising deficits the intentional act of a system that depends on creating more debt instruments that banks can use as collateral to lend nine times face value of those debt-instruments to the public?



•  For example, US military programs are black holes for currency. Billions of dollars routinely “disappear”.  But are the military programs primarily intended to fight terrorists and foreign adversaries?  Or are they primarily intended to be patriot-supported means to generate more debt instruments that banks can use to create fiat dollars to stimulate the US and even foreign economies?

If that question seems absurd, remember that President G.W. Bush not only refused to raise taxes during his administration, he also lowered them.  The economy seemed “stimulated” by lower taxes.

But was the stimulation really caused by lower taxes?

Or was that stimulation due to larger government deficits, greater government debt, more government borrowing, the creation of more US bonds that (in our promise-based monetary system) could be used by banks as collateral that (in a multiplied reserve banking system) could be used to lend nine times the face value of the bonds—and thereby “stimulate” the economy?



The Money Tree

In combination, the “promise-based monetary system” and “multiplied reserve banking” are a little like having a checking account where, every time you write a check, the bank adds nine times the face value of your check to your account.  I.e., if you write a check for $100, the bank adds $900 to your account.  If you write a check for that $900, the bank adds another $8,100 to your account.  If you write a check for $8,100, the bank adds $72,900 to your account. . . .

Pretty cool, hmm?

But how long could such a Ponzi-scheme last?

How long before the people you’re paying with checks begin to realize there’s something fishy about your financial premises and stop taking your checks?

How long do you suppose you could support yourself (and stimulate your local economy) by simply going deeper and deeper into debt?  How long could you do so before you became bankrupt?

Similarly, how long can our big government go deeper and deeper into debt before it (like Greece) has to admit that it can’t keep its promises (pay its debts), goes bankrupt, and collapses the whole Ponzi-scheme?