2 + 2 = the Western Money/Banking System is Fatally Flawed

We are in a midst of an evolving financial crises and a Presidential campaign. Progressives take note. It is very unlikely it makes one iota of difference which of the leading Democratic candidates is elected. Consider how Bill Clinton repealed a centerpiece of the Roosevelt legacy, and who he did it for.

From F. William Engdahl’s article, The Financial Tsunami, Part III: Greenspan's Grand Design:

“Blankfein as most of Wall Street bankers and financial insiders saw the New Deal as an aberration, openly calling for return to the days J. P. Morgan and other tycoons of the 'Gilded Age' of abuses in the 1920's. Glass-Steagall, Blankfein's "aberration" was finally eliminated because of Bill Clinton. Goldman Sachs was a prime contributor to the Clinton campaign and even sent Clinton its chairman Robert Rubin in 1993, first as "economic czar" then in 1995 as Treasury Secretary. Today, another former Goldman Sachs chairman, Henry Paulson is again US Treasury Secretary under Republican Bush. Money power knows no party.

Before the ink was dry on Bill Clinton's signature repealing Glass-Steagall, the Greenspan fed was fully engaged in hyping their next crisis-the deliberate creation of a stock bubble to rival that of 1929, a bubble which then, subsequently the Fed would pop just as deliberately.

Clinton presented the pen he used in November 1999 to sign the repeal act, the Gramm-Leach-Bliley Act, into law as a gift to Sanford Weill, the powerful chairman of Citicorp, a curious gesture for a Democratic President, to say the least.”

Will any of the leading Democratic candidates be any different?

From Jim Willie, CB: Gold & Math on a Napkin:

“DAMAGE SUMMARY ON A NAPKIN"

PRIME MORTGAGE BOND LOSSES AT LEAST $2 TRILLION
SUBPRIME MORTGAGE BOND LOSSES TOTAL OVER $1 TRILLION
THE TOTAL MORTGAGE BOND LOSSES ARE OVER $3 TRILLION
THE OFFICIAL ESTIMATES ARE WRONG BY A FACTOR OF 10 !!!

For the longest time white collar crime has been minimized and tolerated. Rob a store of $500 with a gun and receive 10 years in prison. Rob a pension fund of $500 million with a pen and not even be indicted, let alone even be deemed in need of social isolation. Why are Wall Street bankers not being indicted for fraud? Of course, it makes sense. Because the banking system would collapse without their beneficence and key role steering the economy. We all need their guiding hands. And also, because they run the government prosecutor agencies, a minor fact. In the last month, when watching the debacle unfold, a mindboggling thought came. The criminals on Wall Street are designing the solution. Why is that? Only in America can perpetrators of fraud design solutions to the grotesque problems they caused. Not only that, they will probably administer the programs as part of the solutions, thus profit more.”

What did Willie mean when he wrote that “the banking system would collapse without their beneficence and key role steering the economy.”? It is difficult to explain in a convincing way, because the explanation requires a little math.

And often, when teaching mathematics to high school students, I say something, write it on the whiteboard, and heads nod, but 80% of the kids haven’t got a clue as to what I’m talking about. When I tell adults how the banking system works, that percentage rises to 99%.

But, Jim Willie’s “DAMMAGE SUMMARY ON A NAPKIN” inspired me to try once again to explain mathematically the fatal flaw in our monetary/banking system.

Consider the following spreadsheet, which I will explain below.

Assume one hundred people each have $10,000 available to deposit in a bank. There are ten banks, each completely empty of funds. The money supply is (100)(10,000) = $1,000,000. Pennies have been rounded off to the nearest dollar in the spreadsheet.

The people deposit their money all in Bank 1. Total deposits = $1,000,000. This is the total initial money supply. The bank has no money of its own.

The “reserve” requirement is 20%. That means the bank is permitted by law to issue loans of up to $80,000. Now get this. When the bank makes loans, none of the $1,000,000 of the depositor’s money will actually be lent out. It stays put right there in the depositor’s accounts. The depositors may continue to write checks and draw on the funds.

The $80,000 that the bank lends out begins life as a computer-bookkeeping entry, no more, no less. With the push of a button, the $80,000 worth of credit (new money) is created on a computer. This “money” is typically issued in the form of a cashier’s check or “bank check”, which the borrowers then go and deposit in their personal accounts at other banks.

This credit-money is just as real as the $1,000,000 belonging to the original one hundred people. At this point, there is now $1,800,000 in circulation.

The process of lending based on “reserves” may now be repeated at other banks where the $800,000 of new money is now on deposit. For simplicity, assume it is all deposited at Bank 2. This bank may now make loans in the amount of 80% of $800,000, and keep 20% in “reserve”. That is, loans of $640,000 may be created “out of nothing”.

Of course, the $800,000 remains in the depositors’ accounts, and the $640,000 in loans is all new credit-money. At this point, there is now $2,952,000 in circulation, in the “Cumulative Money Supply”, and banks have created all but $1,000,000 of it.

From the spreadsheet, you can see how the money supply grows as the borrowers deposit their money in Bank 3, Bank 4, Bank 5, etc. Even more interesting is the result when you consider what happens when all of these loans are repaid, with interest.

Again for simplicity, I made the assumption that all the loans were 30 year fixed-rate home mortgages at 5% interest. For example, the monthly payments for a total loan amount of $800.000 on those terms would be $4,295. After 30 years of such monthly payments, the borrower would repay the bank the $800,000 in “principle”, and interest payments of $746,046. The bank then deletes the original computer bookkeeping entry it made, that which created the $800,000 to begin with, and pockets the $746,046. Not a bad profit for lending money it never had to begin with, eh?

A key point to note here is that as each loan is repaid, the principle amount that was created to generate the loan in the first place, is wiped out. As all ten bank loans are repaid, the money supply will shrink back down to the original $1,000,000 that did not begin life as debt. That original $1,000,000 is what is called “debt-free” money, or “high-powered money” in banking jargon.

Now comes the problem. It is not enough for debtors to pay back the principle on the loan. They must also pay interest. At the bottom of the spreadsheet, you can see that as all the principle is paid back, the money supply will revert from $4,570,503 back to $1,000,000. But, below that you can see the money supply will revert from $4,570,503 to $-2,329,701 as all principle is paid back and interest is paid.

What the heck does that negative number mean??? It means that when the banks created the money for the loans, they did not create any money to pay the interest on the loans, and the money to pay the interest must come out of the original $1,000,000 money supply. By the “miracle” of fractional reserve banking, the interest payments are greater than the original money supply by $2,329,701. By making loans on so many times the original money supply, a situation was created in which it was mathematically impossible to repay the loans.

So how does the existing system work, or appear to work? Well, the implication is actually quite clear. The U.S. monetary situation is actually worse than what is portrayed in my spreadsheet. About 97% of all “money” in our system is debt, not high-powered debt free money. It is mathematically impossible for this debt to be repaid with interest. Long before it was all repaid, the money supply would drop to zero, and the economy would grind to a halt. In fact, the money supply would only have to drop by 10% or so and a deflationary depression would be triggered.

The obvious conclusion is that debts cannot be repaid. They cannot even be significantly repaid, or the contraction in the money supply will lead to a vicious circle and deflationary depression. This applies to Government national debt and personal debt alike. The "fleas" on the dog must be tolerated. But, debt cannot be rolled over forever either, because gradually increasing debt/income ratios will eventually also overtake the ability of borrowers to make payments.

The only “solution” is for the system to periodically collapse in a deflationary depression. In a depression, a large amount of debt is destroyed, in a sense rebooting the system and permitting the game to continue, kind of like the way Zion had to be destroyed periodically in the Matrix trilogy, to restore order to the symbiotic machine/man system. In essence, every once in a while the dog must die to kill the fleas.

These analogies are not altogether whimsical in that the money supply via credit-money creation must either expand forever like a fraudulent world-consuming pyramid scheme, or there must be loan defaults, bankruptcies, and depression to allow the system to reset.

The current artificially low interest rates are just a response to the fact that the system is on the verge of collapse. The low rates are an attempt to encourage lending, increase the money supply, and put enough new credit-money in the hands of debtors to permit them to continue paying their existing debts with even more borrowed money. In effect, only when the public is absolutely spent, and the system is on the verge of collapse, do the bankers offer help. And what generous help it is, indeed. They give debtors who cannot make payments on their existing debt of all things, handouts and more credit!!! Anything to preserve the big con.