Most people don't understand the world's monetary system or banking.  According to Henry Ford that's probably a good thing, since he believed that if they were made to understand it there would be a revolution the following morning.  He was probably right, but let's lift the veil and see what's under there anyway.  

Most people like to think of a bank as a warehouse for money.  They like to think of it as a place where they deposit money and then assume that the money is stored in a secure vault so that they could, if they so chose, go to the bank and ask for the money in cash and the bank would be obliged to give it to them.  That's the way banking should work.  It is not the the way, however, that it does work — not by a long shot.

Imagine that you have several very valuable Persian carpets that you need to store.  You might look for a reputable warehouse facility with good security and a climate controlled environment where you could store them.  If you return to the warehouse some time later to get your rugs, you would rightly be alarmed if the proprietor told you that the rugs are no longer there because he leased them out to a hotel for the rest of the year.  If that were to happen, you would call the police immediately and have the warehouse owner arrested.  No doubt he would be charged with either theft or embezzlement.   He would be tried and  quite possibly sent to prison.  In addition,  you would probably file suit to try to recover your carpets or at least their value from his business or personal assets. I don't suspect that many would argue that it should be otherwise.  The area of law that covers this type of relationship is called a bailment. You as the owner of the carpets are the bailor and the warehouseman, in this case, is referred to as the bailee. This contractual relationship transfers possession of the carpets, but not the ownership of them. Further, under ordinary circumstances, the bailee is not entitled to use the goods that are in his possession.  Yet when it comes to depositing your money in a bank, things do not work this way — far from it.

Unlike a warehouse, where you still hold title to the goods you have stored and those items are expected to be delivered into your possession upon request, banks are not governed by the same laws.  The money that you deposit into a bank becomes an asset of the bank. The bank is then considered to owe you the amount that you deposited, as though you made a loan to the bank.  By law, banks are only required to hold in reserve a fraction of the money deposited and are free to loan out the rest. This system is called "fractional reserve" banking and is now common throughout the world.

 The amount of money that has been deposited in a bank, plus the amount they have on their books as accounts receivable is called their Net Transaction Accounts (NTA).  The percentage of the NTA that must be held in reserve depends on the amount of money that the bank has on its books.  For banks that have NTA values of from $0 to $9.3 million dollars they are allowed to hold 0% of the money in reserve.  Banks that have over $9.3 million but less than $43.9 million must hold 3% of their depositors' money in reserve.  Banks that have over $43.9 million must hold 10% of their depositors' money in reserve.  Even these reserve funds are not kept in the bank.  A bank's reserves are actually a checking account that is kept with the Federal Reserve.  When compared with the laws that govern warehousing and pawn brokers, the banks actions  amount can be viewed as legalized embezzlement, on the one hand,  or the moral equivalent of counterfeiting on the other. 

The underlying theory behind this legalized embezzlement scheme is that not all of their depositors are likely to show up at the same time and ask for their money.  Normally, this is the case, which is why they continue getting away with it year after year.  However, when large numbers of  depositors do show up and ask for their money, it's called a "run on the bank" and the bank will either close its doors to try to avoid paying money out, or the bank will quickly fail, since only a small fraction of the money deposited in the bank is actually available.  The rest of the money has been loaned out to borrowers.  In fact, banks generally try to loan out as much as they are legally allowed to loan and when they can loan no more, the bank is said to be "loaned up." 

But the trail doesn't end there.  When someone borrows money from a bank they are generally issued a check which they then deposit in their own bank.  That money goes onto the books of that bank as an asset and, assuming it is a large bank, it may in turn loan out 90% (remember that 10% must be held in reserve for large banks) of the amount deposited from the first loan. Then that money is loaned and deposited in another bank and the cycle continues until the amount has been carved down to nothing.

While this pyramid embezzling scheme would be bad enough in its own right, recall that I likened it to counterfeiting as well.  Let's look at why this is so.  It turns out that about $9,000 worth of loans (if we follow the money trail through a series of banks) will be granted for each $1,000 deposited.  So where did the other $8,000.00 come from?  It didn't come from anywhere, it is money created, literally, from thin air.  The act of granting the loan creates the money, which is, in fact, just an entry in a banks ledger.  Creating money from thin air, does however increase the number of dollars in circulation. When you hear the phrase "increasing the money supply," this is what is meant.  When you increase the money supply, you create inflation, which appears to the common person as rising prices, but is, in reality, loss of value in each individual unit of money. 

Money, as it turns out, is simply a commodity like any other and when the supply of anything, whether it is  wheat, cotton, silver or money  is increased, its value is reduced.  The only difference is that when you reduce the price of other commodities, it is a boon to the consumer and serves to raise the standard of living.  When you devalue the dollar through inflation, it is a curse  that appears to be rising costs of literally everything and consequently lowers the standard of living.

In summary, through fractional reserve banking, banks are legally allowed to embezzle the money of their depositors, to lend that money to others in order to profit themselves, to create money in a way that is the moral equivalent of counterfeiting, and to increase inflation, thereby lowering the standard of living for all Americans. 

The practice of fractional banking should be outlawed, once and for all, and banks should be required to maintain 100% of their depositors' money in reserve.  They could earn a  profit by charging storage fees,  exactly as the warehouseman does and by selling other products such as checks. Bank runs would then be unnecessary, since people would be certain that their money could be requested on demand,  bank failures would cease, the money supply would not be increased through the practice of loaning up, and the resulting inflation that it causes would cease.

While fractional banking is morally equivelant to counterfeiting, ordinary banks do not literally print dollar bills.  For that you need the biggest of all banks, the Federal Reserve.  That will be the topic of a future article.

Today, Christina Romer, the top White House economic advisor, said that the effects of the stimulus bill were tapering off.   She went on to say that by the fourth quarter of 2009 the effects of the stimulus bill will no longer be  contributing to economic growth.  So where are the jobs? 

It's hard to say the words economist and progressive in the same sentence without a chuckle, and yet there are thousands of them being turned out by universities across the nation, just like the ones that Dr. Romer was training at the University of California, Berkeley.  If one listens to what progressives try to pass off as economics, one might believe that the recently enacted Stimulus legislation could create jobs — even if they are government jobs.  The truth is, however, that there can never be a net growth of jobs nationwide when created by means of government money.  Not in the past.  Not now.  Not ever.  The reasons are actually pretty simple and don't require an advanced degree in economics from Berkeley to comprehend. Yet they have been passing this fallacy of government job creation off on the American people for generations — and getting away with it.  It's time that we get a little wiser.

First, and most important, the government has no money that it has not taken from someone else (if you're thinking well, they can borrow or print it, we'll get to that in a moment.) The principle method for government acquisition of money is through taxation.   When they take money from one group of people to create government jobs for another group of people, those that were taxed have less money to spend and the prudent don't borrow money to buy things on credit.  Instead they  buy fewer clothes, fewer washing machines, fewer houses, fewer cars, and  less food.  This means that fewer people will be hired to make clothes,build  washing machines, houses and cars, and farmers will not make as much money from growing crops.  The jobs created by the government are offset by the jobs lost or not created in other sectors of the economy resulting in zero net growth in jobs at best. All that has been accomplished is that one group of people has been deprived of the use of their money, certain sectors of the economy fail to grow,  while another group benefits by receiving the money and other sectors of the economy grow.  The net benefit is like cutting the end off of a blanket and sewing it back on to the other end.   But wait, isn't that what's called redistribution of wealth?  Yes it is.  That's what the President told Joe the Plumber he wanted to do and that's exactly what he's doing.  But "growing the economy from the bottom up," as he puts it, makes as much sense as growing corn from the top down.  It has not worked, can not work and will never work except in the topsy turvy minds of progressives.  Yet having failed miserably the first time,  the odds are the Democrats will try to generate support for doubling down on this  fool's bet.

I told you I'd come back to the issue of the government borrowing or printing money to create jobs.  Borrowing or creating money for government job creation works even less well than taxation.  If the government borrows money from somewhere, say China, the American people will still have to pay the money back through taxation, but this time with a nice bit of interest tacked on to it.  The interest on the debt for the fiscal year ending in October 2009 is $383,363,826,680.60 — but who's counting. The good news is that this can't go on for much longer.  The bad new is that the reason is that United States is quickly becoming a subprime borrower and it's going to be hard to find lenders as foolish as Fannie Mae and Freddy Mac.  

The other method is printing the money (they don't actually have to print it, it's just an entry in an accounting ledger.)  This is an even more insidious form of taxation, but one that has worked well for the government since 1913 when the Federal Reserve was created. While it is truly sinister and evil beyond belief, one must give them high marks for having come up with a con that has lasted one hundred years without the public ever catching on.  When the  Fed creates "liquidity" (creates money out of thin air to give to the government through bonds) it pushes more money into the system (increases the money supply) , the result is that each individual dollar is worth less than it was before, but people don't see the value of the dollar go down, they perceive what appears to be the cost of products going up.  It doesn't matter if the products are houses, cars, milk, gold or oil everything looks like it's getting more expensive.  Wait, here's the beauty of the con — the people don't blame the government that caused the problem.  They blame the producers of the products for  raising prices and being greedy profit mongers.  Then the government is able to hold hearings to regulate them and raise their taxes yet further with full public support.  Now is that slick or what?  The effect on the economy is, however, recession and massive layoffs, but that's not what really counts in Washington.

Rarely will you find someone that understands wealth for what it actually is: surplus production. Beyond that though, wealth is the ladder that allowed mankind to climb above his savage, disease-ridden and brutal history to create the standards of living that Americans see around them every day, but take for granted. The reality is that even the poorest Americans live much easier, healthier, and longer lives than their ancestors of even 150 years ago.

In order to gain a clearer understanding of the true nature of wealth, it is only necessary to take a few short steps back to the days of the American settlers who founded this country. Imagine that you live, like some of the early settlers, at a subsistence level. You plant corn and some other vegetables and hunt a little game in order to survive. At the subsistence level, you have no wealth. Your only goal is to stay alive. And if you plan to live for longer than just that one year, you will need to set aside enough of your harvest to provide you with seeds to plant again the following year. Thus, you have some savings; but if you consume that seed now, you will likely perish following year. Again, you have no wealth, but you can afford to continue living.

If through planning, forethought, and lots of hard work you are able to grow more crops than you can consume, have enough seed to plant again the following year, and still have surplus, then you have acquired some wealth. Wealth is created by the hand of the producer and is nothing more than surplus goods. With a portion of the wealth you created, you could trade for a pair of shoes, clothes or tools. These items would then represent the surplus you created during the year by your own efforts. Perhaps you had enough foresight to expand your fields, plant more seed, and the following year you have even larger surplus (wealth) that you could use to barter for other goods. This is the method by which wealth was once created, and it remains the way that honest men create it today: through planning, forethought, and hard work at some gainful employment, enterprise, or industry.

In the days of the early settlers, however, people often bartered the actual surplus commodities that they produced with others who had produced different commodities that they either needed or wanted. Honest men traded value for value with others who were willing to trade. The concept of trading value for value between honest and willing people is the root idea of the economic system known as capitalism.

In addition to barter, early colonists also used gold and silver coins and particularly Spanish dollars, known as Pieces of Eight, so called because they were often divided into eight bits for smaller transactions. They traded gold and silver coins for labor, food, tools, lumber, tobacco, and other products. The coins, just like any of the other goods for which they traded, represented the surplus that was produced. Thus, they represented wealth. Gold and silver coins became widely used as a means of storing wealth because they were of known weight, purity, value, durability, easily divisible, easily aggregated, and easily portable.

As the colonists acquired wealth, the person that produced it was able to raise his standard of living beyond that of mere subsistence. Furthermore, when that wealth was traded, value for value, with others in the community, it served to raise the standard of living of the persons to whom it was transferred as well. As the trading continued within the community, and ultimately the nation, the standard of living was raised for all of the participants in the trading network that developed. In this way, through hard work, innovation, and the production of surplus goods, coupled with free trade among willing participants, the standard of living continued to grow to the point where we stand today — poised precariously on the precipice of history.

For those who have read this far, I'm sure most of you think, "Well that was simple. Everybody knows that." The sad truth is that while the basic principles of capitalism and wealth are indeed simple, it seems that very few people today actually do understand it; and of those that do, many would dispute it. If you actually did know and believe it, then congratulations. Start explaining it to as many others as you can. When you hear statements such as this one by Barack Obama on October 8, 2008, "We need policies that grow our economy from the bottom-up, so that every American, everywhere has the chance to get ahead," ask yourself how that fits into the definition of capitalism and the creation of wealth as described earlier in this article. How can one create a robust economy based on the upward flow of wealth from those who live below the subsistence level and who produce nothing while consuming the wealth of others. The short answer is that it can not, so long as those people continue to be held in the state of welfare bondage where they are neither encouraged or expected to produce anything of value.