[R-G] [BillTottenWeblog] Borrowing from Peter to Pay Paul

[Bill Totten]

The Wall Street Ponzi Scheme called Fractional Reserve Banking

by Ellen Brown, webofdebt.com

Global Research (January 03 2009)


Cartoon in the New Yorker: A gun-toting man with large dark glasses,
large hat pulled down, stands in front of a bank teller, who is reading
a demand note. It says, "Give me all the money in my account".


Bernie Madoff showed us how it was done: you induce many investors to
invest their money, promising steady above-market returns; and you
deliver - at least on paper. When your clients check their accounts,
they see that their investments have indeed increased by the promised
amount. Anyone who opts to pull out of the game is paid promptly and in
full. You can afford to pay because most players stay in, and new
players are constantly coming in to replace those who drop out. The
players who drop out are simply paid with the money coming in from new
recruits. The scheme works until the market turns and many players want
their money back at once. Then it's game over: you have to admit that
you don't have the funds, and you are probably looking at jail time.

A Ponzi scheme is a form of pyramid scheme in which earlier investors
are paid with the money of later investors rather than from real
profits. The perpetuation of the scheme requires an ever-increasing flow
of money from investors in order to keep it going. Charles Ponzi was an
engaging Boston ex-convict who defrauded investors out of $6 million in
the 1920s by promising them a 400 percent return on redeemed postal
reply coupons. When he finally could not pay, the scam earned him ten
years in jail; and Bernie Madoff is likely to wind up there as well.

Most people are not involved in illegal Ponzi schemes, but we do keep
our money in accounts that are tallied on computer screens rather than
in stacks of coins or paper bills. How do we know that when we demand
our money from our bank or broker that the funds will be there? The fact
that banks are subject to "runs" (recall Northern Rock, Indymac and
Washington Mutual) suggests that all may not be as it seems on our
online screens. Banks themselves are involved in a sort of Ponzi scheme,
one that has been perpetuated for hundreds of years. What distinguishes
the legal scheme known as "fractional reserve" lending from the illegal
schemes of Bernie Madoff and his ilk is that the bankers' scheme is
protected by government charter and backstopped with government funds.
At last count, the Federal Reserve and the US Treasury had committed
$8.5 trillion to bailing out the banks from their follies {1}. By
comparison, M2, the largest measure of the money supply now reported by
the Federal Reserve, was just under $8 trillion in December 2008 {2}.
The sheer size of the bailout efforts indicates that the banking scheme
has reached its mathematical limits and needs to be superseded by
something more sustainable.

Penetrating the Bankers' Ponzi Scheme

What fractional reserve lending is and how it works is summed up in
Wikipedia as follows:

"Fractional-reserve banking is the banking practice in which banks keep
only a fraction of their deposits in reserve (as cash and other liquid
assets) with the choice of lending out the remainder, while maintaining
the simultaneous obligation to redeem all deposits immediately upon
demand. This practice is universal in modern banking ... The nature of
fractional-reserve banking is that there is only a fraction of cash
reserves available at the bank needed to repay all of the demand
deposits and banknotes issued ... When Fractional-reserve banking works,
it works because:

"1. Over any typical period of time, redemption demands are largely or
wholly offset by new deposits or issues of notes. The bank thus needs
only to satisfy the excess amount of redemptions.

"2. Only a minority of people will actually choose to withdraw their
demand deposits or present their notes for payment at any given time.

"3. People usually keep their funds in the bank for a prolonged period
of time.

"4. There are usually enough cash reserves in the bank to handle net
redemptions.

"If the net redemption demands are unusually large, the bank will run
low on reserves and will be forced to raise new funds from additional
borrowings (eg, by borrowing from the money market or using lines of
credit held with other banks), and/or sell assets, to avoid running out
of reserves and defaulting on its obligations. If creditors are afraid
that the bank is running out of cash, they have an incentive to redeem
their deposits as soon as possible, triggering a bank run."

Like in other Ponzi schemes, bank runs result because the bank does not
actually have the funds necessary to meet all its obligations. Peter's
money has been lent to Paul, with the interest income going to the bank.

As Elgin Groseclose, Director of the Institute for International
Monetary Research, wryly observed in 1934:

"A warehouseman, taking goods deposited with him and devoting them to
his own profit, either by use or by loan to another, is guilty of a
tort, a conversion of goods for which he is liable in civil, if not in
criminal, law. By a casuistry which is now elevated into an economic
principle, but which has no defenders outside the realm of banking, a
warehouseman who deals in money is subject to a diviner law: the banker
is free to use for his private interest and profit the money left in
trust ... He may even go further. He may create fictitious deposits on
his books, which shall rank equally and ratably with actual deposits in
any division of assets in case of liquidation." {3}

How did the perpetrators of this scheme come to acquire government
protection for what might otherwise have landed them in jail? A short
history of the evolution of modern-day banking may be instructive.

The Evolution of a Government-Sanctioned Ponzi Scheme

What came to be known as fractional reserve lending dates back to the
seventeenth century, when trade was conducted primarily in gold and
silver coins. How it evolved was described by the Chicago Federal
Reserve in a revealing booklet called "Modern Money Mechanics" like this:

"It started with goldsmiths. As early bankers, they initially provided
safekeeping services, making a profit from vault storage fees for gold
and coins deposited with them. People would redeem their "deposit
receipts" whenever they needed gold or coins to purchase something, and
physically take the gold or coins to the seller who, in turn, would
deposit them for safekeeping, often with the same banker. Everyone soon
found that it was a lot easier simply to use the deposit receipts
directly as a means of payment. These receipts, which became known as
notes, were acceptable as money since whoever held them could go to the
banker and exchange them for metallic money.

"Then, bankers discovered that they could make loans merely by giving
their promises to pay, or bank notes, to borrowers. In this way, banks
began to create money. More notes could be issued than the gold and coin
on hand because only a portion of the notes outstanding would be
presented for payment at any one time. Enough metallic money had to be
kept on hand, of course, to redeem whatever volume of notes was
presented for payment.

"Transaction deposits are the modern counterpart of bank notes. It was a
small step from printing notes to making book entries crediting deposits
of borrowers, which the borrowers in turn could 'spend' by writing
checks, thereby 'printing' their own money."

If a landlord had rented the same house to five people at one time and
pocketed the money, he would quickly have been jailed for fraud. But the
bankers had devised a system in which they traded, not things of value,
but paper receipts for them. It was called "fractional reserve" lending
because the gold held in reserve was a mere fraction of the banknotes it
supported. The scheme worked as long as only a few people came for their
gold at one time; but investors would periodically get suspicious and
all demand their gold back at once. There would then be a run on the
bank and it would have to close its doors. This cycle of booms and busts
went on throughout the nineteenth century, culminating in a particularly
bad bank panic in 1907. The public became convinced that the country
needed a central banking system to stop future panics, overcoming strong
congressional opposition to any bill allowing the nation's money to be
issued by a private central bank controlled by Wall Street. The Federal
Reserve Act creating such a "bankers' bank" was passed in 1913. Robert
Owens, a co-author of the Act, later testified before Congress that the
banking industry had conspired to create a series of financial panics in
order to rouse the people to demand "reforms" that served the interests
of the financiers {4}.

Despite this powerful official backstop, however, the greatest bank run
in history occurred only twenty years later, in 1933. President
Roosevelt then took the dollar off the gold standard domestically, and
Federal Reserve officials resolved to prevent further bank runs after
that by flooding the banking system with "liquidity" (money created as
debt to banks) whenever the banking Ponzi scheme came up short.

"Too Big to Fail": The Government Provides the Ultimate Backstop

When these steps too proved insufficient to keep the banking scheme
going, the government itself stepped up to the plate, providing bailout
money directly from the taxpayers. The concept that some banks were "too
big to fail" came in at the end of the 1980s, when the Savings and Loans
collapsed and Citibank lost fifty percent of its share price.
Negotiations were conducted behind closed doors, and "too big to fail"
became standard policy. Bank risk was effectively nationalized: banks
were now protected by the government from loss regardless of risk-taking
or bad management.

There are limits, however, to the amount of support even the
government's deep pocket can provide. In the past two decades, the
bankers' lending scheme has been kept going by an even more speculative
scheme known as "derivatives". This is a complex subject that has been
explored in other articles, but the bottom line is that more dollars are
now owed in the derivatives casino than exist on the planet. (See Ellen
Brown, "It's the Derivatives, Stupid!" and "Credit Default Swaps:
Derivative Disaster Du Jour", www.webofdebt.com/articles.)

Attempting to fill the derivatives black hole with taxpayer money must
inevitably be at the expense of other essential programs, such as Social
Security and Medicare. Interestingly, Social Security and Medicare
themselves are in some sense Ponzi schemes, since earlier retirees
collect their benefits from the contributions of later workers. These
programs, too, may soon be facing bankruptcy, in this case because their
mathematical models failed to account for a huge wave of Baby Boomers
who would linger longer than previous generations and demand expensive
drugs and care through their senior years, and because the fund money
has have been drawn on by the government for other purposes. The
question here is, should the government be backstopping private banks
that have mismanaged their investment portfolios at the expense of
workers contractually entitled to a decent retirement from a fund they
have paid into all their working lives? The answer, of course, is no;
but there may be a way that the government could do both. If it were to
nationalize the banking system completely - if the government were to
assume not just the banks' losses but their profits, oversight and
control - it might have the funds both to maintain Social Security and
Medicare and to provide a sustainable credit mechanism for the whole
economy.

Replacing Private with Public Credit

Readily available credit has made America "the land of opportunity" ever
since the days of the American colonists. What has transformed this
credit system into a Ponzi scheme that must continually be propped up
with bailout money is that the credit power has been turned over to
private parties who always require more money back than they create in
the first place. Benjamin Franklin reportedly explained this defect in
the eighteenth century. When the directors of the Bank of England asked
what was responsible for the booming economy of the young colonies,
Franklin explained that the colonial governments issued their own money,
which they both lent and spent into the economy:

"In the Colonies, we issue our own paper money. It is called 'Colonial
Scrip'. We issue it in proper proportion to make the goods pass easily
from the producers to the consumers. In this manner, creating ourselves
our own paper money, we control its purchasing power and we have no
interest to pay to no one. You see, a legitimate government can both
spend and lend money into circulation, while banks can only lend
significant amounts of their promissory bank notes, for they can neither
give away nor spend but a tiny fraction of the money the people need.
Thus, when your bankers here in England place money in circulation,
there is always a debt principal to be returned and usury to be paid.
The result is that you have always too little credit in circulation to
give the workers full employment. You do not have too many workers, you
have too little money in circulation, and that which circulates, all
bears the endless burden of unpayable debt and usury."

In an article titled "A Monetary System for the New Millennium",
Canadian money reform advocate Roger Langrick explains his concept in
contemporary terms. He begins by illustrating the mathematical
impossibility inherent in a system of bank-created money lent at interest:

"[I]magine the first bank which prints and lends out $100. For its
efforts it asks for the borrower to return $110 in one year; that is it
asks for ten percent interest. Unwittingly, or maybe wittingly, the bank
has created a mathematically impossible situation. The only way in which
the borrower can return 110 of the bank's notes is if the bank prints,
and lends, $10 more at ten percent interest  ...  The result of creating
100 and demanding 110 in return, is that the collective borrowers of a
nation are forever chasing a phantom which can never be caught; the
mythical $10 that were never created. The debt in fact is unrepayable.
Each time $100 is created for the nation, the nation's overall
indebtedness to the system is increased by $110. The only solution at
present is increased borrowing to cover the principal plus the interest
of what has been borrowed."

The better solution, says Langrick, is to allow the government to issue
enough new debt-free dollars to cover the interest charges not created
by the banks as loans:

"Instead of taxes, government would be empowered to create money for its
own expenses up to the balance of the debt shortfall. Thus, if the
banking industry created $100 in a year, the government would create $10
which it would use for its own expenses. Abraham Lincoln used this
successfully when he created $500 million of 'greenbacks' to fight the
Civil War."

National Credit from a Truly National Banking System

In Langrick's example, a private banking industry pockets the interest,
which must be replaced every year by a ten percent issue of new
Greenbacks; but there is another possibility. The loans could be
advanced by the government itself. The interest would then return to the
government and could be spent back into the economy in a circular flow,
without the need to continually issue more money to cover the interest
shortfall.

The fractional reserve Ponzi scheme is bankrupt, and the banks engaged
in it, rather than being bailed out by its victims, need to be put into
a bankruptcy reorganization under the FDIC. The FDIC then has the
recognized option of wiping their books clean and taking the banks'
stock in return for getting them up and running again. This would make
them truly "national" banks, which could dispense "the full faith and
credit of the United States" as a public utility. A truly national
banking system could revive the economy with the sort of money only
governments can issue - debt-free legal tender. The money would be
debt-free to the government, while for the private sector, it would be
freely available for borrowing at a modest interest by qualified
applicants. A government-owned bank would not need to rob from Peter to
advance credit to Paul. "Credit" is just an accounting tool - an advance
against future profits, or the "monetization" (turning into cash) of the
borrower's promise to repay. As British commentator Ron Morrison
observed in a provocative 2004 article titled "Keynes Without Debt":

"[Today] bank credit supplies virtually all our everyday means of
exchange, and this brings into sharp focus the simple fact that modern
money is no longer constrained by outmoded intrinsic values. It is pure
fiat [enforced by law] and simply a glorified accounting system ...
Modern monetary reform is about displacing the current economic paradigm
of 'what can be afforded' with 'what we have the capacity to
undertake'." {5}

The objection to government-issued money has always been that it would
be inflationary, but today some "reflating" of the economy could be a
good thing. Just in the last year, more than $7 trillion in purchasing
power has disappeared from the money supply, including wealth
destruction in real estate, stocks, mutual fund shares, life insurance
and pension fund reserves {6}. Money is evaporating because old loans
are defaulting and new loans are not being made to replace them.

Fortunately, as Martin Wolf noted in the December 16 Financial Times,
"Curing deflation is child's play in a 'fiat money' - a man-made money -
system". The central banks just need to get money flowing into the
economy again. Among other ways they could do this, says Wolf, is that
"they might finance the government on any scale they think necessary." {7}

Rather than throwing money at a failed private banking system, public
credit could be redirected into infrastructure and other projects that
would get the wheels of production turning again. The Ponzi scheme in
which debt is just shuffled around, borrowing from one player to pay
another without actually producing anything of real value, could be
replaced by a system in which the national credit card became an engine
for true productivity and growth. Increased "demand" (money) would come
from earned wages and salaries that would increase "supply" (goods and
services) rather than merely servicing a perpetually increasing debt.
When supply keeps up with demand, the money supply can be increased
without inflating prices. In this way the paradigm of "what we can
afford" could indeed be superseded by "what we have the capacity to
undertake".

_____

Ellen Brown developed her research skills as an attorney practicing
civil litigation in Los Angeles. In Web of Debt, her latest book, she
turns those skills to an analysis of the Federal Reserve and "the money
trust". She shows how this private cartel has usurped the power to
create money from the people themselves, and how we the people can get
it back. Her earlier books focused on the pharmaceutical cartel that
gets its power from "the money trust". Her eleven books include
Forbidden Medicine, Nature's Pharmacy (co-authored with Dr Lynne
Walker), and The Key to Ultimate Health (co-authored with Dr Richard
Hansen). Her websites are www.webofdebt.com and www.ellenbrown.com.

Notes

1. Kathleen Pender, "Government Bailout Hits $8.5 Trillion", San
Francisco Chronicle (November 26 2008).

2. "Federal Reserve Statistical Release H.6, Money Stock Measures",
www.federalreserve.gov (December 18 2008).

3. Robert de Fremery, "Arguments Are Fallacious for World Central Bank",
The Commercial and Financial Chronicle (September 26 1963), citing E
Groseclose, Money: The Human Conflict, pages 178-79.

4. Robert Owen, The Federal Reserve Act (1919); "Who Was Philander
Knox?", www.worldnewsstand.net/history/PhilanderKnox.htm. (1999).

5. Ron Morrison, "Keynes Without Debt",
www.prosperityuk.com/prosperity/articles/keynes.html (April 2004).

6. Martin Weiss, "Biggest Sea Change of Our Lifetime", Money and Markets
(December 22 2008).

7. Martin Wolf, "'Helicopter Ben' Confronts the Challenge of a
Lifetime", Financial Times (December 16 2008).

Disclaimer: The views expressed in this article are the sole
responsibility of the author and do not necessarily reflect those of the
Centre for Research on Globalization. The contents of this article are
of sole responsibility of the author(s). The Centre for Research on
Globalization will not be responsible or liable for any inaccurate or
incorrect statements contained in this article.

The CRG grants permission to cross-post original Global Research
articles on community internet sites as long as the text & title are not
modified. The source and the author's copyright must be displayed. For
publication of Global Research articles in print or other forms
including commercial internet sites, contact: crgeditor at yahoo.com

www.globalresearch.ca contains copyrighted material the use of which has
not always been specifically authorized by the copyright owner. We are
making such material available to our readers under the provisions of
"fair use" in an effort to advance a better understanding of political,
economic and social issues. The material on this site is distributed
without profit to those who have expressed a prior interest in receiving
it for research and educational purposes. If you wish to use copyrighted
material for purposes other than "fair use" you must request permission
from the copyright owner.

For media inquiries: crgeditor at yahoo.com

(c) Copyright Ellen Brown, webofdebt.com, 2009

(c) Copyright 2005-2007 GlobalResearch.ca

http://www.globalresearch.ca/index.php?context=va&aid=11600


TO POST A COMMENT, OR TO READ COMMENTS POSTED BY OTHERS, please click
on the word "comment" highlighted at the end of the version of this
essay posted at http://billtotten.blogspot.com/