Debt-damned economics: either learn monetary reform, or kiss your assets goodbye (4 of 7)

The following is my high school teaching assignment for Advanced Placement Macroeconomics students (available as extra credit for other classes) on how money is created. I offer this for non-profit use; divided into seven sections:


3. Fractional reserve banking

“This proposal (debt-free money created by government to directly pay for infrastructure) will of course be opposed by the bankers from whom it takes the lucrative privilege of creating purchasing power. It would however insure the safety of deposits, give large revenues to the government, provide complete social control over monetary matters and prevent abnormal fluctuations in the capital market. At the same time it would permit the allocation of productive resources…to remain primarily in private hands. All in all it seems the most promising program for the reform of our monetary and credit system…”  Paul Douglas in the Chicago Plan booklet (19). The Great Depression in the US (1929-1941) motivated professional economists to comprehensively and creatively address its causes. Upon consideration of previous US economic depressions in 1837, 1873, and 1893, prominent economists led by Henry Simons at the University of Chicago proposed monetary reform as the nation’s most effective and practical policy response, known as the Chicago Plan (20) (and here [21]). This proposal was endorsed by Simons’ colleague, Paul Douglas, Frank Graham and Charles Whittlesley of Princeton, Irving Fisher of Yale, Earl Hamilton of Duke, Willford King of NYU, and sent to a thousand academic economists for their input. Three hundred twenty responded to the mailed proposal and survey (an impressively high number for a cold-call proposal and survey) from 157 universities, with 73% in full agreement with the proposal, 12.5% in approval with various considerations in its implementation, and only 14% in disagreement.

“The bankers will favor a course of special legislation to increase their power…They will never cease to ask for more, …so long as there is more that can be wrung from the toiling masses of the American People…The struggle with this money power has been going on from the beginning of the history of this country.” – Peter Cooper, famous American inventor in his letter to President Hayes, June 1, 1877 (22).

Fractional reserve banking” is how banks and the banking industry create credit. An individual bank creates credit and “so-called lends” it to the public as a fraction of the deposits the public puts in the bank. Because the money so-called lent ends up in another bank that then so-called lends the money again, the effect in the overall economy is a multiplier effect rather than an individual bank phenomenon of a fraction. It works like this: the definition of “fractional reserve banking” is that banks keep a regulated “fraction” of their total deposits “on reserve,” called their reserve ratio (RR) that they cannot “lend,” and can create new credit out of thin air up to the total of all their customers’ deposits minus their RR.

Among AP Econ teachers, our teaching experience agrees with John Kenneth Galbraith’s quote above that this is difficult to grasp. But stick with it; these mechanics are as understandable as the mechanics of simple items on your desk: seeing how a stapler works, the geometry how facial tissues are put into the box, and far simpler than your phone!

So: once a bank is established, they must hold a percentage (ratio) of their total deposits “on reserve” that is not leant to customers. This rate is set by the Federal Reserve (Fed), 10% for established banks and less for smaller ones (however, banks get around these limits (23) and will always make credit on terms profitable to the bank).

This means that if you deposit money into your bank, they can then create credit up to their limit in new “loans.” If you deposit $100, the bank can create new/thin-air credit of $90 to anyone asking for a loan. That’s the micro picture.

The macro picture is that the new credit then circulates to other banks and is “re-leant” at 90% and so on. Let’s say that someone borrows the $90 from your bank, purchases something, and then the $90 ends up deposited in another bank. The receiving bank can create credit, let’s say 90% of up to $81 in new credit. The injection of increasing the money supply comes from the Federal Reserve. They create money out of nothing and then use it to buy government securities or non-voting shares of banks, etc. If they buy a government bond for $1,000 from money they create out of nothing, this new money increases the money by the formula 1/RR. Assuming a simplified textbook understanding of a RR of 10% of deposits that banks cannot create credit from, in this case of the Fed creating $1,000, the new credit/money multiplied from the banking system is $1000 x 1/10%, or $1000 x 10 = $10,000. This is the macro effect if all receiving banks create credit up to their reserve requirement and all “lend” out the new credit.

Because the Federal Reserve is owned by the banking industry, this causes a classic conflict of interest: the banking industry’s profit comes from expanding the money supply and then creating credit to “lend” to us at interest. Expanding the money supply is in conflict with the public’s interest to limit the supply of money to guard its value from inflation.

Some people are confused by the Fed’s ownership. What’s openly stated by the Fed’s attorneys (24) is that the Fed is owned by their member banks. They pay dividends to its shareholders (25). Court cases have found in each instance that the Federal Reserve is not a government agency (26). You cannot find them in a government agency organizational chart in any branch of government. Back when people used to use phone books, the Federal Reserve would not exist in the government section, but be listed in the business section shortly after Federal Express.


19 more info here: Herman, C. Top 10 Americans for monetary reform: #10: 86% of Economics professors during Great Depression. Oct. 5, 2009:

20 Zarlenga, S. The 1930s Chicago Plan and the American Monetary Act. AMI Monetary Reform Conference, Oct. 2005:

21 Asia Times. Ashari, H; Krichene, N. Dust off the Chicago Plan. Sept. 17, 2008:

22 Herman, C. President Andrew Jackson, Peter Cooper on monetary reform. March 8, 2012:

23 Web of Debt Blog. Brown, E. Why do banks want our deposits? Hint: it’s not to make loans. Oct. 26, 2014:

24 Washington’s Blog. Federal Reserve attorneys: Fed banks are “not agencies” but “independent corporations” with “private boards of directors.” July 26, 2011:

25 Global Research. Brown, E. Who owns the Federal Reserve? Oct. 8, 2008:

26 Washington’s Blog. Everyone knows that the Federal Reserve banks are PRIVATE… except the American people. July 13, 2013:

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  • Bev

    Everyone’s comments disappeared.
    Here are just some of the comments returned:

    An Alternative to Capitalism (since we cannot legislate morality)

    Several decades ago, Margaret Thatcher claimed: “There is no alternative”. She was referring to capitalism. Today, this negative attitude still persists.

    I would like to offer an alternative to capitalism for the American people to consider. Please click on the following link. It will take you to my essay titled: “Home of the Brave?” which was published in the OPEDNEWS:
    John Steinsvold
    Perhaps in time the so-called dark ages will be thought of as including our own.
    Georg C. Lichtenberg

    Bearly Magical
    As I read this article, a couple of red flags appeared in my non-economist mind. One is that not all the interest in intergovernmental transfers is going to the fed and the banksters. Much of it goes to public pensions and social security, well funded programs that look for interest to stay in the black, and invest in government bonds. I would hate to see that interest rate be dropped. Another red flag, from the intro to the article and not the body, speaks of a simpler income tax. Bill Bradley tried that and got nowhere. It would be easy to make income tax fairer and simpler, but the crooks who tinker with these things always screw the poor and middle class even more as they say they pretend to “fix” things.
    Our government is 99.99% corrupt and I cringe every time economists “reform” it. Beyond the supply and demand curves, it seems that the practice of economics is to steal while rationalizing that the system is being made to function better. I fear that economists would screw social security long before they took a penny from the banksters in the fed.

    Carl_Herman Bearly Magical
    1: You missed the section that states the ~$400 billion annual interest cost for the national debt has a savings of ~1/2 if the debt is paid BECAUSE ~$200 billion is paid back into government programs. So no red flag there.
    2: The fact that others have proposed changes in income tax is immaterial to the case for massive savings from monetary reform, and the ability to change that tax. No red flag there.
    3. The mechanics of debt-free money and at-cost credit stand, despite whatever corruptions have occurred in the past with lies and spin to maintain the current system of debt.

    A note on the claim that the Public Banking Institute advocates at-cost credit. The banking model most often referred to by Ellen Brown, founder of the PBI, is the model presented by the Bank of North Dakota. This is no true public bank. It does not issue at-cost credit. It uses proxy private banks and does not deal directly with the people who purportedly “own” it because it is their money that capitalizes it. If you want a home mortgage, you go to a private bank, which is supported and back stopped by the BND, and you get a market rate, created by the private banking market. It is a “banker’s bank”, not a public bank. Currently the only genuine model of public banking is seen in the American Monetary Act, which became legislation via Dennis Kucinich in the 113th Congress, known as HR2990. Ms. Brown’s public bank is bogus. She is a supporter of the Fed.

    Bev jadan
    Hey jadan, I agree with you so much about former Rep. Dennis Kucinich’s NEED Act HR2990 ( at ) being the real solution that what would turn this economy around fast and may be the only way to help our survival as a species by providing the enormous monies to pay engineers to try to reduce the terrible danger of Fukushima, WIPP, the 400 aging nuclear power plants and try to re-stabilize climate change for the many generations it will take. The bill, the legislation was introduced to Congress in different years, in 2011 the introduced bill was called HR HR 6550. It still needs to be re-introduced ever year until it is passed into law.

    And, the act does not create a a public bank, rather a public money system:
    Why Promoting States to do Banking is a Distraction and Diversion, and Reforms Nothing

    It’s the monetary system which must be changed to end the fiscal crisis, and State governments cannot do this – it’s a matter for the Federal Government.

    Under present constitutional and legal conventions, the only institutions that can create money without debt are national treasuries and/or central banks. State governments within a federal nation cannot do this – the problem can only be solved at the national level.

    Proposals promoting anything else would require a constitutional amendment, which is not necessary.

    Historical experience has taught us what we need to do:
    1. Put the Federal Reserve System into the U.S. Treasury.
    2. Stop the banking system creating any part of the money supply.
    3. Create new money as needed by spending it on public infrastructure, including human infrastructure, e.g. education and health care.

    These 3 elements must all be done together, and are all in draft legislative form as the proposed American Monetary Act
    Professor Kaoru Yamaguchi’s Model of HR 2990
    Professor Yamaguchi (Berkeley, Doshisha Universities) shows that Kucinich’s HR 2990 NEED Act:
    (1) Provides the funding for infrastructure repair (which solves the unemployment crisis)
    (2) Pays off the national debt as it comes due
    (3) Does this without inflation! Click here to watch a video of Professor Yamaguchi’s presentation to the 2010 AMI Conference. Wow!
    How the Economists Facilitated the Crisis and How HR 6550* Solves it
    by AMI
    Review of Ellen Brown’s “The Web of Debt”
    in Book Reviews, by AMI

    Time to End Reserve-Based Money, Coffee with Joe, March 27, 2012

    jadan Bev
    Thanks for underlining the distinction between public banking and a public money system. There’s confusion about the meaning of public banking. Private banks currently create our money supply through their normal banking activities, and if states and localities do the same thing and play the same game, then we can call it public banking. This seems to be what Ellen Brown believes. But as Stephan Zarlenga & Co take pains to point out, the state does not go into the banking business; it merely issues the money supply, the debt-free currency, which the banks then use in their retail banking business. The banks will do what most people think they do right now: loan out money that depositors entrust with them. They will no longer loan money into existence through fractional reserve lending. They will be using public money created by the US Treasury, not the private banking system and the Fed. The “public” in public banking is the debt-free money created by the people’s sovereign government. It’s not who’s running the banks, private parties or government entities.

    Thanks also for the links. These guys are a little abstruse for the average Joe, however.

    Carl_Herman Bev

    Hi Bev ,
    Do you think the $3 trillion annual direct savings is an accurate estimate for monetary reform and at-cost credit? It’s probably double this with indirect savings, such as from the infrastructure investment increasing productivity.

    Bev Carl_Herman
    I cannot confirm amounts you are suggesting. However, at-cost credit is still debt. You have previously offered that a negative interest rate could reduce credit/debt. And, everyone is near debt-saturation. And, how does that begin to affect perhaps quadrillions of dollars of derivatives. I would guess that even double the amount as you suggest, cannot begin to pay huge engineering efforts to try to lessen the danger of radiation from Fukushima, WIPP, and the 400 aging nuclear power plants in addition to climate change instability, all of which will take generations to attempt. Keeping money as debt does not sound like a plan for the survival of the species.

    Carl_Herman jadan
    Hi jadan,
    Ellen Brown is a friend and colleague of mine. She is forever in my human being “Hall of Fame.”

    Yes, she refers to the state-owned Bank of North Dakota as a possible model for the public benefits of at-cost credit. ND is the only state with increasing budget surpluses. She is also one of the very strongest voices to accurately explain and document the benefits of TAKING DOWN THE FED’S RACKET for debt-free money. Ellen points to the obvious benefits of both the American Monetary Act and, and encourages cities, counties, and states to explore the power of public banking for they can take for themselves without an act of Congress.

    Think for a moment, jaden: if given the choice, would the public take a 5% mortgage over paying any state tax?

    PBI, Ellen, and I want the facts to be widely known, and for the public to best respond in good-faith experimentation to maximize public benefits.

    jadan Carl_Herman
    That’s nice Ms Brown is your friend and colleague, and I would have to say I think of her as a friend, also, though I’ve never met her. However, she has given me bouts of cognitive dissonance occasionally through her advocacy of a public bank that is not a public bank but instead a capitulation to the private banking cartel, a terminal political compromise. She is a supporter of the Fed system by default. This is not “good faith experimentation”, it is a con that was put in place in 1919, that she actively sells today as a public bank. The BND is not going to eliminate state taxes, Carl. That’s where its capitalization comes from! That’s a pipe dream based on the currently bursting fracking bubble. I’m waiting for the failure of fracking investments to break lots of these private banks underwritten by the BND. These loans are guaranteed by the people’s assets, so let the bail outs begin, and then tell me this bank is dedicated to the public interest! The BND did not create the financial good fortune of ND. Fracking has done that. Fracking will bring that bank to its knees, in addition to despoiling that relatively pristine agricultural country….

    Carl_Herman jadan
    We all go through cognitive dissonance to discern strictly mechanical models that can work (debt-free money for direct payment of public goods and services, public credit as one possible model to reduce how much money is in the system, etc.) versus how experiments that seem to have some aspects working can help our understanding, AND how experiments have been corrupted and compromised.

    Ellen is just pointing to the mechanics of how banking works, and how that power could be put into the hands of city, county, and state public servants. Honest people in those positions should jump on this power for at-cost credit rather than being “served” by banksters.

    jadan Carl_Herman
    She’s doing more than that, Carl. She’s actively promoting the BND as a model of public banking and making claims about the role and efficacy of that banking model that are not true on the face of it. The BND is a tool for the paternalistic oligarchs of ND who want to protect their patch from the bigger and more powerful oligarchs back east. But my objection to EB’s advocacy is not on the merits of this particular banking scheme, but on the fact that she is a de facto supporter of the Federal Reserve System through this advocacy. The BND is a member of the Minneapolis Federal Reserve and it does not challenge the private money monopoly; it supports this private monopoly and it uses public funds to do it! That’s a really neat trick! It’s an iteration of the clever con put in place in 1913.

    Public banking means public control over the creation of the money supply and nothing less. It means we use greenbacks as opposed to FRN’s. Ellen Brown, as the foremost voice of public banking because of her public relations skill, is actually undermining public banking very much like her hero, William Jennings Bryan, considered to be the foremost voice of Populism in the late 19th Century, actually destroyed the political future of Populism in 1896. That’s another story, Carl, but let’s get rid of cognitive dissonance around this issue by being clear about what public banking is and what it isn’t.

    Public banks use public money, not private money. The Federal Reserve Note is a privately issued fiat currency. Only the sovereign government can issue fiat money, as Lincoln did, when it was called the “greenback”. This is called the “money power” which was stolen from us by the lying bankster/oligarchs from the time of Alexander Hamilton. The “Bank of California” EB talks about is a BND writ large, and not a public bank at all because it integrates into the private Federal Reserve System, just as the BND does.

    The Fed system has failed spectacularly throughout its history, most recently in 2008. Ellen Brown is promoting a scheme to save this failed privately held system through her advocacy of the BND banking model. If the privately held banking system can capitalize itself with public assets, voila! No worries! (Isn’t that what the bail outs mean, a capitalization via public debt?) Think about this, Carl, and you’ll have a case of cognitive dissonance that doesn’t respond to aspirin! Think about EB as a disinfo agent for the Federal Reserve System….the closer you get to some one, the less of them you can see…

    Carl_Herman jadan
    jaden, you’re certainly welcome to your own analysis 🙂

    Ellen’s book attacking the Fed is probably the most-widely read: Web of Debt:

    I advocate not waiting for Congress, but for honest local government officials to learn the power of banking for themselves, use it, and IF THEY ARE HONEST, then it’s easy to see the value of creating debt-free money for the direct payment of public goods and services.

    jaden: the mechanics of creating credit through banking is a tool like a hammer or screwdriver. In good hands, it makes work easier. For your local governments, wouldn’t you prefer an at-cost line of credit, or to over-tax you as a “rainy day” fund?

    jadan Carl_Herman
    We’re not dealing with banking reform, Carl, when we talk about public banking. We’re talking about monetary reform, systemic reform. If we do not get rid of debt money itself and escape from the web of debt in which we are all currently entangled, nothing will change. The only way to get rid of debt money is to eliminate the Federal Reserve system. If you try to compromise with the Fed system, as Ellen Brown is doing, nothing will change, except your idealism. You aren’t going to set up this so-called public bank and then decide to create debt free money after all. The prospect for creating debt free money will be gone because you are owned by the Fed. No evolution is going to happen, Carl. Do you see states clamoring to go into the banking business? I haven’t noticed it. It just won’t happen because nobody knows banking better than banksters. You want to compete with Jamie Dimon and Lloyd Blankfein, Carl? Good luck! 🙂

  • Bev

    Pardon me. I was wrong. I had the wrong series number. All the following is still found at Series 7 at
    Cost-benefit analysis for monetary reform in your world of the present (7 of 7)

    Pardon my wasting your time….and mine.

  • Bev

    Wait a minute. I googled a phrase from and google’s first post from washington’sblog led me to an article where it was not to be found, because it never was posted here. Very funny google. You seem to do this more and more.