Econ 101 Part 3 – How the Fed Makes Magic Money

Our entire monetary system is based on a complete fantasy. It’s a hoax, and you’re the dupes. If anyone else did what our federal banking system does, he’d go to prison. Why? Because fractional reserve banking creates counterfeit money. The paper and base-metal coins we use for money are essentially worthless, and one day there will be a jarring reality check.

Let me explain how it works.

Suppose I need you to lend me $1 million. Suppose you’re like most people and you don’t have $1 million to lend. What you have instead is a magic spreadsheet. You can just sit at your desk and lend me $1 million that you don’t have. Now I’m going to tell you what happens next… it’s really neat.

I’ve borrowed the million bucks, and so now I’m making installment payments, which include interest and principal. Over the next twenty years you collect about $3 million from me. Two million is interest, and you have to pay taxes on that as income. But the other million — this is the cool part — that’s return of principal, so you don’t pay taxes on that. Pretty swift, eh? Remember, you didn’t actually have that million bucks to start with, and now you do, plus about another million after taxes, for a total of 2 million bucks free and clear. Not bad for someone who had nothing to start with.

That’s how fractional reserve banking works. But there’s something even more awesome than that. It’s a very special bank, called the Federal Reserve. This is a private bank owned by a bunch of private citizens and corporations, most of whom are undisclosed to the public.

The special thing about the Fed is that it lends money to the government. Gargantuan amounts of money. When they lend this money, it comes out of the magic spreadsheet — the fed doesn’t actually have the money to lend. It just invents it. Poof! There it is. But the government pays about $500 billion a year in interest on the national debt, and do you know where it comes from? Taxes. You pay it.

That’s why the Fed doesn’t care whether the government ever pays off the principal of the national debt. The secret members of the Fed are sharing in an enormous amount of annual income, and they started with nothing anyway. The bigger the national debt, the more they earn. So there’s absolutely no reason for them to demand payment of the principal.

History teaches us that economies like this always collapse eventually, but hey, the gravy train is great while it lasts!

Just be ready. If you want to understand how money really works, buy the wonderful book Whatever Happened to Penny Candy? It’s like a whole economics course in 190 pages.

~ SnoMan