The Global Poker Playoffs: a short story about Money Supply

Mayer Amschel Rothschild, the godfather of modern banking, purportedly said “Give me control of a nations money supply and I care not who makes the laws.”  What did he mean by that?  Is it true?  Since the Federal Reserve Bank controls the money supply of the United States as the world’s largest and most influential Central Bank, does this mean that this institution is more powerful than Congress, more powerful than the Executive Branch of the government, that it operates above and beyond the control of the Republicans or Democrats?  Is the Federal Reserve above the law?  Was Rothschild right?  What exactly is the money supply, anyway?

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Let’s begin at the beginning.  What is banking?  Before modern banking, virtually all trade was in the form of barter.  Barter only works when there is a double coincidence of wants, which means you have hot dogs for sale at the same time that I have lemonade for sale, and you happen to want my lemonade at exactly the same time that I have a craving for a hot dog.  We both want whatever commodity the other is selling at the same time.  Obviously, this kind of trade quickly becomes very cumbersome, slow, and difficult.  Eventually people found that certain commodities became so common, and so universally in demand, that they became more useful as a means of exchange than for their original value.  This is, for example, how salt came to be used as money.  Originally it was universally desired for its ability to season and preserve food.  People started using salt as a means of trading all other commodities, because they all knew that if they received payment in the form of salt, they could in turn use that same salt to trade with others.  Salt became more valuable as money than it was as just salt.

In time two precious metals replaced salt:  gold and silver.  They were used as money because they were universally in short supply, universally desired, they were portable, and they had high value for their volume and weight.  Gold and silver had to be mined from the ground, and there was no way any speculator was going to be able to mess with the “money supply” of the day by pumping large amounts of new gold or new silver into existing circulation.  These metals were too hard to find, too hard to dig out of the ground, too expensive and too labor intensive to extract from the soil for the money supply to expand unexpectedly or significantly.  The money supply in the form of all the gold and silver in circulation was stable and therefore not prone to change.  The purchasing power of an ounce of gold did not change much.

Because these metals were heavy, in time individuals became gold brokers:  that is, they stored the gold for others.  They would receive the gold, and write out a receipt to the owner of the gold.  The owner of the gold would then use that paper receipt in the same way he would have used the actual gold:  as money.  These gold brokers, also called goldsmiths, quickly learned that mostly the gold just sat in their warehouse collecting dust, and they decided they would write more receipts than they had gold.  In theory, each receipt they wrote could be redeemed at face value for real gold, and that was 100% true when they only wrote receipts at a 1 to 1 ratio for the gold.  When they wrote twice as many receipts as they had gold, they were counting on the high unlikelihood that the holders of both sets of receipts would attempt to redeem them at the same time on the same day.  Eventually they wrote more and more receipts for the same stockpile of gold.  Why would they do this?  Because they charged interest for the use of these receipts.  Now for a moment, just stop and think of the profit potential of this racket.  You own no gold.  You agree to warehouse someone else’s gold, and you give him a receipt.  Then nine more people come to you for a loan of x amount of gold, but you don’t give them gold, you give each of them another receipt.  All ten of those receipts now in circulation are acting as the same amount of money as the gold on deposit—multiplied by ten!!  You as the goldsmith have increased the money supply out of thin air!!  There are ten receipts floating around out there, each of them supposedly redeemable by the same brick of gold in your warehouse.  And the goldsmith is charging interest on all those pieces of paper, and he is counting on only one of the borrowers asking to redeem his receipt at a time.  And thus is born the fractional reserve system of banking.  At heart the system is based on fraud:  the banker (or goldsmith) is pretending that he has the full value of the paper he gives you available for redemption should you ask for it, when he knowingly has only a fraction of that amount available.  He is playing the odds at the margin, betting the future of his business on the odds that you will not ask for it all back at one time, or even at the same time as his other customers.

The money supply is the total number of receipts he has in circulation out there at any given time.  Now let’s fast forward to the current 21st century.  You’ve already figured out that receipts have morphed into money, or currency.  Now all of a sudden, it becomes much easier to mess with the money supply, i.e. all the currency in circulation at any given moment.  How?  Well, since currency is no longer redeemable for precious metals, it is in effect anchored to nothing more than the willingness of the public to use it and accept it.  So if you want to increase the money supply, all you have to do is print more paper currency and slip it into circulation.  But in the digital age even that isn’t necessary.  Printing of currency is done to replace worn out currency, and other than that, printing is used only metaphorically to mean digits transmitted electronically; journal entries into a national bookkeeping system.

Central  Banks are created to facilitate the manipulation of the money supply in a nation.  The Central Bank is a consortium of the largest banks in a nation that acts like a cartel, like OPEC does for oil producing nations, and it acts as the lender of last resort for all the other banks in that nation.  It pools the national money supply, and makes funds available to its member banks as the need arises.  It is determined what the amount of reserves should be required for each dollar the member banks loan out.  Now let’s do some simple math.  If it helps, get out a piece of paper and a small calculator and follow me along here for a minute.  Suppose the Federal  Reserve loans $1,000,000 to a member bank, Bank A,  at its inter-bank interest rate (lower than the public rate).  Suppose also that Bank A is required to keep 10% of all deposits in reserve.  So it keeps $100,000, or 10% in reserve.  Bank A then loans out the balance of the $1,000,000, or $900,000 to a customer of the bank.  The customer takes the face amount of his new loan, or $900,000 and uses it to buy something from a supplier.  The supplier deposits the $900,000 in his bank, Bank B.  Bank B keeps 10% of that $900,000, or $90,000 on reserve, and loans out the balance of $810,000 to another of its customers.  Just keep doing this for fifteen consecutive transactions, and you will discover that the original $1,000,000 that the Federal Reserve loaned to Bank A has already become almost $8,000,000 in circulation, with over $200,000 of the original $1,000,000 available in the fifteenth bank!  Almost as if by magic, in just fifteen transactions, $1,000,000 has been multiplied to $8,000,000 in the money supply.

So why would anyone want to expand the money supply?  Politicians do, in order to create inflation.  Inflation is increasing the money supply in order to reduce the purchasing power of the currency, in our illustration, the dollar.  This is called intentionally debasing the currency.  When you have more money chasing the same amount of goods and services available for exchange, the price of the goods and services goes up.  Which is another way of saying it now takes more of the currency to purchase the same thing.  This is good for debtors, and bad for creditors.  Why?  The debts the debtor owes are being paid back with dollars that have less purchasing power.  The creditor gets the face amount of his principal back, but those dollars now have less purchasing power than when he loaned them out.  Suppose that creditor loaned out those funds at 5% interest, but they are repaid to him with 7% less purchasing power.  That lender will soon be out of business.  He has lost money.

Now, who is the biggest debtor you can think of?  Come on now, try hard, it will come to you.  Yes!  The U.S. government.  As the theory went, it never mattered how much money the government borrowed, as long as it borrowed from its own citizens.  But if that government paid its own citizens back with intentionally devalued currency, it actually committed an act of fraud against its own citizens, did it not?  It picked their pockets without a vote.  If a political party raised taxes by an equivalent amount, it would be summarily voted out of office.  But when the Federal Reserve Bank does the dirty work for them, through the back door, financially illiterate people just shrug their shoulders; what can anyone do about inflation?  It’s probably those greedy businessmen raising prices to improve their profits!

But wait a minute, you say!  Stop!  The government hasn’t been just borrowing from its own citizens.  It’s been borrowing from foreign nations and global investment funds.  In fact it has borrowed so much from these foreigners that many of them have doubts about the ability of the U.S. government to ever repay them, even with devalued currency.  They have stopped buying U.S. government debt.  So let’s see, now.  The citizens of the country aren’t buying much of the government debt; the foreign governments have stopped buying U.S. government debt; our government is running out of potential lenders.  Who can it borrow from next?  Ah, they found a creative answer:  the U.S. government will go to their lender of last resort, and borrow from them.  Who is that?  You guessed it:  the Federal Reserve Bank.  How does the U.S. government borrow from the Fed?  The U.S. government borrows money by selling Treasury Bonds, which are nothing more than a government-issued I.O.U.  A Treasury bond, also called a T-bill, is a debt instrument, a promise to repay at some future time.  When no one else wants to buy them, the government sells them to the Fed.  In buying the bonds, the Fed gives the Treasury money to spend, which puts it into the money supply of the nation.  And when you increase the money supply by $1,000,000, in the fractional reserve banking system, after only fifteen transactions, with a 10% reserve requirement, that money has been multiplied by a factor of 8, with money still working in the system.  What happens when you inflate the money supply by hundreds of billions, or trillions, as has been happening in the last 24 months?

So the Fed creates money out of thin air, gives it to the government, which puts it into circulation into the economy in an effort to jump start the economy.  So where’s the inflation that should be there?  Prices are holding their own or even going down slightly.  What’s going on?

I’m going to address this and other questions in my next article, but in conclusion of this one, I want to paint a mental image for you.  The U.S. government isn’t the only nation in this poker game.  All of them are on board.  As one of our original patriots said in a totally different context, “We’ll all hang together, or we’ll each hang separately.”  No one wants to be left out of this poker game.  All of the currencies of the world are tied to the dollar, and have been for over forty years.  Most of the rich countries and many of the emerging nations have invested heavily in U.S. debt; so much so that if the U.S. decides to default, it can take the global financial system down with it.  So as the U.S. goes, so goes the world.

Now picture a large room with many tables and poker players, all engrossed in the Global Poker Playoffs.  Every player acts civilly, but every player ultimately seeks to trump all the others.  About a dozen or so of the players have nuclear weapons strapped to their belts, and the weapons are hot.  Nerves are raw.  Every player in the room knows that he is playing with the entire wealth of his family and tribe back home, and he knows he dare not come home empty handed.  His life might depend on it, and certainly his stature in his community, his personal economic future.  His family would share in his economic loss and disgrace.  In the center of the room is the largest table, with the biggest players.  The playing is intense, and the bidding escalates.  No one calls, no one dares to call, and the chips pile up in huge piles on the table.  Everyone is starting to question what resources lie behind those chips, and everyone knows what the risks are if a player isn’t good for his bets.  Everyone knows everyone else is bluffing, but no one dares to call, because everyone has overplayed his hand.  Suddenly the unthinkable happens.  Someone bumps the table; piles of chips fall over, spilling into each other, rolling towards the edge of the table.  Players start grabbing for the most valuable chips at the margins, upsetting the entire table.  Nervous hands move quickly towards their belts, chaos breaks out in the room, some run for the exits . . .

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