Where Money Comes From, Part 1

I decided to use the holiday season while news is slow and people are out spending money to write a little bit about our money and where it comes from. I will be talking mainly about the Federal Reserve, what it does, how it interacts with the government and why it is important for people to know something about it. This is not a fun topic. I do my best to write in a way that people who don’t really pay attention to politics can understand and enjoy. This is going to be a stiff test, so I ask that if you are one of those people to try and stick it out. I am not an expert in any way on anything I talk about, (so far). I am not an economist or a political scientist but I do, however, enjoy learning things and understanding how the world we live in works, so I write this blog as a way to organize my thoughts. This topic is going to take more than one blog, so I think I will break it up into a few parts.

Where does money come from? It’s not something most people think about much. Money comes from the government right? They print the money we use. Well actually, not really. There are a few main players in this game, so let’s meet them. First you have the congress, it’s their job to spend the money that our government uses to pay for stuff. There is the treasury department, which is in charge of printing the physical money, and you have the Federal Reserve, which is like our national bank.

The congress votes to spend money on stuff like roads, war or whatever. The only problem is that they don’t have any money in the government, they have to get some from somewhere else. What they do is have the treasury department print a piece of paper called a treasury bond, which is basically an IOU that says if you give me money so I can buy stuff, I’ll pay you back later with interest. Banks buy these bonds and take them to sell to the Federal Reserve, who writes them a check to buy the bonds. The checking account that they write this check from has no money in it. They give this check to the bank that bought the Treasury bond and presto, money is created. To recap the government traded an IOU from the Treasury department for an IOU from the Federal Reserve and money is created out of thin air.

This money is deposited into a bank where it is spent on whatever the congress voted to spend it on. It is used to pay government employee salaries, contractors doing work for the government and other people. These workers in turn deposit the money into their personal banks. Let’s follow government employee “Joe” for a minute. He gets his paycheck of $1000 deposited into his bank account. What he is actually doing is loaning his paycheck to the bank. The bank then puts $100 of that paycheck aside for Joe and lends the other $900 out to other people. This doesn’t mean that Joe only has $100 in the bank. What happens is that the bank just creates $900 more dollars out of thin air to make sure Joe doesn’t freak out while they give his original $900 away to people who need a loan. This is called fractional reserve banking. It means that the bank only has to keep a fraction of the deposited cash on hand at any given time. The percentage can vary, but 10% is normal. Joe’s $1000 deposit immediately becomes $1900. When the person that took out the loan for the $900 puts the money into their bank, the bank deposits $900, keeps $90 safe and lends out the remaining $810. Now Joe’s $1000 has been increased to $2710. This goes on and on until the original $1000 becomes $10,000. Fun fact: 97% of all money is virtual. Just numbers on a computer screen. To recap, congress trades an IOU for an IOU from the Federal Reserve and money is created, People deposit that money into banks where they just magically add 90% more money into the system.

People who have jobs work for money. This money generally comes from someone who got a loan from a bank who gave them someone else’s money, then replaced that money with new money. The guy who got a loan to start a business uses some of that money to pay an employee. This is where our money comes from. We then, in turn, pay taxes to send some of that money back to congress so they can pay for more stuff. Congress then has to use some of the tax money to pay interest on the IOU that got sold to the Federal Reserve. This all happens on a massive scale. To recap, congress trades an IOU created out of thin air for an IOU from the Federal Reserve created out of thin air, to give to people to put into banks where 90% more money is created out of thin air and lives on a computer screen in a bank. This money is lent out so people can start businesses and pay people with this money created out of thin air in order to collect taxes to pay interest on money created out of thin air by the Federal Reserve. Clear? Good.

What this really means is that every single dollar in existence is debt. If you had to borrow the first dollar, how do you pay that back? You have to borrow more dollars to pay back the first one. And so on, and so on. Every dollar in your bank account is owed to someone else, by someone else. If there was no debt, there would be no money. This is how money is created in virtually every country on earth, throughout history. Of course it is not sustainable and will eventually crash, just like every other time in history. This seems like a good place to stop. I will continue to explore this topic further next week. Don’t forget to buy that thing for that person you forgot about.

PS. Look at a dollar bill, or the one in the picture above. What does it say at the very top? It’s not money, it’s a Federal Reserve Note.


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