Posted by: John Gilmore | September 16, 2006

German Central Bank Admits that Credit is Created Out of Thin Air

The article below is a good read when you have some time – short and to the point. Many people believe high inflation is on the way – and I agree. You may be wondering – with all of the Federal Reserve actions flooding the system with dollars – why isn’t inflation taking off now? To understand what is happening – you need an understanding of the difference between our monetary base and our money supply. Our monetary base consists of all commercial bank reserves held at the Fed. Commercial banks are required to hold a fraction of their ‘reserves’ at the Fed (fractional reserve banking) – in order to make loans. Once a bank loans money into our economy (mortgages, auto loans, etc.) – money is then added to our money supply (money in circulation in the system). In our system – money = debt.

Where is the majority of the Fed’s money going? Are the Fed’s actions helping the economy?

Here’s one piece of the answer (taken from the Federal Reserve’s website):

Our monetary base is rising dramatically (now over $1.2 trillion). Why? Banks aren’t lending at required levels due to a number of factors. Commercial/Residential real estate prices continue to decline, unemployment is high, home foreclosures continue to rise, the Fed is now paying interest on deposits (interesting timing), we’re beginning to understand that borrowing money forever is a bad idea, etc. etc. In a nutshell – our monetary system has reached a debt saturation point. Banks are getting hammered (loan defaults) and don’t want to lend (to protect themselves) – couple this with the fact that consumers don’t want to borrow because they’re already in trouble – and you’ve got a perfect storm. This creates a serious problem in a debt based monetary system – since our monetary system requires exponential debt growth to create the money required to pay back interest (since we never create the money required in this system to pay interest). If debt growth declines – money supply declines – leading to a downward spiral of increasing defaults, foreclosures, bankruptcies, etc.

Since debt creation is falling dramatically – our money supply is now contracting (again – money = debt in this system). This is the dirty little secret that the mainstream media talking heads never mention.

M3 (total U.S. money supply) money supply is now contracting – and the trend is not good.

The system is failing. There can be no economic recovery in this system if our money supply continues to contract.

This is becoming clear in a number of economic indicators.

Probably the clearest indication that our debt based system is failing can be seen in the following graphs. Karl Denninger (someone I believe has a firm grasp of the situation) posted the following in December 2008:

The graph above shows us the impact on nominal GDP (economic growth) resulting from a $1.00 increase in U.S. debt (money). You’ll notice that we’ll be at ‘zero hour’ when $1.00 of new debt has no positive impact on economic growth.

So – fast forward to today. Where are we?

From Nathan’s Economic Edge – (someone else I trust):
Saturday, March 20, 2010

THE Most Important Chart of the CENTURY

The latest U.S. Treasury Z1 Flow of Funds report was released on March 11, 2010, bringing the data current through the end of 2009. What follows is the most important chart of your lifetime. It relegates almost all modern economists and economic theory to the dustbin of history. Any economic theory, formula, or relationship that does not consider this non-linear relationship of DEBT and phase transition is destined to fail.

It explains the “jobless” recoveries of the past and how each recent economic cycle produces higher money figures, yet lower employment. It explains why we are seeing debt driven events that circle the globe. It explains the psychological uneasiness that underpins this point in history, the elephant in the room that nobody sees or can describe.

This is a very simple chart. It takes the change in GDP and divides it by the change in Debt. What it shows is how much productivity is gained by infusing $1 of debt into our debt backed money system.

Back in the early 1960s a dollar of new debt added almost a dollar to the nation’s output of goods and services. As more debt enters the system the productivity gained by new debt diminishes. This produced a path that was following a diminishing line targeting ZERO in the year 2015. This meant that we could expect that each new dollar of debt added in the year 2015 would add NOTHING to our productivity.

Then a funny thing happened along the way. Macroeconomic DEBT SATURATION occurred causing a phase transition with our debt relationship. This is because total income can no longer support total debt. In the third quarter of 2009 each dollar of debt added produced NEGATIVE 15 cents of productivity, and at the end of 2009, each dollar of new debt now SUBTRACTS 45 cents from GDP!

This is mathematical PROOF that debt saturation has occurred. Continuing to add debt into a saturated system, where all money is debt, leads only to future defaults and to higher unemployment.


So – we’re now at ‘zero hour’ – when every $!.00 of new debt/money added to our system now subtracts from economic growth/productivity – and this is a worldwide phenomenon – not just the U.S.

How much longer can the world’s economy continue without a serious economic ‘event’ – stock market crashes, sovereign debt defaults, currency values plunging, etc.? I’m not sure – but I would bet that since we’re nearing the end of many of the government/Central Bank ‘stimulus’ actions – the time draws near.

At some point in the near future – the world’s economy will begin a rapid decline – most likely preceded by a stock market crash or a nation defaulting on its debt (see Greece) – or a combination of both. Once this happens, I’m sure many political and financial leaders will point the blame at everyone and everything – except the truth.

jg – March 22, 2010

German Central Bank Admits that Credit is Created Out of Thin Air

Submitted by George Washington on 03/19/2010 16:17 -0500

Preface: Most people think that banks lend solely from their base of deposits.

Some also know that with fractional reserve banking, they can loan out many times more than they actually have in reserves.

But very few people – with the exception of those in the banking industry and financial experts – know where credit really comes from. Many ZH readers are in the banking industry or financial experts, so this may seem obvious.

Germany’s central bank – the Deutsche Bundesbank (German for German Federal Bank) – has admitted in writing that banks create credit out of thin air.

As the Bundesbank states in a publication entitled “Money and Monetary Policy” (pages 88-93; translation provided by Google translate, but German speaker Festan von Geldern confirmed the basic translation):

4.4 Creation of the banks money

Money is created by “money creation”. Both [central banks] and private commercial banks can create money. In the euro monetary system [money creation] arises mainly through the granting of loans, as well as the fact that central banks or commercial banks to buy assets such as gold, foreign currencies, real estate or securities. If the central bank granted a loan from a commercial bank and crediting the amount in the account of the bank at the central bank, created “central bank money.”

Money creation by commercial banks

The commercial banks can create money itself, the so-called bank money. The money creation process through which commercial banks can be explained by the related postings: If a commercial bank to a customer a loan, they booked in its balance sheet as an asset against a loan receivable the client – for example, 100,000. At the same time, the bank writes down the customer’s checking account, which is run on the liabilities of the bank’s balance sheet, 100,000 euros good. This credit increases the deposits of customers on its current account – it creates deposit money, which increases the money supply.

In other words, money is created as book-entry by purchasing assets or entering credits on the left side of the balance-sheet and corresponding deposits on the right side. In other words, credit is created out of thin air.

Frontiers of money creation

The above description might leave the impression that the commercial banks are able to draw an infinite amount of money in bank accounts. If this were really so, this could be inflationary. The central bank therefore takes effect on the extent of lending and money creation. It requires commercial banks to hold the reserve.

As I’ve previously pointed out, the Federal Reserve is taking the same tack, creating conditions that guarantee that American banks will have huge excess reserves so as to prevent inflation. Back to the publication:

Central banks, commercial banks can typically obtain only by the fact that the central bank granted them credit. For these loans, commercial banks have to pay the central bank interest rate. Increase this rate, the central bank, the “prime rate”, the commercial banks usually raise their part, the rates at which they lend themselves. There will be a general rise in interest rates. This, however, dampens the tendency of businesses and households, the demand for loans. By raising or lowering the key interest rate the central bank can thus influence the business sector demand for credit – and thus on Lending and bank money creation.

The commercial banks need central bank money to cover not only for the reserve, but also to the cash needs of its customers. Each bank customer may be credit in the bank account into cash to pay off. If the stocks of the banks in cash to be in short supply, the central bank can create only remedy. Because only they are permitted to bring additional notes in circulation. To meet the cash needs of its clients, the commercial bank must therefore include, where appropriate, with the central bank for a loan. This leads to the creation of central bank money. The so-purchased assets for central bank money can pay off the commercial bank in cash let. Thus, the cash is in circulation: from the central bank to commercial banks and from these to the bank customers.

Central Bank money is also to cover the non-cash payments are required: a customer transfers money from its credit to a customer at another bank, this results in many cases led to the sending bank central bank needs to transfer money to the receiving bank. The central banks then moves from one bank to another.

The commercial banks can use the surplus of central bank money and to award additional credits to businesses and households. As previously described, arises from the award of additional credits additional demand for central bank money – which can be covered in this special situation of great uncertainty among banks by the existing excess liquidity. The abundant supply of liquidity relief, a bank that wants to provide a loan, from the traditional consideration of how much money they need after the award of credit is, how it is constituted, and at what cost. Using the so-called money creation multiplier can be estimated how large the potential for additional Credit limit is.

Do you get it now?

Private banks don’t make loans because they have extra deposits lying around. The process is the exact opposite:

(1) Each private bank “creates” loans out of thin air by entering into binding loan commitments with borrowers (of course, corresponding liabilities are created on their books at the same time. But see below); then

(2) If the bank doesn’t have the required level of reserves, it simply borrows them after the fact from the central bank (or from another bank);

(3) The central bank, in turn, creates the money which it lends to the private banks out of thin air.

It’s not just Bernanke … the central banks and their owners – the private commercial banks – have been running the printing presses for hundreds of years.

Of course, as I pointed out Tuesday, Bernanke is pushing to eliminate all reserve requirements in the U.S. If Bernanke has his way, American banks won’t even have to borrow from the Fed or other banks after the fact to have reserves. Instead, they can just enter into as many loans as they want and create endless money out of thin air (within Basel I and Basel II’s capital requirements – but since governments are backstopping their giant banks by overtly and covertly throwing bailout money, guarantees and various insider opportunities at them, capital requirements are somewhat meaningless).

The system is no longer based on assets (and remember that the giant banks have repeatedly become insolvent) It is based on creating new debts, and then backfilling from there.

It is – in fact – a monopoly system. Specifically, only private banks and their wholly-owned central banks can run printing presses. Governments and people do not have access to the printing presses (with some limited exceptions, like North Dakota), and thus have to pay the monopolists to run them (in the form of interest on the loans).

At the very least, the system must be changed so that it is not – by definition – perched atop a mountain of debt, and the monetary base must be maintained by an authority that is accountable to the people.

Note: When I receive a better translation I will post it.


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