The fractional reserve money industry – part of chapter 2 of research study

The fractional reserve banking industry is different to the several industries explored above in that it does not directly produce the typical environmentally-problematic phenomena associated with the ‘other’ industries (for example, the fossil-fuel industry). The ‘other’ industries can be shown to be directly engaged in, for example, deforestation, which links to several other ecological issues directly, such as the loss of topsoil and the defilement of fresh water sources. The fractional reserve banking industry, quite contrarily, deals with fiat currency, which is to say a debt-based currency largely digitised and therefore not tangible in the same way as, say, a bulldozed field. However, the fractional reserve banking system, i.e. the monetary system ‘regulated’ by reserve and commercial banks in all nations, fuels the need to pay back the loans and the interest on loans inherent in the existence of fiat currency in the first place. The fractional reserve banking system, in this ecologically-sensitive view, is a viscous circle where constant economic growth is demanded by default, largely in the form of the continued growth of various industries that have traditionally been associated with monetary growth, the fossil-fuel industry being the main hub of such growth historically.

An interesting quote from the ‘governor’ of the US Federal Reserve in the 1930s and 1940s, Marriner Stoddard Eccles1, draws attention to the counter-intuitive notion that money is debt – this is an important concept to begin with when considering where money comes from and how the fractional reserve monetary system works to create new money. Questioned by congressman Patman about a past Federal Reserve purchase of U.S. government bonds, Eccles made the point that if “there were no debts in our money system, there wouldn’t be any money.” (Robinson 2009: 184 – 185) This is due to two main reasons, both of which will be explained below before turning briefly to the ecologically problematic implications of the system.

The first reason involves government ‘securities’: according to businessdictionary.com2, government ‘securities’ are bonds, “notes, and other debt instruments sold by a government to finance its borrowings. These are generally long-term securities with the highest market ratings.” Note the use of the phrase debt instrument – securities are debt instruments issued by governments to other parties in order to achieve given ends. In the case of the sale of these debt instruments from a government to a reserve bank (via the government treasury and bond traders), the ‘given end’ is the creation of a monetary deposit in selected commercial banks, which the reserve bank ‘creates’: the reserve bank purchases the government securities, which is to say that it purchases debt-instruments from the government, and in turn the reserve bank will authorise credit in selected commercial banks with deposits of whatever amounts – more on this below. For now, it is important to consider this slightly different definition of ‘government security’ from a second source3: “A government debt obligation (local or national) backed by the credit and taxing power of a country; as a result, there is very little risk of default.” it is clear again in this second definition of government security that what a government trades with a reserve bank is an obligation rather than than anything immediately tangible. The counter-intuitive aspect of the above ‘transaction’ is that the reserve bank does not buy government securities with money it has itself accrued and stored in its own reserves. This is explained in Modern Money Mechanics4, a booklet published by the Federal Reserve Bank of Chicago detailing the workings of the modern monetary system. To quote the opening line of the online booklet, the “purpose of this booklet is to describe the basic process of money creation in a ‘fractional reserve’ banking system” (In the example below, the reserve bank is the American one, called the Federal Reserve; from now on, ‘reserve bank’, ‘Federal Reserve’, and ‘the Fed’, will all be used interchangeably):

“Suppose the Federal Reserve System, through its trading desk at the Federal Reserve Bank of New York, buys $10,000 of Treasury bills from a dealer in U. S. government securities. In today’s world of computerized financial transactions, the Federal Reserve Bank pays for the securities with an “electronic” check drawn on itself. Via its “Fedwire” transfer network, the Federal Reserve notifies the dealer’s designated bank (Bank A) that payment for the securities should be credited to (deposited in) the dealer’s account at Bank A. At the same time, Bank A’s reserve account at the Federal Reserve is credited for the amount of the securities purchase. The Federal Reserve System has added $10,000 of securities to its assets, which it has paid for, in effect, by creating a liability on itself in the form of bank reserve balances.”

The final words of the above paragraph need to be reiterated, as they summarise the first reason why money in the global fractional reserve system is debt: the Fed pays for government securities “by creating a liability on itself in the form of bank reserve balances”; in other words, the Fed ‘pays’ for the purchase of government securities via the creation (credit) of the reserve deposit in the bank – nothing is deducted from either the Fed nor the Bank, while government is left with a debt obligation. Neither the government nor the Fed, it can therefore be argued, work with anything tangible in the creation of money; instead, the government uses ‘obligations’ (in the commercial sectors these are called ‘securities’ or ‘bonds’ – debt instruments) while the Fed ‘purchases’ such obligations by creating ‘liabilities on itself’. This strange interaction between the Fed and the government is the first step in adding new money to the money supply. But the Fed partly makes its money from interest repaid on the original amount it draws on itself; this is stated at federalreserveeducation.org5: “The Federal Reserve’s income is derived primarily from the interest on U.S. government securities that it has acquired through open market operations.” It is not inaccurate to state that the Fed earns interest from creating money out of nothing – later on in this section, it will be seen that this amounted to $700 billion in the US by 2008, and grew to $2 trillion in 2013; in response to such a system, Wright Patman (the congressman mentioned above who questioned Eccles in the 1940s) said on September 29, 1941, as reported in the Congressional Record of the House of Representatives (pages 7582-7583), records which are quoted at the website michaeljournal.org6:

“When our Federal Government, that has the exclusive power to create money, creates that money and then goes into the open market and borrows it and pays interest for the use of its own money, it occurs to me that that is going too far. I have never yet had anyone who could, through the use of logic and reason, justify the Federal Government borrowing the use of its own money… I am saying to you in all sincerity, and with all the earnestness that I possess, it is absolutely wrong for the Government to issue interest-bearing obligations. It is not only wrong: it is extravagant. It is not only extravagant, it is wasteful. It is absolutely unnecessary.”

For the sake of clarity now, a description of the process whereby money is created via the ‘transaction’ between government and reserve bank will be offered again, this time by globalresearch.ca7:

“When the government is short of funds, the Treasury issues bonds and delivers them to bond dealers, which auction them off. When the Fed wants to “expand the money supply” (create money), it steps in and buys bonds from these dealers with newly-issued dollars acquired by the Fed for the cost of writing them into an account on a computer screen. These maneuvers are called “open market operations” because the Fed buys the bonds on the “open market” from the bond dealers. The bonds then become the “reserves” that the banking establishment uses to back its loans.”

This process indebts governments to reserve banks – in trading government securities for the computerised deposits of money created ‘from nothing’, so to speak, the fed is indeed attaining a ‘bond’ from the government, and a bond is a promise to repay; the following definition from investopedia.com8 draws attention to the fact that ‘security’ and ‘bond’ are synonymous, and that a promise to repay is inherent in the ‘transaction’:

“A bond (or debt obligation) issued by a government authority, with a promise of repayment upon maturity that is backed by said government. A government security may be issued by the government itself or by one of the government agencies. These securities are considered low-risk, since they are backed by the taxing power of the government.”

Further defining ‘treasury bonds’, the same website9 draws attention to the obligation to pay interest to the fed by the government: “A marketable, fixed-interest …government debt security with a maturity of more than 10 years. Treasury bonds make interest payments semi-annually and the income that holders receive is only taxed at the federal level.” The following definition of government security, already partly used in this section, highlights the fact that the interest paid to the fed by the government comes from general taxes of a country: “A government debt obligation (local or national) backed by the credit and taxing power of a country”. In short, the taxes collected from a citizenry pay for the interest owed to the Fed, as evident is the following comment from Patman10:

“We have what is known as the Federal Reserve Bank System. That system is not owned by the Government. Many people think that it is, because it says `Federal Reserve’. It belongs to the private banks, private corporations. So we have farmed out to the Federal Reserve Banking System that is owned exclusively, wholly, 100 percent by the private banks — we have farmed out to them the privilege of issuing the Government’s money. If we were to take this privilege back from them, we could save the amount of money that I have indicated in enormous interest charges [i.e. taxation].”

To repeat, as stated above, the US debt to the fed reached 2 trillion dollars in August 2013 – this is the contemporary “amount of money” that Patman would be referencing if he were commenting ‘today’.

The second reason why Eccles’s counter-intuitive statement above – that if “there were no debts in our money system, there wouldn’t be any money” – is true is due to the fact that banks are only required to have a ‘reserve’ of actual deposits of around ten per cent, as stated in Modern Money Mechanics11: “the reserve requirement against most transaction accounts is 10 percent”. A footnote is added that provides more specific information on this limit: “For each bank, the reserve requirement is 3 percent on a specified base amount of transaction accounts and 10 percent on the amount above this base”; this is mentioned because, in attempting to find information on the South African Reserve Bank (SARB) for comparison reasons, its minimum reserve ration is identified only as 2.5 per cent in a document issued by the SARB12: “the Reserve Bank … introduced one reserve ratio of 2,5 per cent on the total liabilities of banks”. Whether or not one is talking about ‘base amount’ reserve limits of 2.5 per cent or 3 per cent, or a 10 per cent ‘above base’ limit, does not really matter because the factional reserve monetary system entails the creation of money from debt regardless of minimum reserve ratios, and this is the case for all countries using fiat currency, which is to say every country on Earth. For the purpose of this study, the amount referred to as an example in the Modern Money Mechanics booklet will be maintained for the purpose of providing graphs from the booklet – the amount is $10 000 (American dollars). The following two graphs from the .pdf version of Modern Money Mechanics13 outline how money is loaned out – and indeed created – with a ten per cent reserve limit:



The above graphs detail a process wherein, from a reserve of $10 000, new money to the value of $100 000 is created. It is explained in Modern Money Mechanics14 how this is possible:

“Of course, they [- the banks -] do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers’ transaction accounts. Loans (assets) and deposits (liabilities) both rise by $9,000. Reserves are unchanged by the loan transactions. But the deposit credits constitute new additions to the total deposits of the banking system.”

As the first graph shows, after the amount of 10,000 has been deposited and 9,000 of it loaned out under the 10% reserve limit, a bank will (presumably) be paid back the 9,000 by whoever borrowed it, so the bank will literally count the 9,000 loan amount as part of its deposits and work with 19,000 as the new deposit amount. Ten per cent of that 19,000 becomes the new reserve amount of 1900, this time leaving 8,100 as ‘excess’ on the original 10,000 deposit, and this 8100 is loaned out alongside the 9,000 already loaned – the 8,100 will also presumably be paid back, so again it is considered to be part of the bank’s deposits. Under the 10% reserve requirement, the gradually decreasing ‘excess’ will continue to be loaned on the original 10,000 amount until the excess value is zero, by which time new ‘money’ has grown to 100,000, i.e. ten times the original deposit amount. As the above quote from Modern Money Mechanics reveals, this would not be possible if a bank actually gave any of the original deposit to someone as the loan; rather, in participating in the fractional reserve process, someone who takes a loan creates the amount of money they borrow simply in ‘transacting’ with the bank. Of course, the person loaning the money also agrees to pay back interest on the loan amount when s/he signs for the ‘loan’, but as has been seen, money to pay the interest can come into existence 1) only when the government becomes further indebted to the fed when the latter buys government securities to back the creation of new bank deposits (a digital action only that ‘costs’ the fed nothing but guarantees it long-term interest repayments), and 2) when more loans are granted by banks. Astronomical levels of debt, including interest on loans, therefore, has accrued since the fractional reserve system began – world debt is above 54 trillion US dollars and rising15. Baring in mind the money-creation process described above, and considering the 54+ trillion dollar rising global debt, the following comment from Professor Antal E. Fekete, founder of the “New Austrian School”, is provided with some context16:

“The world economy, sagging as it is under the weight of its debt tower and fast depreciating irredeemable currencies, is clearly on its way to self-destruction. The forcible elimination of, first, silver and then a hundred years later of gold, from the monetary system removed the only ultimate extinguishers of debt we have. In consequence, total debt can only grow, never contract. The process is hidden since the unpaid and unpayable debt is accumulating as sovereign debt of governments. The world is deluding itself that sovereign debt can increase indefinitely as governments can extend its maturity indefinitely. In 2008 we had the wake-up call that it cannot.”

The Bank of England released two documents in 2014, one called ‘Money in the modern economy: an introduction’17, the other ‘Money creation in the modern economy’18, in which the above information about the creation of money is clarified and corroborated. The second document, for example, begins with the words, “This article explains how the majority of money in the modern economy is created by commercial banks making loans.” In the first, the following is found:

“Most money in the modern economy is in the form of bank deposits, which are created by commercial banks themselves… When a bank makes a loan to one of its customers it simply credits the customer’s account with a higher deposit balance. At that instant, new money is created…”

The second article provides further corroborative information, information that succinctly shatters the ‘common’ conception that when a bank loans money to a customer, it does so by lending out money that has been deposited by other customers: “rather than banks lending out deposits that are placed with them, the act of lending creates deposits — the reverse of the sequence typically described in textbooks.”

Globalresearch.ca19 adds some interesting perspective on the implications that the fractional reserve money system has for the creation of interest on loans:

“The website of the Federal Reserve Bank of New York explains that as money is redeposited and relent throughout the banking system, this 10% held in “reserve” can be fanned into ten times that sum in loans; that is, $10,000 in reserves becomes $100,000 in loans. Federal Reserve Statistical Release H.8 puts the total “loans and leases in bank credit” as of September 24, 2008 at $7,049 billion. Ten percent of that is $700 billion. That means we the taxpayers will be paying interest to the banks on at least $700 billion annually – this so that the banks can retain the reserves to accumulate interest on ten times that sum in loans.”

To reiterate: $700 billion owed to banks in interest in 2008, based on a ‘transaction’ between the US government and the US federal reserve where the former ‘traded’ debt-instruments for the latter’s electronic ‘creation’ of deposits in selected banks (by August 2013, this amount exceeded 2 trillion dollars20 – a consequence of the unprecedented rates at which the USA has been issuing new money via the processes described here since the financial crisis of 2008). The ‘deposit’ of computerised money by the fed into a commercial bank after the securitisation process, a process whereby government is indebted to the fed (reason one above supporting the view that money is debt), is part of the creation of the said bank’s reserves; such a deposit only exists electronically, based on a promise by government to honour its ‘debt’ to the fed via taxation, but the said commercial bank counts the electronic sum of money as part of its reserves. So part of the ten per cent ‘reserves’ that a commercial bank loans out in the fractional reserve system described in the above paragraphs is the ‘money’ ‘created from debt’ and is used to create more ‘money from debt’ through the counter-intuitive bank-lending fractional reserve process – indeed, the only way to make sense of how any of this works is to view money as debt, as Eccles did. Patman realised this, a realisation that sparked the kind of response from him already seen in this section, as well as the following one, ‘introduced’ by globalresearch.ca21 at the opening of this quote:

“In another bit of sleight of hand known as “fractional reserve” lending, the same reserves are lent many times over, further expanding the money supply, generating interest for the banks with each loan. It was this money-creating process that prompted Wright Patman, Chairman of the House Banking and Currency Committee in the 1960s, to call the Federal Reserve “a total money-making machine.” He wrote:

“When the Federal Reserve writes a check for a government bond it does exactly what any bank does, it creates money, it created money purely and simply by writing a check.”

What does any of the above information about the creation of the majority of money in circulation by commercial banks making loans have to do with the ecological crisis? An initial glimpse of an answer can first be seen with the World Bank22: one document issued by it contains the following: “The world economy needs ever-increasing amounts of energy to sustain economic growth”. Economic growth is measured in numbers that increase as the money supply does, but it has been shown above that as the money supply is increased, so is global debt (money is debt), inherent in which is an obligation to pay money back (which requires more money expansion/creation, entailing more debt), hence constant expansion of lucrative industrial activity that is historically dominant in global business. This kind of industrial activity comes in many forms, and it has been shown above that some of the largest ones (for example, the fossil-fuel industry) have devastating consequences for the ecology of the planet.

With world debt at over 54 trillion dollars23 in mid-Augsut 2014, it is not unreasonable to state that recession is always in the background of economic discourse – indeed, various countries have been in, or still are in, or border close to, a state of recession since the 2008 financial crisis. outlines the following ecological consequence of such a situation:

“One direct link between the current monetary system and the environment is the effect that recessions have on environmental regulation and investing in the long term. In a recession it is common to hear the argument that costs to businesses are too high due to regulations which are represented as onerous, and that the relaxation of these regulations would allow businesses to hire, resulting in reduced unemployment and increased output.”

“Although the validity of this argument is debatable, it is propagated by those who believe it to be true, by those who see the recession as an opportunity to lower their costs, and by those who did not believe the regulations were required in any case. While the benefits of environmental regulations accrue over the long-term, the government’s chances of re-election usually hinge on the short-term health of the economy. As such the long-term environmental benefits of regulation often lose out to short-term political and economic considerations.”

Furthermore, it is pointed out at quite simply that the current monetary system requires constant growth. Constant economic growth implies lucrative activity, much of which is again in the form of the expansion of existing industries of the type already commented upon above. The monetary system, according to the aforementioned source, is engaged in constant economic growth in four ways; to quote directly from the source:

  • Debt repayments: since loans have to be repaid in instalments on fixed dates people are incentivised to pursue activities that provide quick returns. People pay off debt by producing more goods and services. Higher levels of debt incentivise higher levels of growth.

  • Asset price bubbles occur as banks create money through lending into assets they can receive the largest returns on, e.g. housing. In order to maintain standards of living when faced with an increase in the cost of essentials e.g. rent, individuals must either work more in order to pay the higher prices, or borrow more to make up the difference. Both borrowing and working more increase economic growth.

  • Loan repayments: when loans are repaid money is destroyed and the money supply shrinks. This generally results in a self reinforcing recession. To avoid this, new loans need to made simultaneously, increasing a need for growth as above .

  • Indebtedness in society is liable to increase economic activity, as individuals struggle to pay off the interest on their debt. In other words, debt drives growth.

The need for continued economic growth fuelled partly by the fractional reserve money system is commented on at at wiki.mises.org24; the two “critics” are listed as David Korten and Henri Monibot: there “are also critics… who contend fractional reserve banking (by creating a necessity for indefinite economic growth) leads to environmental destruction and a sudden, catastrophic depletion of the earth’s natural resources as the unsustainable, exponential consumption of the world’s scarce natural resources reaches its inevitable limits.”

Such information contextualises the following statement made by neweconomics.org25: “From climate change to the financial crisis it is clear the current economic system is not fit for purpose”. It is pointed out at the same site26 that “there are serious questions as to whether a relatively unregulated system dominated by private money creation in the form of interest bearing debt is best suited to the challenges facing modern humanity.”

[Note: Extensive information about the counter-intuitive process of money creation and the consequences of the process can be found at, a site that describes itself as follows: “The Mises Institute is the world’s largest, oldest, and most influential educational institution devoted to promoting Austrian economics, freedom, and peace in the tradition of classical liberalism. Since 1982, the Mises Institute has provided both scholars and laymen with resources to broaden their understanding of the economic school of thought known as Austrian economics. This school is most closely associated with our namesake, economist Ludwig von Mises. We are the worldwide epicenter of the Austrian movement.” This is not a conspiracy-based website; indeed, it is highly credible and details economic views from various credible sources. The research conducted in this section is fully corroborated at the site, and dismissing the subject of enquiry as a conspiracy is not academically or logically viable.]