The Real Reason for Inflation and Deflation

In a previous post (Inflation: Why Your Dollar Just Doesn’t Buy As Much) I posted two videos from YouTube about money and inflation. I was so intrigued by those videos that I bought a couple books to learn more.

In this post I would like to discuss the claims made in the first video that I believe are incorrect. The narrator’s basic claim is that we have inflation because the dollar has been taken off the gold standard, meaning the dollar is no longer backed by gold. The current dollar, our Federal Reserve Note, has a value subject to manipulation whereas gold has maintained value over time.

The Constitution says that Congress has the right:

To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures

But our governing leaders could never determine exactly what “money” should be or who should make it. Gold and silver were used for the payment of debts, but gold was leaving the country to pay for imports and taxes. Not enough gold was being mined to replace the gold shipped overseas or to expand with the population and economy.

In the late 17th century Massachusetts began printing its own paper money–government IOUs to be repaid at a later date–to pay militiamen and their widows for a military campaign against Canada. Then other colonies printed their own money, either backed by hard currency or legal tender itself. In the early 18th century Benjamin Franklin printed money as currency secured against future tax revenues.

The colonies prospered. Money was no longer being drained off by England. Colonial assemblies began issuing paper money as loans at low interest rates that were backed by real property or other assets. The interest paid on these loans was put back into circulation, not siphoned off by private parties. Some of the loans were never paid off and helped increase the money supply to keep pace with a growing economy. Money also came into the country via import duties.

But some of the colonies printed too much money and did not require it to be recycled back to the government in the form of excise taxes or interest on loans, so their money began to depreciate. The American colonies were expected to provide raw materials to England at reasonable rates, and British merchants and bankers weren’t too happy about the depreciation of their investments. They successfully petitioned King George II to ban the issuance of new paper money in the colonies in 1751.

In 1764, Benjamin Franklin visited London to try to get the ban lifted. But the Bank of England influenced Parliament to pass the Currency Act making it illegal for the colonies to print their own paper money. This caused the money supply to be reduced by half and colonists had to pay taxes to Britain in silver and gold. If they didn’t have it, they had to borrow it at high interest. Within a year poverty and unemployment abounded. The colonists revolted and began printing their own money again, which was a crime considered intolerable by the crown. And so began the Revolution.

But the Revolutionary war cost a lot of money to wage, and the new government had to pay for it. So the new continental congress issued its own paper currency called the Continental with which they funded the war. Most of this paper was issued as IOUs to be redeemed after the war. But British bankers counterfeited the Continental and flooded the colonies with it, reducing its value. Its value was finally ruined by speculators who convinced the population that it would be worthless when America lost the war and then bought it up for a fraction of its value.

The war over money continued with the chartering of private banks, dissolution of same, money printed as IOUs, money printed as legal tender, wars, depressions, etc., until the Federal Reserve Bank, a private bank without reserves, was legalized by the government. And it’s been downhill ever since.

Our government, which has the constitutional right to print its own money interest-free, has been tricked by private bankers into borrowing the money at interest and has been falling into greater and greater debt thereby. And who pays the interest on the debt?

The Real Reason for Inflation

Our banks use fractional reserve banking. They are required to keep a reserve of money in their vaults to service the customer withdrawals on any given day. They are allowed to loan out ten times what they take in deposits.

For example, I deposit $100 in my checking account. The bank reserves $10 and loans $90 to you. You spend your $90, which is then deposited in another checking account. The bank reserves $9 and loans out $81. And on and on. Thus $100 physical dollars are used to create $900 ledger dollars, all of which are earning interest. But where will the interest come from to pay the debt? It hasn’t been created by the bank. If you create $10 and expect $11 back, where does the extra $1 come from? You have to fight your neighbor for it from an increasingly reduced supply.

So the $100 ends up becoming $10 because $900 was lent but $990 was repaid. Get it? And who got the $90? Yes, some of it came back into the economy, but those rich bankers are sitting on most of it and controlling the world by funding some corporations and witholding funds from others, buying politicians and lobbies, buying the media that feeds you information they want you to believe, and then contracting the money supply and pulling in the defaulting banks and properties like a great net pulls in schools of fish. Meanwhile, the $100 in my checking account that allowed them to earn $90 is earning ZERO. In fact, I’m paying $10 a month to maintain that account. How whacked is that?

Reserve requirements apply only to transaction accounts, which are components of M1, a narrowly defined measure of money. Deposits that are components of M2 and M3 (but not M1), such as savings accounts and time deposits such as CDs, have no reserve requirements and therefore can expand without regard to reserve levels. Furthermore, the Federal Reserve operates in a way that permits banks to acquire the reserves they need to meet their requirements from the money market, so long as they are willing to pay the prevailing price (the federal funds rate) for borrowed reserves. Consequently, reserve requirements currently play a relatively limited role in money creation in the United States.–Wikipedia

Does that make sense? The 10 percent reserve requirement only applies to accounts like your checking account where you can remove the money at any time by withdrawal, writing a check, or using a debit card. And even then the reserve may not be required. But no reserve is required on savings accounts, time deposits, etc.

This means the bank can make as much money as their shareholders think they can get away with. They just have to make sure they have enough in reserve to handle the withdrawal demands at the window. This is why banks get in trouble financially and have to be bailed out by the government (um, that’s you and me again). They loan more money than they should and often imprudently. And if too many people demand withdrawal of their money on a given day, called a “run on the bank,” the bank can become insolvent if they’re not able to borrow the shortfall.

It’s not the Federal Reserve printing money that causes inflation. That’s just an end effect of the true cause: the banks creating debt money on which interest is due. Increased credit creates more interest debt and subsequent inflation. The screwy thing is that if we paid all the debt back we wouldn’t have any money! At least that’s my understanding. If you have another take on it, please comment. I’d love to hear it.

The real issue…was not what money consisted of but who created it. Whether the medium of exchange was gold or paper or numbers in a ledger, when it was lent into existence by private lenders and was owed back to them with interest, more money would always be owed back than was created in the first place, spiraling the economy into perpetual debt. A dollar borrowed at 6 percent interest, compounded annually, grows in 100 years to be a debt of $13,781. That is true whether the money takes the form of gold or paper or accounting entries. The banks lend the dollar into existence but not the additional $13,780 needed to pay the loan off, forcing the public to go further and further into debt in search of the ephemeral interest due on their money-built-on-debt. Merchants continually have to raise their prices to try to cover this interest tab, producing perpetual price inflation.” –Ellen Hodgson Brown, J.D. The Web of Debt

(The information in this post was derived mostly from Ellen Hodgson Brown’s book referenced above.)