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Zeitgeist: Addendum - Part One - Page 3

Author: Edward L Winston
Added: August 16th, 2009

This is page three of part one of four in my series of articles on Zeitgeist: Addendum. Please refer to the introduction if you were lead to this page.

The different degrees of what is considered money is defined as:

Type: Definition
M0 Hard currency; cash, coinage, and central bank reserves
M1 (M0) + Deposits in checking accounts and traveler's checks
M2 (M1) + Deposits in savings accounts and in money market accounts.
M3 This has been discontinued by the Federal Reserve as of 2006
(M2) + Deposits of large amounts, institutional money market funds, and large liquid assets.

At the beginning of Modern Money Mechanics the booklet states it is only looking at the M1 money, something which Zeitgeist ignores and thus messed up their math and concept very badly. Money is a medium of the economic process and not an active part of it by itself, commodities and money are always mixed and mashed. There's a correlation between production (be it goods or services) and the movement of money. If there's an increase in the commercial bank money supply, it is because the production and circulation of commodities demands it. 

Zeitgeist never mentions this and goes on to say this:

Here is where it gets really interesting, for as based on the Fractional Reserve practice, that 10 billion dollar deposit instantly becomes part of the bank's Reserves, just as all deposits do. And regarding reserve requirements, as stated in Modern money mechanics:

"A bank must maintain legally required reserves, equal to a prescribed percentage of its deposits. It then quantifies this by stating: under current regulations, the reserve requirement against most transaction accounts is 10%."

This means that with a ten billion dollar deposit, 10% or 1 billion is held as the required reserve, while the other 9 billion is considered an excessive reserve and can be used as the basis for new loans.

While the bank will sometimes keep some of the depots for various purposes, including lending, in reality the percentage would be much lower. Zeitgeist then goes on to talk more:

Now, it is logical to assume that this 9 billion is literally coming out of the existing 10 billion dollars deposit. However, this is actually not the case. What really happens is that the 9 billion is simply created out of thin air, on top of the existing 10 billion dollar deposit. This is how the money supply is expanded. 

As stated in Modern Money Mechanics, "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 [loan contracts] in exchange for credits [money] to the borrower's transaction accounts."

In other words, the 9 billion can be created out of nothing, simply because there is a demand for such a loan, and there is a 10 billion dollars deposit to satisfy the reserve requirements.

Now, let's assume that somebody walks into this bank and borrows the available 9 billion dollars. They will then most likely take that money and deposit it into their own bank account.

The process then repeats, for that deposit becomes part of the banks reserves, 10% is isolated and in turn 90% of the 9 billion, or 8.1 billion, is now available as newly created money for more loans. And, of course, that 8.1 can be loaned out and redeposited creating an additional 7.2 billion, to 6.5 billion.. to 5.9 billion, etc.

This deposit-money creation-loan cycle can technically go on to infinity. The average mathematical result is that about 90 billion dollars can be created on top of the original 10 billion. In other words, for every deposit that ever occurs in the banking system, about 9 times that amount can be created out of thin air.

The process is this: The $9 billion being lent is actually a new deposit which returns to the bank, and thus it can lend out another $8.1 billion. This is what many critical of fractional reserve banking point out, and say it's "creating" new deposit of $8.1 billion. That new sum can then be used to create deposits of $7.29 billion, $6.56 billion, and so on. If you add all of these figures up, you do indeed get $90 billion out of $10 billion - making total deposits $100 billion.

According to Zeitgeist that $90 billion is new money out of thin air, but Zeitgeist is wrong. The process described in the Zeitgeist film is the creation of new deposits: M1 not M0. The film makes no distinction between these two and calls the deposits "money" and then claims they are made out of thin air. 

There is no actual increase in physical money - it is merely the use of money as a measure of value. This means that transactions can be settled between banks without the need for large sums of hard currency be exchanged. The effect of multiplication allows a sum of money to enact the part of a much larger amount. There has been no new money created. This system is used because it optimizes the circulation of money.

So, that we understand how money is created by this fractional reserve banking system, a logical, yet elusive, question might come to mind:

What is actually giving this newly created money value?

The answer: The money that already exists.

The new money essentially steals value from the existing money supply,  for the total pool of money is being increased, irrespective to demand for goods and services, and, as supply and demand finds equilibrium, prices rise, diminishing the purchasing power of each individual dollar. This is generally referred to as "inflation" and inflation is essentially a hidden tax on the public.

Further digging itself into a pit of nonsense, the film goes beyond the "thin air" argument, which it was incorrect about, and says the new money steals from the value of the existing money supply. If a central bank has money printed ad infinitum without regard for consequences it will certainly cause inflation, however that's M0, but increasing M1, as we have discussed, does not print money into existence - a bank cannot lend more than is deposited within.

Zeitgeist then tell us that "inflation is a hidden tax on the public", but doesn't say where this tax is paid and to whom it goes. The film essentially misses the entire point about inflation. Inflation is represents the falling value of money, but the rising value of commodities. The total value in the economic system remains the same. The supply of money by itself does not determine the value of money. Many economists are accepting of mild inflation because it discourages hoarding of cash and instead puts deposit to work through the banking system.

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