How does the Fed “create” money out of nothing?

Answer: It is a four-step process. But first a word on bonds. Bonds are simply promises to pay — or government IOUs. People buy bonds to get a secure rate of interest. At the end of the term of the bond, the government repays the principal, plus interest (if not paid periodically), and the bond is destroyed. There are trillions of dollars worth of these bonds at present. Now here is the Fed moneymaking process:

Step 1. The Fed Open Market Committee approves the purchase of U.S. Bonds on the open market.

Step 2. The bonds are purchased by the New York Fed Bank from whomever is offering them for sale on the open market.

Step 3. The Fed pays for the bonds with electronic credits to the seller’s bank, which in turn credits the seller’s bank account. These credits are based on nothing tangible. The Fed just creates them.

Step 4. The banks use these deposits as reserves. Most banks may loan out ten times (10x) the amount of their reserves to new borrowers, all at interest.

In this way, a Fed purchase of, say a million dollars worth of bonds, gets turned into over 10 million dollars in bank deposits. The Fed, in effect, creates 10% of this totally new money and the banks create the other 90%.

This also explains why the Fed consistently holds about 10% of the total US Treasury bonds. It had to buy those (with accounts or Fed notes the Fed simply created) from the public in order to provide the base for the rest of the money the private banks then get to create, most of which eventually winds up being used to purchase Treasury bonds, thus supplying Congress with the borrowed money to pay for its expenditures.

Due to a number of important exceptions to the 10% reserve ratio, some loans require less than 10% reserves, and many no (0%) reserves, making it possible for banks to create many times more than ten times the money they have in “reserve”. Due to these exceptions from the 10% reserve requirement, the Fed creates only a little under 2% of the total US money supply, while private banks create the other 98%.

To reduce the amount of money in the economy, the process is just reversed — the Fed sells bonds to the public, and money flows out of the purchaser’s local bank. Loans must be reduced by ten times the amount of the sale. So a Fed sale of a million dollars in bonds, results in 10 million dollars less money in the economy.

Banks can operate without charging interest

Imagine paying off a £150,000 mort-gage and ending up with not only a mortgage-free house, but also £150,000 in cash.

In our interest-driven banking system, it would be inconceivable.

But for 32,000 members of Sweden's unique JAK Bank, the dream of getting rid of interest has become a reality.

Bank co-founder Eva Stenius is in Otara this week to speak at the Auckland Eco Show, a five-day "tent city" of talks, demonstrations and displays on sustainable living, housing, energy and agriculture.

Mrs Stenius said borrowers in the member-owned JAK Bank earn the right to interest-free loans after saving with the bank - also without earning interest - for several years.

Then, if they take out a £150,000 mortgage, they have to keep up repay-ments until they pay back the £150,000 loan plus up to a further £150,000 - a form of forced saving which means that each borrower in turn finances the next borrower.

The big difference from interest-based banking is that, instead of that extra £150,000 disappearing in interest pay-ments to the bank, the borrowers ultimately get back the money they were forced to save.

"It's among friends. We are circulating the money amongst ourselves independent of others who want to exploit us," Mrs Stenius said. "It is based on humanitarian values rather than profit."

The system depends on people being willing to save before and after taking out a loan without receiving interest.

Mrs Stenius says JAK members are willing to do that, to qualify for an interest-free mortgage themselves, and to help their families and communities.

"You have complete control over where your money goes," she said.

"Maybe you would like to give your savings points to your children for their education, or to help fund starting a business, or you might donate it for JAK to invest in community development or women's enterprises or sustainable development.

"A typical JAK member is one with ethical values. Quite a lot are my age [60s] and many are well educated. And there is a big group with less money who are into alternative living in the countryside.

"There are also a lot of immigrants from the Muslim community because of the Muslim law of no interest."

Mrs Stenius and her then-husband, Per, helped establish the Swedish JAK Bank in 1970, inspired by a similar Danish bank which later merged with a larger commercial bank.

The name comes from the Swedish words Jord, Arbete, Kapital - land, labour and capital, "the three corner-stones to economic development".

The Swedish bank learned from the mistakes of its Danish predecessor, which ran out of cash because too many members wanted big loans as soon as possible.

In the Swedish system, a person's loan entitlement is calculated on a strict formula based on "savings points".

"We are the safest bank in Sweden," Mrs Stenius said. "You can't just have a big loan - you also have to contribute."

Administration costs are covered by a $40 annual membership fee and a one-off loan fee based on a formula which works out at the equivalent of about a 2 per cent annual interest rate.

The bank has 30 paid staff in two offices, and members do their banking over the telephone.

But it also has 460 trained volunteers who organise lectures and exhibitions on sustainable development around the country.

For more information about the JAK: www.jak.se


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Why do we need it, watch this - well before the current 'credit crisis'

Also, if you can get a copy of The Money Masters

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