By Omar Javaid, Sr. Editor, Critic MAGAZINE
Trust is the name of the game, mistrust is the code followed. Today digital currency is the fuel of financial system, and it extracts value from the paper currency (backed by nothing) in circulation. But on the contrary it deems to have the power to purchase anything based on its value derived from the trust in the economy of the nation it belongs to (demand of currency in international market: more economic strength, more demand, and more value). The Economic Strength of the nation? Is only a matter of perception, as proved many time in the history. In present times the economic strength stands over a bubble of debt in the economy. The bubble expands with the ever growing debt, with a fraction of real wealth to back. The ultimate result.... the Bubbles are there to burst, leading to benefit of the few, and disaster for millions. Case in point: sub-prime mortgage crises in America.
Since the time Lehman brothers declared bankruptcy, a plethora of articles with analysis of the entire fiasco, its causes and impacts has been published but probably none (at least I cannot find one) has really disclosed or talked about the real root cause of the entire disaster. When I look at the entire scene, the question that pops in my mind is how a debt of $11 trillion in 'mortgages', alone, is loaned out when there is only $1.3 Trillion of printed notes available? In addition to this Credit card debts, other types of public and private loans mounting to a total of around $50 Trillion, only in American economy? (Total U.S. mortgage debt outstanding was $10.7 trillion at the end of the third quarter 2006. Source: http://www.freeratesearch.com/en/newsroom/mortgage_statistics/)
Out of Thin Air
A common man, uninformed of this jugglery, would eventually ask that how on earth can this ever be possible. The answer is simple but seems like a joke, a nasty one indeed. The Banks creates money out of thin air when they have to loan out to someone? Magic? No! The process they use is called fractional reserve banking and the effect is called Money Multiplier in economics.
"The study of money, above all other fields in economics, is one in which complexity is used to disguise truth or to evade truth, not to reveal it (p15). The process by which banks create money is so simple that the mind is repelled."
John Kenneth Galbraith, Money: Whence it came, where it went - 1975, p29.
This is the most core of the banking business and all the central bank policies are directly or indirectly related with it. Paper Currency is printed in the quantity, desired by Central Bank, is multiplied as it passes through Fractional Reserve Systems of Conventional banks. The CB imposes a Cash Reserve Requirement i.e. CRR is 7 ~ 10% on commercial banks (even Islamic banks) which determines the amount to be loaned out. A CRR of 20% means that a bank can lend 80 rupees if it has a deposit of Rs. 100. The bank in fact transfer this amount to the borrowers bank account, i.e. the same bank (or any other bank) receives it, again make it a part of the deposits (of the banking system) ready to be loaned again. The cycle continues and the money printed or minted by central bank is multiplied many times in the form of loans and the commercial bank expects it back with interest.
No surprise the amount of debt (increasing every year) is more or less the same as the amount of time and demand deposit (demand deposits are saving and current accounts, and time deposits are long term deposits which are not withdrawn at least for one year) during the same period. Thus money is created continuously as debt in the economy. Today in US economy, only 3% is real money and the remaining is just ... Numbers!!! Same is the case with UK. In Pakistan the cash in circulation is Rs. 982 Billion, which is around 21% of the total Money supply (Rs. 4,672 Billion) and 21.6% of total domestic credit (Rs. 4,531 Billion). These statistics has been taken from http://www.sbp.org.pk/reports/stat_reviews/Bulletin/2008/Sep_08/Money_and_Credit.pdf.
Murray N. Rothbard states in his article “The Case for a 100 Percent Gold Dollar” (http://mises.org/story/1829#_ftn19): In my view, issuing promises to pay on demand in excess of the amount of goods on hand is simply fraud, and should be so considered by the legal system. For this means that a bank issues “fake” warehouse receipts—warehouse receipts, for example, for ounces of gold that do not actually exist in the vaults. This is legalized counterfeiting; this is the creation of money without the necessity for production, to compete for resources against those who have produced. In short, I believe that fractional-reserve banking is disastrous both for the morality and for the fundamental bases and institutions of the market economy.
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