Money for Nothin

How the Federal Reserve Creates Money

You can find pages and pages of explanations for the creation of money by the Federal Reserve. By the time you are done wading through it all you will be just as confused and in the dark as when you started. However if you start with a the basic premise that,

  1. it isn't rocket science.
  2. it's created out of thin air.
  3. it's not done to protect the wealth or security of the common citizen.

Then it gets pretty simple pretty quickly.

The typical way money is created by the FOMC – The short form

It's a simple four-step process.

  1. The FOMC first approves the purchase of US government bonds on the 'open market'. [When the government is short of funds, the Treasury issues bonds and delivers them to independent bond dealers, which auction them off.}
  2. When the FED wants to "expand the money supply'"i.e. create money the New York Fed bank buys these government bonds from the independent securities dealers (financial markets always have an equal number of buyers and sellers).
  3. The Fed pays for its purchases with electronic credits to the sellers' banks, which, in turn, credit the sellers' bank accounts. These credits are literally created out of nothing.
  4. The banks receiving the credits use them as reserves and loan out several times the amount of the money held in reserve due to the magic of fractional reserve banking. If their reserve requirement is 10% then 10 times the money put into reserve can be loaned out. The banks can create new loans because of these increased reserves. As the money is loaned the money supply in the U.S. increases.

Or a short and simple way to look at it is:

"The Federal Reserve uses open-market operations to either increase or decrease reserves. To increase reserves, the Federal Reserve buys U.S. Treasury securities by writing a check drawn on itself. The seller of the Treasury security deposits the check in a bank, increasing the seller's deposit. The bank, in turn, deposits the Federal Reserve check at its district Federal Reserve bank, thus increasing its reserves" [ 1 ] When a bnak increases it's reserves it can loan more money due to the magic of fracional reserve banking.

"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." [ 2 ]

Another way to create money

The FOMC can also change the reserve requirements for the banks. This allows banks to increase or decrease the loans it makes. Once again creating money from nothing.

And one more way to create money

The FED also loans money to banks for short periods of time. This is called the discount rate. If the discount rate is low enough then banks can borrow from the FED and loan the loan out to the bank's borrowers. in fact the bank can loan multiple times the FED loan out to borrowers due to the magic of fractional reserve banking.

[ 1 ] Money Supply, by Anna J. Schwartz: The Concise Encyclopedia of Economics: Library of Economics and Liberty

 [ 2 ] Who Owns The Federal Reserve?, by Ellen Brown