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@verdi327
Created January 7, 2012 20:41
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How do govt's spend more than they have and how does new money make its way into the system.

#How the Fed is Responsible for Consistent Monetary Inflation and Credit Expansion You may have heard… our country is broke. Our current national debt is over 15 trillion dollars. That number is astronomically high, to the point where it is even hard to conceptualize it, let alone how to pay it back. You may ask yourself, how in the hell did the debt every reach such a level? Well, in the next 300 words I will explain how governments can spend more money then they take in and how new money makes its way into the economy.

For example, let’s say Congress decides it needs five new Blackhawk helicopters, which cost 1 billion dollars. Having already spent its budget Congress decides to take out a loan. So, it creates 1 billion dollars worth in Treasury Bills, or Notes, or Bonds depending on its desired duration. Private investors buy some of these Bills up, but the Fed through its “open market” activities purchase the majority. The Fed writes a check to Congress for 1 billion dollars. Where did this money come from? It was created out of thin air; it never existed before, and was simply the result of a few keystrokes in a computer. In today’s financial press, this is known as “monetizing the debt.”

On a whole, the monetary supply of the country has increased by 1 billion dollars. But, this is not the end of the inflationary cycle. The contractor receives the billion dollars and deposits it into his bank account, let’s say at Bank of America. Bank of America is now excited because it has just received a deposit of 1 billion dollars, which constitutes as “reserves” for the bank. The law requires the bank to only keep 10% of deposits on hand and the rest can be loaned out. So, the bank is now eligible to loan out 900 million dollars.

This process continues throughout the banking system as people take new loans to buy things and banks receive new deposits, which they are able to continue to lend out an additional 90% off those deposits. All and all this creates an inverted pyramiding of money where the original 1 billion dollars created by the Fed results in the addition of ten billion dollars in the monetary supply. This is known in commercial banking as the “money multiplier effect,” which is the result of fractional reserve banking.

It is important to note that all of this money originated from 1 billion dollars, which was created out of nothing. Suddenly, spending 15 trillion in the red doesn’t seem that impossible anymore.

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