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D. Rockefeller, the “Robber Barons” who orchestrated the Federal Re-
serve Act in 1913. (More on this in Chapter 13.)
As for keeping “reserves,” Wright Patman decided to see for him-
self. Having heard that Federal Reserve Banks hold large amounts of
cash, he visited two regional Federal Reserve banks, where he was led
into vaults and shown great piles of government securities (I.O.U.s
representing debt).i When he asked to see their cash, the bank offi-
cials seemed confused. He repeated the request, only to be shown
some ledgers and bank checks. Patman wrote:
The cash, in truth, does not exist and never has existed. What
we call “cash reserves” are simply bookkeeping credits entered
upon the ledgers of the Federal Reserve Banks. These credits are
created by the Federal Reserve Banks and then passed along
through the banking system.5
Where did the Federal Reserve get the money to acquire all the
government bonds in its vaults? Patman answered his own rhetorical
It doesn™t get money, it creates it. 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. [When] the recipient of the check wants cash, then the
Federal Reserve can oblige him by printing the cash ” Federal
Reserve notes ” which the check receiver™s commercial bank
can hand over to him. The Federal Reserve, in short, is a total
money-making machine.6

Turning Debt into Money

The Federal Reserve is indispensable to the bankers™ money-making
machine, but the dollar bills it creates represent only a very small
portion of the money supply. Most money today is created neither by
the government nor by the Federal Reserve. Rather, it is created by
private commercial banks.
The “money supply” is defined as the entire quantity of bills, coins,
loans, credit, and other liquid instruments in a country™s economy.

A “security” is a type of transferable interest representing financial value.

The securities composing the federal debt consist of U.S. Treasury bills (or T-
bills -- securities which mature in a year or less), Treasury notes (which mature
in two to ten years), and Treasury bonds (which mature in ten years or longer).

Chapter 2 - Behind the Curtain

“Liquid” instruments are those that are easily convertible into cash.
The American money supply is officially divided into M1, M2, and
M3. Only M1 is what we usually think of as money “ coins, dollar
bills, and the money in our checking accounts. M2 is M1 plus savings
accounts, money market funds, and other individual or “small” time
deposits. (The “money market” is the trade in short-term, low-risk
securities, such as certificates of deposit and U.S. Treasury notes.) M3
is M1 and M2 plus institutional and other larger time deposits
(including institutional money market funds) and eurodollars
(American dollars circulating abroad).
In 2005, M1 (coins, dollar bills and checking account deposits)
tallied in at $1.4 trillion. Federal Reserve Notes in circulation came to
$758 billion, but about 70 percent of those circulated overseas, bringing
the figure down to $227.5 billion in use in the United States.7 The U.S.
Mint reported that in September 2004, circulating collections of coins
came to only $993 million, or just under $1 billion.8 M3 (the largest
measure of the money supply) was $9.7 trillion in 2005.9 Thus coins
made up only about one one-thousandth of the total money supply
(M3), and tangible currency in the form of coins and Federal Reserves
Notes (dollar bills) together made up only about 2.4 percent of it. The
other 97.6 percent magically appeared from somewhere else. This was the
money Wright Patman said was created by banks when they made
The mechanics of money creation were explained in a revealing
booklet published by the Chicago Federal Reserve in the 1960s, called
“Modern Money Mechanics: A Workbook on Bank Reserves and
Deposit Expansion.”10 The booklet is a gold mine of insider information
and will be explored at length later, but here are some highlights. It
begins, “The purpose of this booklet is to describe the basic process of
money creation in a ˜fractional reserve™ banking system. . . . The actual
process of money creation takes place primarily in banks.” The Chicago
Fed then explains:
[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 in exchange for credits to the borrowers™ transaction
The booklet explains that money creation is done by “building up”
deposits, and that this is done by making loans. Contrary to popular
belief, loans become deposits rather than the reverse. The Chicago Fed
Web of Debt

[B]anks can build up deposits by increasing loans and
investments so long as they keep enough currency on hand to
redeem whatever amounts the holders of deposits want to
convert into currency. This unique attribute of the banking
business was discovered many centuries ago. It started with
goldsmiths . . . .
The “unique attribute” discovered by the goldsmiths was that they
could issue and lend paper receipts for the same gold many times
over, so long as they kept enough gold in “reserve” for any depositors
who might come for their money. This was the sleight of hand later
dignified as “fractional reserve” banking . . . .

The Shell Game of the Goldsmiths Becomes
“Fractional Reserve” Banking

Trade in seventeenth century Europe was conducted primarily with
gold and silver coins. Coins were durable and had value in them-
selves, but they were hard to transport in bulk and could be stolen if
not kept under lock and key. Many people therefore deposited their
coins with the goldsmiths, who had the strongest safes in town. The
goldsmiths issued convenient paper receipts that could be traded in
place of the bulkier coins they represented. These receipts were also
used when people who needed coins came to the goldsmiths for loans.
The mischief began when the goldsmiths noticed that only about
10 to 20 percent of their receipts came back to be redeemed in gold at
any one time. They could safely “lend” the gold in their strongboxes
at interest several times over, as long as they kept 10 to 20 percent of
the value of their outstanding loans in gold to meet the demand. They
thus created “paper money” (receipts for loans of gold) worth several
times the gold they actually held. They typically issued notes and
made loans in amounts that were four to five times their actual supply
of gold. At an interest rate of 20 percent, the same gold lent five times
over produced a 100 percent return every year “ this on gold the gold-
smiths did not actually own and could not legally lend at all! If they
were careful not to overextend this “credit,” the goldsmiths could thus
become quite wealthy without producing anything of value themselves.
Since more money was owed back than the townspeople as a whole
possessed, the wealth of the town and eventually of the country was
siphoned into the vaults of these goldsmiths-turned-bankers, while
the people fell progressively into their debt.11

Chapter 2 - Behind the Curtain

If a landlord had rented the same house to five people at one time
and pocketed the money, he would quickly have been jailed for fraud.
But the goldsmiths had devised a system in which they traded, not
things of value, but paper receipts for them. The system was called
“fractional reserve” banking because the gold held in reserve was a
mere fraction of the banknotes it supported. In 1934, Elgin Groseclose,
Director of the Institute for International Monetary Research, wryly
A warehouseman, taking goods deposited with him and devoting
them to his own profit, either by use or by loan to another, is
guilty of a tort, a conversion of goods for which he is liable in
civil, if not in criminal, law. By a casuistry which is now elevated
into an economic principle, but which has no defenders outside
the realm of banking, a warehouseman who deals in money is
subject to a diviner law: the banker is free to use for his private
interest and profit the money left in trust. . . . He may even go
further. He may create fictitious deposits on his books, which shall
rank equally and ratably with actual deposits in any division of assets
in case of liquidation.12
A tort is a wrongdoing for which a civil action may be brought for
damages. Conversion is a tort involving the treatment of another™s
property as one™s own. Another tort that has been applied to this
sleight of hand is fraud, defined in Black™s Law Dictionary as “a false
representation of a matter of fact, whether by words or by conduct,
by false or misleading allegations, or by concealment of that which
should have been disclosed, which deceives and is intended to deceive
another so that he shall act upon it to his legal injury.” That term was
used by the court in a landmark Minnesota lawsuit in 1969 . . . .

Taking It to Court

First National Bank of Montgomery vs. Daly was a courtroom
drama worthy of a movie script. Defendant Jerome Daly opposed the
bank™s foreclosure on his $14,000 home mortgage loan on the ground
that there was no consideration for the loan. “Consideration” (“the
thing exchanged”) is an essential element of a contract. Daly, an at-
torney representing himself, argued that the bank had put up no real
money for his loan.
The courtroom proceedings were recorded by Associate Justice Bill
Drexler, whose chief role, he said, was to keep order in a highly charged
Web of Debt

courtroom where the attorneys were threatening a fist fight. Drexler
hadn™t given much credence to the theory of the defense, until Mr.
Morgan, the bank™s president, took the stand. To everyone™s surprise,
Morgan admitted that the bank routinely created the money it lent
“out of thin air,” and that this was standard banking practice.
“It sounds like fraud to me,” intoned Presiding Justice Martin
Mahoney amid nods from the jurors. In his court memorandum, Jus-
tice Mahoney stated:
Plaintiff admitted that it, in combination with the Federal Reserve
Bank of Minneapolis, . . . did create the entire $14,000.00 in money
and credit upon its own books by bookkeeping entry. That this was
the consideration used to support the Note dated May 8, 1964
and the Mortgage of the same date. The money and credit first
came into existence when they created it. Mr. Morgan admitted
that no United States Law or Statute existed which gave him the
right to do this. A lawful consideration must exist and be tendered to
support the Note.
The court rejected the bank™s claim for foreclosure, and the defen-
dant kept his house. To Daly, the implications were enormous. If
bankers were indeed extending credit without consideration “ without
backing their loans with money they actually had in their vaults and
were entitled to lend “ a decision declaring their loans void could topple
the power base of the world. He wrote in a local news article:
This decision, which is legally sound, has the effect of declaring
all private mortgages on real and personal property, and all U.S.
and State bonds held by the Federal Reserve, National and State
banks to be null and void. This amounts to an emancipation of
this Nation from personal, national and state debt purportedly
owed to this banking system. Every American owes it to himself
. . . to study this decision very carefully . . . for upon it hangs the
question of freedom or slavery.13
Needless to say, however, the decision failed to change prevailing
practice, although it was never overruled. It was heard in a Justice of
the Peace Court, an autonomous court system dating back to those
frontier days when defendants had trouble traveling to big cities to
respond to summonses. In that system (which has now largely been
phased out), judges and courts were pretty much on their own. Justice
Mahoney went so far as to threaten to prosecute and expose the bank.
He died less than six months after the Daly trial, in a mysterious
accident that appeared to involve poisoning.14
Chapter 2 - Behind the Curtain

Since that time, a number of defendants have attempted to avoid
loan defaults using the defense Daly raised; but they have met with
only limited success. As one judge said off the record, using a familiar
Wizard of Oz metaphor:
If I let you do that “ you and everyone else “ it would bring the
whole system down. . . . I cannot let you go behind the bar of the
bank. . . . We are not going behind that curtain!15
In an informative website called Money: What It Is, How It Works,
William Hummel states that banks today account for only about 20
percent of total credit market debt. The rest is advanced by non-bank
financial institutions, including finance companies, pension funds,
mutual funds, insurance companies, and securities dealers. These in-
stitutions merely recycle pre-existing funds, either by borrowing at a
low interest rate and lending at a higher rate or by pooling the money
of investors and lending it to borrowers. In other words, they do what
most people think banks do: they borrow low and lend high, pocket-
ing the “spread” as their profit. What banks actually do, however, is
something quite different. Hummel explains:
Banks are not ordinary intermediaries. Like non-banks, they
also borrow, but they do not lend the deposits they acquire. They
lend by crediting the borrower™s account with a new deposit . . . . The
accounts of other depositors remain intact and their deposits
fully available for withdrawal. Thus a bank loan increases the
total of bank deposits, which means an increase in the money supply.16
If the money supply is being increased, money is being created by
sleight of hand. What Elgin Groseclose called the “diviner law” of the
bankers allows them to magically pull money out of an empty hat.

The “Impossible Contract”

There are other legal grounds on which the bankers™ fractional
reserve loans might be challenged besides failure of consideration and
fraud. In theory, at least, these loan contracts could be challenged
because they are collectively impossible to perform. Under state civil
codes, a contract that is impossible to perform is void. 17 The
impossibility in this case arises because the banks create the principal
but not the interest needed to pay back their loans. The debtors
scramble to find the interest somewhere else, but there is never enough
money to go around. Like in a grand game of musical chairs, when
the music stops, somebody has to default. In an 1850 treatise called
Web of Debt

The Importance of Usury Laws, a writer named John Whipple did the
math. He wrote:
If 5 English pennies . . . had been [lent] at 5 per cent compound
interest from the beginning of the Christian era until the present


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