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Businesses and individuals do need a ready source of credit, and
that credit could be created from nothing and advanced to borrowers
under a 100 percent reserve system, just as is done now. The difference
would be that the credit would originate with the government, which
alone has the sovereign right to create money; and the interest on it
would be returned to the public purse. In effect, the government would
just be serving as a “credit clearing exchange,” or as the accountant in
a community system of credits and debits. (More on this later.)

A System of National Bank Branches
to Service Basic Public Banking Needs?

Hummel points out that if private banks could no longer lend their
deposits many times over, they would have little incentive to service
the depository needs of the public. Depository functions are basically
clerical and offer little opportunity for income except fees for service.
Who would service the public™s banking needs if the banks lost interest
in that business? In How Credit-Money Shapes the Economy, Professor
Guttman notes that our basic banking needs are fairly simple. We
need a safe place to keep our money and a practical way to transfer it
to others. These services could be performed by a government agency
on the model of the now-defunct U.S. Postal Savings System, which
operated successfully from 1911 to 1967, providing a safe and efficient
place for customers to save and transfer funds. It issued U.S. Postal
Savings Bonds in various denominations that paid annual interest, as
well as Postal Savings Certificates and domestic money orders.15 The
U.S. Postal Savings System was set up to get money out of hiding,

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attract the savings of immigrants accustomed to saving at post offices
in their native countries, provide safe depositories for people who had
lost confidence in private banks, and furnish more convenient
depositories for working people than were provided by private banks.
(Post offices then had longer hours than banks, being open from 8
a.m. to 6 p.m. six days a week.) The postal system paid two percent
interest on deposits annually. The minimum deposit was $1 and the
maximum was $2,500. Savings in the system spurted to $1.2 billion
during the 1930s and jumped again during World War II, peaking in
1947 at almost $3.4 billion. The U.S. Postal Savings System was shut
down in 1967, not because it was inefficient but because it became
unnecessary after private banks raised their interest rates and offered
the same governmental guarantees that the postal savings system had.16
The services offered by a modern system of federally-operated bank
branches would have to be modified to reflect today™s conditions, but
the point is that the government has done these things before and
could do them again. Indeed, if “fractional reserve” banking were
eliminated, those functions could fall to the government by default.
Hummel suggests that it would make sense to simplify the banking
business by transferring the depository role to a system of bank branches
acting as one entity under the Federal Reserve. Among other
advantages, he says:
Since all deposits would be entries in a common computer
network, determining balances and clearing checks could be done
instantly, thereby eliminating checking system floatiii and its
logistic complexities. . . .
With the Fed operating as the sole depository, payments
would only involve the transfer of deposits between accounts
within a single bank. This would allow for instant clearing,
eliminate the nuisance of checking system float, and significantly
reduce associated costs. Additional advantages include the
elimination of any need for deposit insurance, and ending
overnight sweepsiv and other sterile games that banks play to

iii
Float: the time that elapses between when a check is deposited and the funds
are available to the depositor, during which the bank is collecting payment from
the payer™s bank.
iv
The overnight sweep is a tactic for maximizing interest by “sweeping” funds
not being immediately used in a low-interest account into a high-interest ac-
count, where they remain until the balance in the low-interest account drops
below a certain minimum.

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get around the fractional reserve requirement.17
In Hummel™s model, the Fed would be the sole depository and
only its branches would be called “banks.” Institutions formerly called
banks would have to close down their depository operations and
would become “private financial institutions” (PFIs), along with fi-
nance companies, pension funds, mutual funds, insurance companies
and the like. Some banks would probably sell out to existing PFIs.
PFIs could borrow from the Fed just as banks do now, but the interest
rate would be set high enough to discourage them from engaging in
“purely speculative games in the financial markets.” Without the de-
pository role, banks would no longer need the same number of branch
offices. The Fed would probably offer to buy them in setting up its
own depository branch offices. Hummel suggests that a logical way
to proceed would be to gradually increase the reserve ratio require-
ment on existing depositories until it reached 100 percent.

The National Credit Card
A system of publicly-owned bank branches could also solve the
credit card problem. Hummel notes that imposing a 100 percent reserve
requirement on the banks would mean the end of the private credit
card business. Recall that when a bank issues credit against a
customer™s charge slip, the charge slip is considered a “negotiable
instrument” that becomes an “asset” against which the bank creates
a “liability” in the form of a deposit. The bank balances its books
without debiting its own assets or anyone else™s account. The bank is
thus creating new money, something private banks could no longer
do under a 100 percent reserve system. But the ability to get ready
credit against the borrower™s promise to pay is an important service
that would be sorely missed if banks could no longer engage in it. If
your ability to use your credit card were contingent on your bank™s
ability to obtain scarce funds in a competitive market, you might find,
when you went to pay your restaurant bill, that credit had been denied
because your bank was out of lendable funds.
The notion that money has to “be there” before it can be borrowed
is based on the old commodity theory of money. Theorists from Cotton
Mather to Benjamin Franklin to Michael Linton (who designed the
LETS system) have all defined “money” as something else. It is simply
“credit” “ an advance against the borrower™s promise to repay. Credit
originates with that promise, not with someone else™s deposit of
something valuable in the bank. Credit is not dependent on someone
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else having given up his rights to an asset for a period of time, and
“reserves” are not necessary for advancing it. What is wrong with the
current system is not that money is advanced as a credit against the
borrower™s promise to repay but that the interest on this advance accrues to
private banks that gave up nothing of their own to earn it. This problem
could be rectified by turning the extension of credit over to a system of
truly national banks, which would be authorized to advance the “full
faith and credit of the United States” as agents of Congress, which is
authorized to create the national money supply under the Constitution.
Credit card services actually are an extension of the depository
functions of banks. The link with bank deposits is particularly obvious
in the case of those debit cards that can be used to trigger ATM
machines to spit out twenty dollar bills. When you make a transfer or
withdrawal on your debit card, the money is immediately transferred
out of your account, just as if you had written a check. When you use
your credit card, the link is not quite so obvious, since the money
doesn™t come out of your account until later; but it is still your money
that is being advanced, not someone else™s. Again, your promise to
pay becomes an asset and a liability of the bank at the same time,
without bringing any of the bank™s or any other depositor™s money
into the deal. The natural agency for handling this sort of transaction
would be an institution that is authorized both to deal with deposits
and to create credit-money with accounting entries, something a truly
“national” bank could do as an agent of Congress. A government
banking agency would not be driven by the profit motive to gouge
desperate people with exorbitant interest charges. Credit could be
extended at interest rates that were reasonable, predictable and fixed.
In appropriate circumstances, credit might even be extended interest-
free. (More on this in Chapter 42.)

Old Banks Under New Management

The branch offices set up by a truly federal Federal Reserve would
not need to be new entities, and they would not need to take over the
whole banking business. They could be existing banks that had been
bought by the government or picked up in bankruptcy. As we™ll see in
Chapter 43, the same mega-banks that handle a major portion of the
nation™s credit card business today may already be insolvent, making
them prime candidates for FDIC receivership and government takeover.
If just those banking giants were made government agencies, they

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might provide enough branches to service the depository and credit
card needs of the citizenry, leaving the lending of pre-existing funds
to private financial institutions just as is done now.
Note too that the government would not actually have to run these
new bank branches. The FDIC could just hire new management or
give the old management new guidelines, redirecting them to operate
the business for the benefit of the public. As in any corporate
acquisition, not much would need to change beyond the names on the
stock certificates. Business could carry on as before. The employees
would just be under new management. The banks could advance
loans as accounting entries, just as they do now. The difference would
be that interest on advances of credit, rather than going into private
vaults for private profit, would go into the coffers of the government.
The “full faith and credit of the United States” would become an asset of the
United States.

A Money Supply That Regulates Itself?

Hummel points to another wrinkle that would need to be worked
out in a 100 percent reserve system: the extension of credit by private
banks plays an important role in regulating the national money supply.
Public borrowing is the natural determinant of monetary growth. When
banks extend credit, the money supply expands naturally to meet the
needs of growth and productivity. If a 100 percent reserve requirement
were imposed, the money supply could not grow in this organic way,
so growth would have to be brought about by some artificial means.
One alternative would be for the government to expand the money
supply according to a set formula. Milton Friedman suggested a fixed
4 percent per year. But such a system would not allow for modifying
the money supply to respond to external shocks or varying internal
needs. Another alternative would be to delegate monetary expansion
to a monetary board of some sort, which would be authorized to
determine how much new money the government could issue in any
given period. But that alternative too would be subject to the vagaries
of human error and manipulation for private gain. We™ve seen the
roller-coaster results when the Fed has been allowed to manipulate
the money supply by arbitrarily changing interest rates and reserve
requirements. The Great Depression was blamed on Fed tinkering.
Why does the money supply need to be manipulated by the Federal
Reserve? Consumer loans are self-liquidating: the new money they

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create is eventually paid back and zeroes out. But that result is skewed
by the charging of interest, and by the fact that the burgeoning federal
debt never gets repaid but just keeps growing. The money supply
expands because government securities (or debt) are sold to the Federal
Reserve and to commercial banks, which buy them with money created
out of thin air; and it is this unchecked source of expansion that has to
be regulated by artificial means. In a system without a federal debt
and without interest, consumer debt should be able to regulate itself.
That sort of model is found in the LETS system, in which “money” is
created when someone pays someone else with “credits,” and it is
liquidated when the credits are used up. Here is a simple example:
Jane bakes cookies for Sam. Sam pays Jane one LETS credit by
crediting her account and debiting his. “Money” has just been created.
Sam washes Sue™s car, for which Sue gives Sam one LETS credit,
extinguishing the debit in his account and creating one in hers. Sue
babysits for Jane, who pays with the LETS credit Sam gave her. The
books are now balanced, and no inflation has resulted. There is no
longer any “money” in the system, but there is still plenty of “credit,”
which can be created by anyone just by doing work for someone else.
The LETS system is a community currency system in which no
gold or other commodity is needed to make it work. “Money” (or
“credit”) is generated by the participants themselves. Projecting this
account-tallying model onto the larger community known as a nation,
money would come into existence when it was borrowed from the
community-owned bank, and it would be extinguished as the loans
were repaid. That is actually how money is generated now; but the
creators of this public credit are not the community at large but are
private bankers who distort the circular flow of the medium of
exchange by siphoning off a windfall profit in the form of interest.
The charging of interest, in turn, creates the “impossible contract”
problem “ the spiral of inflation and unrepayable debt resulting when
more money must be paid back than is created in the form of loans. In
community LETS systems, this problem is avoided because interest is
not charged. But an interest-free national system is unlikely any time
soon, and interest serves some useful functions. It encourages borrowers
to repay their debts quickly, discourages speculation, compensates
lenders for foregoing the use of their money for a period of time, and
provides retired people with a reliable income. How could these benefits
be retained without triggering the “impossible contract” problem? As
Benjamin Franklin might have said, “That is simple” . . . .

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Chapter 42
THE QUESTION OF INTEREST:
BEN FRANKLIN SOLVES THE
IMPOSSIBLE CONTRACT PROBLEM

“Back where I come from, we have universities, seats of great
learning, where men go to become great thinkers, and when they
come out, they think deep thoughts, and with no more brains than
you have. But they have one thing that you haven™t got, a diploma.”
“ The Wizard of Oz to the Scarecrow




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