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time (say 1850), it would amount in gold of standard fineness to
32,366,648,157 spheres of gold each eight thousand miles in
diameter, or as large as the earth.18
Thirty-two billion earth-sized spheres! Such is the nature of
compound interest -- interest calculated not only on the initial principal
but on the accumulated interest of prior payment periods. The interest
“compounds” in a parabolic curve that is virtually flat at first but goes
nearly vertical after 100 years. Debts don™t usually grow to these
extremes because most loans are for 30 years or less, when the curve
remains relatively flat. But the premise still applies: in a system in
which money comes into existence only by borrowing at interest, the
system as a whole is always short of funds, and somebody has to default.
Bernard Lietaer helped design the single currency system (the Euro)
and has written several books on monetary reform. He explains the
interest problem like this:
When a bank provides you with a $100,000 mortgage, it creates
only the principal, which you spend and which then circulates
in the economy. The bank expects you to pay back $200,000
over the next 20 years, but it doesn™t create the second $100,000
” the interest. Instead, the bank sends you out into the tough
world to battle against everybody else to bring back the second
The problem is that all money except coins now comes from banker-
created loans, so the only way to get the interest owed on old loans is
to take out new loans, continually inflating the money supply; either
that, or some borrowers have to default. Lietaer concluded:
[G]reed and competition are not a result of immutable human
temperament . . . . [G]reed and fear of scarcity are in fact being
continuously created and amplified as a direct result of the kind of
money we are using. . . . [W]e can produce more than enough
food to feed everybody, and there is definitely enough work for
everybody in the world, but there is clearly not enough money
to pay for it all. The scarcity is in our national currencies. In fact,
the job of central banks is to create and maintain that currency scarcity.
The direct consequence is that we have to fight with each other in
order to survive.19
Chapter 2 - Behind the Curtain

$10,000 lent at 6% interest compounded annually
$180,000 Adapted from: www.buyupside.com
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49
Years Held

A dollar lent at 6 percent interest, compounded annually, becomes
ten dollars in less than 40 years. That means that if the money supply
were 100 percent gold, and if banks lent 10 percent of it at 6 percent
interest compounded annually (continually rolling principal and in-
terest over into more loans), in 40 years the bankers would own all the
gold. It also means that the inflation everyone complains about is
actually necessary to keep the scheme going. To keep workers on the
treadmill that powers their industrial empire, the financiers must cre-
ate enough new debt-money to cover the interest on their loans. They
don™t want to create too much, as that would dilute the value of their
own share of the pie; but in a “credit crisis” such as we are facing
today, the central banks can and do flood the market with money
created with accounting entries. In a single day in August 2007, the
U.S. Federal Reserve “injected” $38 billion into the financial markets
to rescue troubled banks and investment firms. Where did this money
come from? It was just an advance of “credit,” something central
banks claim the right to do as “lenders of last resort.” These advances
can be rolled over or renewed indefinitely, creating a stealth inflation
that drives up prices at the pump and the grocery store.20 (More on
this later.)

Web of Debt

The Money Supply and the Federal Debt

To keep the economic treadmill turning, not only must the money
supply continually inflate but the federal debt must continually
expand. The reason was revealed by Marriner Eccles, Governor of the
Federal Reserve Board, in hearings before the House Committee on
Banking and Currency in 1941. Wright Patman asked Eccles how the
Federal Reserve got the money to buy government bonds.
“We created it,” Eccles replied.
“Out of what?”
“Out of the right to issue credit money.”
“And there is nothing behind it, is there, except our government™s
“That is what our money system is,” Eccles replied. “If there were
no debts in our money system, there wouldn™t be any money.”21
That explains why the federal debt never gets paid off but just
continues to grow. The federal debt hasn™t been paid off since the
presidency of Andrew Jackson nearly two centuries ago. Rather, in
all but five fiscal years since 1961 (1969 and 1998 through 2001), the
government has exceeded its projected budget, adding to the national
debt.22 Economist John Kenneth Galbraith wrote in 1975:
In numerous years following the [civil] war, the Federal
Government ran a heavy surplus. [But] it could not pay off its
debt, retire its securities, because to do so meant there would be
no bonds to back the national bank notes. To pay off the debt was
to destroy the money supply.23
The federal debt has been the basis of the U.S. money supply ever
since the Civil War, when the National Banking Act authorized private
banks to issue their own banknotes backed by government bonds
deposited with the U.S. Treasury. (This complicated bit of chicanery
is explored in Chapter 9.) When President Clinton announced “the
largest budget surplus in history” in 2000, and President Bush
predicted a $5.6 trillion surplus by the end of the decade, many people
got the impression that the federal debt had been paid off; but this
was another illusion. Not only did the $5.6 trillion budget “surplus”
never materialize (it was just an optimistic estimate projected over a
ten-year period based on an anticipated surplus for the year 2001
that never materialized), but it entirely ignored the principal owing on
the federal debt. Like the deluded consumer who makes the minimum
monthly interest payment on his credit card bill and calls his credit
Chapter 2 - Behind the Curtain

limit “cash on hand,” politicians who speak of “balancing the budget”
include in their calculations only the interest on the national debt. By
2000, when President Clinton announced the largest-ever budget
surplus, the federal debt had actually topped $5 trillion; and by October
2005, when the largest-ever projected surplus had turned into the
largest-ever budget deficit, the federal debt had mushroomed to $8
trillion. M3 was $9.7 trillion the same year, not much more. It is
hardly an exaggeration to say that the money supply is the federal debt
and cannot exist without it. Commercial loans alone cannot sustain the
money supply because they zero out when they get paid back. In
order to keep money in the system, some major player has to incur
substantial debt that never gets paid back; and this role is played by
the federal government.
That is one reason the federal debt can™t be paid off, but today
there is an even more compelling reason: the debt has simply grown
too large. To get some sense of the magnitude of an 8-plus trillion
dollar debt, if you took 7 trillion steps you could walk to the planet
Pluto, which is a mere 4 billion miles away.24 If the government were
to pay $100 every second, in 317 years it would have paid off only one
trillion dollars of debt. And that™s just for the principal. If interest
were added at the rate of only 1 percent compounded annually, the
debt could never be paid off in this way, because the debt would grow
faster than it was being repaid.25 Paying an $8-plus trillion debt off in
a lump sum through taxation, on the other hand, would require in-
creasing the tax bill by more than $100,000 for every family of four, a
non-starter for most families.26
In the 1980s, policymakers openly declared that “deficits don™t
matter.” The government could engage in “deficit spending” and
simply allow the debt to grow. This policy continues to be cited with
approval by policymakers today.27 The truth is that nobody even expects
the debt to be paid off, because it can™t be paid off “ at least, it can™t while
money is created as a debt to private banks. The government doesn™t
have to pay the principal so long as it keeps “servicing” the debt by
paying the interest. But according to David M. Walker, Director of
the U.S. General Accounting Office and Comptroller General of the
United States, just the interest tab will soon be more than the taxpayers
can afford to pay. When the government can™t pay the interest, it will
have to renege on the debt, and the economy will collapse.28
How did we get into this witches™ cauldron, and how can we get
out of it? The utopian vision of the early American colonists involved
a money system that was quite different from what we have today.
To understand what we lost and how we lost it, we™ll take a journey
back down the Yellow Brick Road to eighteenth century America.
Web of Debt

Chapter 3

Dorothy and her friends were at first dazzled by the brilliancy of
the wonderful City. The streets were lined with beautiful houses all
built of green marble and studded everywhere with sparkling emeralds.
They walked over a pavement of the same green marble, and where
the blocks were joined together were rows of emeralds, set closely,
and glittering in the brightness of the sun. . . . Everyone seemed
happy and contented and prosperous.
“ The Wonderful Wizard of Oz,
“The Emerald City of Oz”

F rank Baum™s vision of a magical city shimmering in the sun
captured the utopian American dream. Walt Disney would
later pick up the vision with his castles in the clouds, the happily-
ever-after endings to romantic Hollywood fairytales. Baum, who was
Irish, may have been thinking of the Emerald Isle, the sacred land of
Ireland. The Emerald City also suggested the millennial visions of the
Biblical New Jerusalem and the “New Atlantis,” the name Sir Francis
Bacon gave to the New World.
The American colonies were an experiment in utopia. In an
uncharted territory, you could design new systems and make new
rules. Paper money was already in use in England, but it had fallen
into the hands of private bankers who were using it for private profit
at the expense of the people. In the American version of this new
medium of exchange, paper money was issued and lent by provincial
governments, and the proceeds were used for the benefit of the people.
The colonists™ new paper money financed a period of prosperity that
was considered remarkable for isolated colonies lacking their own

Chapter 3 - Experiments in Utopia

silver and gold. By 1750, Benjamin Franklin was able to write of New
There was abundance in the Colonies, and peace was reigning
on every border. It was difficult, and even impossible, to find a
happier and more prosperous nation on all the surface of the
globe. Comfort was prevailing in every home. The people, in
general, kept the highest moral standards, and education was
widely spread.

Money as Credit

The distinction of being the first local government to issue its own
paper money went to the province of Massachusetts. The year was
1691, three years before the charter of the Bank of England. Jason
Goodwin, who tells the story in his 2003 book Greenback, writes that
Massachusetts™ buccaneer governor had led a daring assault on Quebec
in an attempt to drive the French out of Canada; but the assault had
failed. Militiamen and widows needed to be paid. The local merchants
were approached but had declined, saying they had other demands
on their money.
The idea of a paper currency had been suggested in 1650, in an
anonymous British pamphlet titled “The Key to Wealth, or, a New
Way for Improving of Trade: Lawfull, Easie, Safe and Effectual.” The
paper currency proposed by the pamphleteer, however, was modeled
on the receipts issued by London goldsmiths and silversmiths for the
precious metals left in their vaults for safekeeping. The problem for
the colonies was that they were short of silver and gold. They had to
use foreign coins to conduct trade; and since they imported more than
they exported, the coins were continually being drained off to England
and other countries, leaving the colonists without enough money for
their own internal needs. The Massachusetts Assembly therefore
proposed a new kind of paper money, a “bill of credit” representing
the government™s “bond” or I.O.U. “ its promise to pay tomorrow on
a debt incurred today. The paper money of Massachusetts was backed
only by the “full faith and credit” of the government.1
Other colonies then followed suit with their own issues of paper
money. Some were considered government I.O.U.s, redeemable later
in “hard” currency (silver or gold). Other issues were “legal tender”
in themselves. Legal tender is money that must legally be accepted in
the payment of debts. It is “as good as gold” in trade, without bearing
Web of Debt

debt or an obligation to redeem the notes in some other form of money
When confidence in the new paper money waned, Cotton Mather,
who was then the most famous minister in New England, came to its
defense. He argued:
Is a Bond or Bill-of-Exchange for £1000, other than paper? And
yet is it not as valuable as so much Silver or Gold, supposing the
security of Payment is sufficient? Now what is the security of
your Paper-money less than the Credit of the whole Country?3
Mather had redefined money. What it represented was not a sum
of gold or silver. It was credit: “the credit of the whole country.”

The Father of Paper Money

Benjamin Franklin was such an enthusiast for the new medium of


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