Our Current System 5.42 The US federal reserve system

The Federal Reserve, the central bank of the United States, provides the nation with a safe, flexible, and stable monetary and financial system.


The Federal Reserve Act makes money created by private bankers using a fractional reserve system our national money. Our money is a Federal Reserve note – an IOU for future value from the Federal Reserve’s privately owned member banks, guaranteed by the common wealth of the United States. The Federal Reserve System (the Fed) is a banking and money creation system made up of about 3, privately owned banks (38 percent of total banks). Membership requires banks purchase shares in the 12 district Federal Reserve banks. All national banks are required to become members. It is optional for state and local banks, who must apply and meet requirements. These 12 regional banks function as a central bank with government charter. The money creation privilege of the Fed’s member banks extends to all private banks in the US.

Key elements of our current choice:

Despite the aspirations of the Fed, it does not, has not and cannot provide a system that is “safe, flexible and stable” – not as currently mandated.

Who Decided?

We the people decided, through our duly elected representatives in the Congress of the United States. In 1913, we passed a law called, The Federal Reserve Act. 11 The law was written in 10 days, in secret, by six bankers on Jekyll Island off the coast of Georgia, and then passed by Congress.12 As with all fractional reserve money creation systems, the choice was not made with all the information on the table. It is fair to say most decision-makers never fully understood the decision they were making; a review of what they chose to argue about will show this to be true. The arguments are mostly about the role of a federal government vs. states’ rights, or an-assumed-to-be-controlling central bank vs. the free market. By now, you should understand that in a fractional reserve system, the central bank is there to support its member banks not to control them.

We have modified The Federal Reserve Act several times since 1913. We have the power to change this law, if and when we decide to make improvements.

The Token

The Federal Reserve Act chooses a unit called a dollar for its token. Roughly 3 percent of the money in use is a physical token we call cash, including less than one percent in coins. Most cash is a paper printed to represent different denominations of money. These notes have been imprinted with information that changed over the years, reflecting shifts in policy regarding money creation. Immediately after the law’s passage, these notes were issued with the imprimatur of many specially chartered state and national banks and labeled national currency.

Initially some notes stated the false promise that they were receipt- money IOUs and could be presented and exchanged for a value of gold or silver. (The banks issuing these notes were never required to keep 100% of their promises in gold or silver on hand. The system has always been fractional reserve.) The text on the note changed over the years, and now our national money bears the words, “Federal Reserve Note United States of America This note is legal tender for all debts public and private.”

Roughly 97 percent of the money in use is a record of dollar money units and has no tangible counterpart.

Authentic & Trustworthy

The Federal Reserve Act makes the money created by the private banks the legal tender of the United States, giving it authenticity. The US Secret Service was established in 1865 to suppress the counterfeiting of US currency, and today – funded by taxpayers – it is responsible for ensuring the authenticity and integrity of our money. The banks also submit to some standards and oversight from their central bank to assure trustworthiness, though they mostly write the standards and the laws to suit themselves and Congress goes along.

The Federal Reserve Act makes our government the ultimate guarantor of the value of the Federal Reserve System IOUs. From 1913–1970 the Federal Reserve System banks were required to back their notes with a 5–25 percent reserve of gold or gold certificates, to support the guarantee from the US government implicit in making the Federal Reserve Notes the national money.13

From 1970 to the present, ownership of a gold reserve has not been required of the private banks. Today, bank reserves consist of IOUs from the Federal Reserve system, the US government, or other IOU assets. Today, our national currency is made trustworthy by a promise from our nation that we will use our credit and common wealth when necessary to keep the promises made by the private bank issued notes. Our money is only as strong as our nation.

Creation & Destruction

WHO: The Federal Reserve Act hands the power to create new money to the private banking sector. Our national currency consists of IOUs from these private bankers.

How is money created? New money is created when a bank issues a loan, exchanging a bank system IOU (a Federal Reserve Note) for the IOU of a borrower. With the exception of more stringent requirements placed on small local and regional banks, reserves no longer exist in practice. Capital-equity requirements were substituted for reserves, but again, the biggest banks are in the 2–4 percent range in practice, which is a negligible constraint on the creation of new money.

How is money destroyed? A physical piece of money like a dollar bill can be burned or shredded. When it’s just worn out, it is replaced by a new bill of the same value, which does not change the amount of money in the supply. But, most money in our current system is an accounting entry and vanishes when a loan is repaid. When bankers are confident they turn right around and recreate the money for someone else, plus more. When bankers are not confident, the money supply shrinks as loans are repaid and few new loans are issued.

A Measure & Store of Value

Our chosen system is by its nature an elastic value money system with an erratically increasing money supply and a continuously declining money value. Over the last 100 years, our money supply increases at a rate of 3–11 percent per annum according to official measures, averaging about 8 percent (Chapter 5.54).

A steadily declining dollar value is how the Fed defines a stable monetary system. The Federal Reserve Act gives the central bank a few ineffective powers to limit the private banks’ money creation so the decline in the value of the dollar remains steady at about 2 percent. Methods of measurement have simply been changed to keep the reported decrease in value closer to the target.14 There are no consequences for failure built into the law.


The Federal Reserve Act establishes 12 regional banks as bankers to the independent banks in their geographic region. Collectively these 12 regional banks are considered the central bank of the United States.

The Federal Reserve Act establishes a central Board of Governors with responsibility to set policy and oversee this central banking system. The members of the Board of Governors are nominated by the President of the United States and confirmed by the Senate for staggered 14 year terms. By law, the appointments must yield a “fair representation of the financial, agricultural, industrial, and commercial interests and geographical divisions of the country,” and no two Governors may come from the same Federal Reserve District.15 It is assumed that the interests represented are those of the industries’ owners, not those who labor in those industries.

Historically the Wall Street community limits the selection of Governors to candidates of their choosing. The Government’s right of appointment is intentionally more a courtesy and window dressing than any form of influence or control. The bankers need only to threaten economic discomfort, which is readily within their power under this law, in order to get their way. This forces the President to ask, “Will Wall Street like this appointment?” And, somehow, the politicians and public have been convinced the question is appropriate.

The central bank is there to supply transfer services to the private member banks, to facilitate borrowing and lending of reserves between the banks, and to act as a lender of last resort to the banks when they cannot get help from each other (creating money for them). The central bank sets the interest rate at which it will lend/ create money for its member banks. This power influences how much money the private banks will create, because they borrow it to establish the anchor for their own lending/money creation, either as a reserve or as high quality equity. But as noted, the requirement for reserves and equity is so small, this power of the central bank is one of slight influence not of direct containment.

The law makes the Regional Reserve Bank of New York the biggest and most powerful of the regional Federal Reserve banks. The NY Fed is the banker to the US Government and the agent for the Federal Reserve System’s Board of Governors. The Fed creates new money by making loans to our government when tax revenues are inadequate to pay our expenses and brokers sales of US Government debt in the marketplace. In a reserve system, having all of the deposits of the largest employer, tax collector, and biggest spender in your vault, is a profitable gift.

In 1913, the citizens of the US married the private banking sector, giving them the power to create money for the nation. Divorce is an option.

So, how does the Federal Reserve System understand its job?