The Federal Reserve
Fractional Reserve Lending
Douglas V. Gnazzo
November 29, 2005
"All the perplexities,
confusion and distresses in America arise not from defects
in the Constitution or confederation, nor from want of honor
or virtue, as much from downright ignorance of the nature of
coin, credit, and circulation." 
Ignorantia juris non excusat
(ignorance of the law does not excuse) is a well established
principle dating back thousands of years. Roman and English law,
precursors of the American system of jurisprudence, both recognized
Be it not forgotten - justice
excuses not the law. The laws of the land are to be made in pursuance
of the Constitution. The Constitution has precedent. Any law
not in pursuance of the Constitution is null and void, as if
it never occurred. So the court has ruled.
"And there is virgin Justice,
the daughter of Zeus, who is honored and reverenced among the
gods who dwell on Olympus, and whenever anyone hurts her with
lying slander, she sits beside her father, Zeus the son of Cronos,
and tells him of men's wicked heart, until the people pay for
the mad folly of their princes who, evilly minded, pervert judgement
and give sentence crookedly." 
No man is above the law - not
even the King. No law is above the Constitution - not even the
King's. All men are created equal. All men are judged accordingly.
He without sin cast the first stone.
The ignorance of coin, credit,
and circulation is unfortunately, a widespread occurrence - causing
perplexities, confusion, and distress, all tearing at the social
fabric of our nation. But who is guilty of these defects - who
has caused them to be?
Is it the fault of the common
man that he cannot understand the complexities of a monetary
system that moved Lord Keynes to say that not one man in a million
No, the common man is not at
fault, the blame lies elsewhere: it rests with those who have
purposefully made the monetary policy so bizarre that even its
keepers have a hard time understanding the delusion they have
John Kenneth Galbraith clearly
understood the illusionary nature of the elite's monetary economists
when he stated that they:
"use complexity to disguise
or to evade the truth, rather than to reveal it." 
The most dishonest monetary
illusion is the shadow cast by fractional reserve lending.
"Because of 'fractional'
reserve system, banks, as a whole, can expand our money supply
several times, by making loans and investments." 
Let's take a closer look at
the sword of State the magi use to create their tricks of prestidigitation
- the scepter of fractional reserves.
What is meant by fractional
reserves? It would seem that reserves are reduced to a fraction,
but a fraction of what? Perhaps we should seek the wise counsel
of the Federal Reserve, as this is their raison d'etre.
Required Reserve Balances
"Required reserve balances
are balances that a depository institution must hold with the
Federal Reserve to satisfy its reserve requirement. Reserve requirements
are imposed on all depository institutions - which include commercial
banks, savings banks, savings and loan associations, and credit
unions - as well as U.S. branches and agencies of foreign banks
and other domestic banking entities that engage in international
Since the early 1990s, reserve
requirements have been applied only to transaction deposits,
which include demand deposits and interest-bearing accounts that
offer unlimited checking privileges. An institution's reserve
requirement is a fraction of such deposits; the fraction - the
required reserve ratio - is set by the Board of Governors within
limits prescribed in the Federal Reserve Act." 
According to the above, the
Board of Governors set required reserve balances within limits
as prescribed by the Federal Reserve Act that depository institutions
must hold on account.
The required reserve ratio
is clearly stated to be a fraction of demand deposits and interest-bearing
accounts that offer unlimited checking privileges.
Notice the wording "since
the early 1990s, reserve requirements have been applied only
to transaction deposits", as such language demonstrates
that previous to the early 1990's reserve requirements were applied
to a larger composite - according to the usage of the word "only".
Which in fact is true, as reserve
requirements have been reduced several times since the Fed took
control in 1913? A closer look at reserve requirements is in
The Federal Reserve has the
following to say in regards to reserve requirements:
have long been a part of our nation's banking history. Depository
institutions maintain a fraction of certain liabilities in reserve
in specified assets. The Federal Reserve can adjust reserve requirements
by changing required reserve ratios, the liabilities to which
the ratios apply, or both." 
Once again, we see the use
of the word "fraction" when discussing reserve requirements,
however, we now have the further clarification of reserves in
"specified assets." Obviously, these "specified
assets" are critically important, as they are the reserves
of our monetary system.
"A depository institution
satisfies its reserve requirement by its holdings of vault cash
(currency in its vault) and, if vault cash is insufficient to
meet the requirement, by the balance maintained directly with
a Federal Reserve Bank or indirectly with a pass-through correspondent
bank (which in turn hold the balances in its account at the Federal
Now we see that depository
institutions satisfy their reserve requirements by holding cash
(currency) in their vaults, or if short, they get some help from
the Fed or a correspondent bank. The next logical question is:
how much cash are they required to have on reserve in their vaults.
From the same Fed publication,
we find the following table:
As can be seen from the above
chart there isn't a heck of a lot of reserves on reserve. Three
of the five categories listed in the chart have zero (0) reserve
requirements. One of the five categories has three (3%) percent
reserves, and the remaining category has approximately ten (10%)
percent reserve requirements.
So, what are the ramifications
of the above listed reserve requirements? From the Fed's publication,
we find the following:
"The supply of balances
can vary substantially from day to day because of movements in
other items on the Federal Reserve's balance sheet. These so-called
autonomous factors are generally outside the Federal Reserve's
direct day-to-day control.
The largest autonomous factor
is Federal Reserve notes. When a depository institution needs
currency, it places an order with a Federal Reserve Bank. When
the Federal Reserve fills the order, it debits the account of
the depository institution at the Federal Reserve, and total
Federal Reserve balances decline.
The amount of currency demanded
tends to grow over time, in part reflecting increases in nominal
spending as the economy grows. Consequently, an increasing volume
of balances would be extinguished, and the federal funds rate
would rise, if the Federal Reserve did not offset the contraction
in balances by purchasing securities. Indeed, the expansion of
Federal Reserve notes is the primary reason that the Federal
Reserve's holdings of securities grow over time." 
Federal Reserve notes are those
little green pieces of paper we all carry around in our wallet
or purse and refer to as cash. A dollar bill is a Federal Reserve
note, as are fives, tens, twenties, fifties, and one hundred
From where does the Fed get
the Federal Reserve Notes? Good question. Let's try and find
Notice in the above quote the
last sentance, which reads, "Indeed, the expansion of Federal
Reserve notes is the primary reason that the Federal Reserve's
holdings of securities grow over time."
With the Fed's holding of securities
entering the picture, we now have two questions to answer: Federal
Reserve notes come from where; and what securities is the Fed
holding due to the expansion of Federal Reserve notes?
The Treasury has a role to
play in this monetary game of musical chairs. The Fed has this
to say regarding the Treasury:
"Another important factor
is the balance in the U.S. Treasury's account at the Federal
Reserve. The Treasury draws on this account to make payments
by check or direct deposit for all types of federal spending.
When these payments clear, the Treasury's account is reduced
and the account of the depository institution for the person
or entity that receives the funds is increased. The Treasury
is not a depository institution, so a payment by the Treasury
to the public (for example, a Social Security payment) raises
the volume of Federal Reserve balances available to depository
From this we see that the Treasury
has an account at the Federal Reserve, and that the Treasury
draws on the account to make payments by check and direct deposit.
Where did the Treasury's account at the Fed come from? Rather
than finding answers, we are discovering more questions.
Open Market Operations
"Open market operations
are the most powerful and often-used tool for controlling the
funds rate. These operations, which are arranged nearly every
business day, are designed to bring the supply of Federal Reserve
balances in line with the demand for those balances at the FOMC's
target rate." 
The more we look, the greater
our task becomes. That is good, as often times its not just the
answers that matter, but asking the right questions as well.
We are getting warmer by the minute.
"In theory, the Federal
Reserve could conduct open market operations by purchasing or
selling any type of asset. In practice, however, most assets
cannot be traded readily enough to accommodate open market operations.
For open market operations to work effectively, the Federal Reserve
must be able to buy and sell quickly, at its own convenience,
in whatever volume may be needed to keep the federal funds rate
at the target level. These conditions require that the instrument
it buys or sells be traded in a broad, highly active market that
can accommodate the transactions without distortions or disruptions
to the market itself. The market for U.S. Treasury securities
satisfies these conditions." 
United States Treasury securities
are the main market the Fed uses to conduct open market operations.
As the money supply continually grows, the buying of Treasury
securities by the Fed occurs more often then selling.
Summary To Date
- Fractional Reserves refers
to monetary reserves required to be on deposit in banks.
- The reserve requirements go
from zero, to 3%, to 10%.
- Federal Reserve notes (cash)
are the predominant reserve deposit.
- When banks need cash, they
go to the Fed.
- The Fed holds U.S. government
securities in its accounts.
- The U.S. Treasury has an account
at the Fed.
- The Fed conducts open market
operation of buying or selling Treasury securities.
The remaining questions before
- Where does the Fed get the
ever-increasing supply of Federal Reserve notes?
- Where did the Treasury account
at the Fed come from?
Where The Money Comes From
Trillions of dollars are said
to be everywhere. I remember as a kid that a million was a big
number. Today billions of dollars are tossed around from computer
to computer without the blink of an eye. Trillions are now the
topic de jour.
Budgets, deficits, and international
money flows are all described using trillions or parts thereof.
We have come a long way. The financial wizards circle high above
the common man. But perhaps the way so chosen is the wrong way,
for the good of all of the people - not just the elite few who
control the strings of the purse, and profit thereby.
go within the Temple of the Wizards of Finance, to see what arts
the conjuring is done by, to see what potions and spells are
cast within fortune's cauldron, and what strange brew precipitates
On that fateful day when Federal
Reserve Notes were first issued, it is obvious that a huge number
of dollar bills had to be printed. Now, the printing press
is pretty much obsolete; the only money that actually gets printed
is used to replace old and worn Federal Reserve notes already
in circulation. In vogue today is electronic money - fast food
The process actually begins
with the Treasury Department printing a piece of paper called
a bond, which is done electronically. Treasury bonds are debt
obligations (liability) of the government to repay a loan - with
The Treasury sells bonds to
the public. The bonds the public does not buy, the Treasury deposits
with the Federal Reserve. When the Fed accepts the bond from
the Treasury, it lists the bond on its books as an asset.
The Fed assumes the government
will make good on its promise to pay back the loan. This is based
on the belief that the government's power to tax the people is
Because the Fed now has an
asset that it didn't have before receiving the Treasury
bond, the Fed can now create a liability that is offset by
its new asset.
The liability that the
Fed creates is a Federal Reserve check. It gives the Treasury
the check in payment for the Treasury bond.
THERE IS NO EXISTING MONEY
IN THE FED'S ACCOUNT TO COVER THIS CHECK.
The Federal Reserve check is
endorsed by the Treasury and is deposited in one of the government's
accounts at the Federal Reserve. The government can use the deposits
to write checks against, to pay for government expenses.
This is the first new money
flow to enter the system. Various government contractors, vendors,
etc. receive these checks as payment for services rendered, and
they take the checks and deposit them in their commercial banks.
The Second Step
This is when the wizards of
finance perform their greatest feats of magic. The deposits in
the commercial banks take on a sort of split personality or dementia,
brought on by a preponderance of delusional thinking.
On the one hand, the deposits
are the bank's liabilities, as they owe the total sums
to their depositors.
However, because of FRACTIONAL
RESERVE lending, the bankers get to lend out 9 times what they
have on deposit.
The commercial banks get
to list the deposits as RESERVES.
In other words, FRACTIONAL
RESERVE lending allows the commercial banks to create 9 times
more money then they have on reserve. The banks lend money they
don't have, and:
...They get to charge interest
As the newly issued money is
put to work by borrowers, they then spend it and the receiver
then deposits it in their bank account, and the bank starts the
reserve lending policy all over again. This is why the...
...Money supply must expand
by the amount of interest owed on the debt.
If it didn't, the debt would
not be able to be serviced. There is no money created without
creating debt, they are one and the same. Wealth is not created
by creating money by fiat - only debt. As the Fed has admitted:
"Commercial banks create
checkbook money whenever they grant a loan, simply by adding
new deposit dollars in accounts on their books in exchange for
a borrower's IOU." 
Fractional reserve lending
invokes the moral hazard of fidelity of contract. Banks have
on deposit (reserve) at most 10% of the "money supply".
This means that if more than
10% of depositors go to the bank at one time to withdraw "our"
money - there isn't any money to withdraw beyond the 10% reserves.
Which means that 90% of the
money supply is non-existent, nothing more than a fleeting illusion.
The bank's solvency stands
on the faith that no more than 10% of depositors will want their
money at the same time. This means that although...
...Banks may appear to be
solvent - they are without question illiquid.
Fractional reserve lending
insures and guarantees that banks cannot possibly be liquid.
Banking is the only type of
business that is allowed to function this way. If any other business
used a similar modis operandi it would be subject to censor,
arrest, court, and possibly imprisonment. Banks cannot fulfill
all of their contracts if demand occurred at the same time. Thus,
the banks are illiquid.
Why the double standard? Why
the dishonesty? Why are they afraid of gold and silver money
as the Constitution mandates? Because it would make them tow
the line or go bankrupt. Less they forget - be ever mindful -
even Zeus cannot deny Destiny.
OCEANIDS: Who then is the steersman of Necessity?
Prometheus: The three-shaped MOERAE
and mindful ERINYES.
OCEANIDS: Can it be that Zeus has less power
than they do?
Prometheus: Yes, in that even he cannot escape what is
Coming Soon - Open Letter To
Seeking Redress For The Return To Honest Money
© 2005 Douglas V. Gnazzo
All Rights Reserved
Adams in a letter to Thomas Jefferson
Works and Days
Kenneth Galbraith Money: Whence It Came, Where It Went
Reserve Bank, New York The Story of Banks, p.5.
 The Federal
Reserve System Purposes and Functions The
Implementation of Monetary Policy
 Same as above
reserve Bank of New York, I Bet You Thought, p.19
Prometheus Bound 515
Douglas V. Gnazzo
V. Gnazzo. All rights reserved.
All Rights Reserved
All other views
and comments are invited.
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