Credit and the Economy

By Patrick Meloy January 2018

Sorry for the ugly page and poor writing, I'm neither a writer nor web designer! This is also a work in progress, I've got the main points down but not a lot of fleshing out has been done. Eventually I hope to have links to expanded explanations of the concepts presented to try and keep the mass of words on the main page to a minimum.


We're all brought up believing in the fantasy that banks loan money but it is not true. Our lack of understanding of banking and credit allows the economy to be manipulated in a way that greatly favours the richest while keeping tight control over the financial success of the rest of us. By controlling credit, unemployment is kept high enough that there is great competition for most jobs and in general those that will work the cheapest get the work, which artificially drives down wages.

We're also fooled into believing that recessions are hard times for everyone when in fact, for those with money to burn, it's a happy time when prices are rock bottom. The true rich (a few million isn't really rich) usually come out of a recession far richer than they went in. On paper they appear to be getting less rich because prices for what they own go down but they're smart enough to BUY when prices are low, not sell, so they lose nothing really. After the recession those paper losses disappear.

Recessions and depressions are presented to us as forces of nature that cannot be predicted or prevented. In reality they are engineered events that are easy to see coming a couple of years in advance. Our world runs on credit. If credit is easy to get and cheap to pay off there's a boom (and eventually a bubble). When credit gets expensive and hard to qualify for it causes a recession. This site is dedicated to explaining the incredibly simple manner in which the economy is controlled to rob the many to benefit the few.

Banks Do Not Loan Money, They Extend Credit

This is something that is pretty well universally misunderstood. We think that people make deposits which the bank then loans out. In reality, loans create deposits. Hard to fathom I know and took me a while to wrap my head around it as well. The biggest issue with understanding the fraud is all the useless detail that is purposefully put out there to make it hard to understand. I'll cut through all that.

If you want more background just search for "fractional reserve banking" and you'll find horribly obfuscated huge descriptions that are nearly impossible to follow. We no longer actually use a fractional reserve system but you'd be hard pressed to figure that out if you just research banking. The idea behind fractional reserve (back when we used it) was that a fraction of every deposit had to be re-deposited with the central bank as a "reserve" in case the bank went bust, the rest of that money could be loaned. We'll assume a 5% reserve requirement (or re-deposit rate, whichever you prefer).

Simplified Explanation of a Fractional Reserve System

Let's say there's a tiny planet someplace in the cosmos with a tiny population that just invented the idea of money. You're the genius that thought it up and you printed $100 for yourself (no, you don't have gold backing it up, the gold standard disappeared in the 1970s).

Being a genius myself, I invent fractional reserve banking and being the charmer (con-man) that I am, I convince you to deposit your $100. Somebody makes up the fractional reserve requirement (that I hate) that says I have to re-deposit $100 x 0.05 = $5 of your deposit with the central bank then I can lend out $95, which I do ASAP.

The person that borrowed the $95 bought a car. They got a cheque from me and gave it to the seller who I have convinced to accept the cheque and deposit it with me to make his deposit grow.

There are now two deposits at my bank. Your $100 and the car dealer's $95. Of course, just like in real life I put a freeze on your deposit and told you that you can't spend any of it until the borrow pays it back, right? What? You've never had a bank notify you that your money has been lent out so it's no longer available? Oooh, that gave me a great idea! I don't call you, I just pretend that both you and the car dealer's accounts have money in them. As long as nobody pulls out $100 or more at once, I'm safe. that is how banks in the real world operate.

So the $95 cheque becomes a $95 deposit that was created by the "loan". The rules say I have to re-deposit 5% so I send $4.75 to the central bank and I have $90.25 to lend out. Wait, don't let your head explode! You're thinking no money can be lent out because it's already been lent out and you SHOULD be right. The law says otherwise.

The $90.25 goes through the deposit process and becomes a $85.74 loan. The process repeats itself until there's nothing left to lend. To figure out the total loans (which is the new amount of money in the world) you can use a spreadsheet and run the numbers or you can just divide the original deposit by the re-deposit rate $100 / 0.05 = $2000. Instead of $100 in the world now everyone believes there is $2000 in the world. Of course there isn't really, $1900 of that is imaginary and only exists as entries in a ledger.

All those people believe they have money in the bank and as long as the total cash withdrawn is less than $100 the scam continues unabated. There was only one actual deposit, the rest of the deposits were created by loans. Without the loans, there could be no deposits. Remember, we don't actually use a fractional reserve system any more because the banks cried crocodile tears about how no other financial institutions had to pay this "Tax".

The body that sets the rules for banking in most of the world is called the Bank for International Settlements or BIS for short. (website ). The international agreement on running banking is called the Basel Accord which is currently at version III (Link ) It is part of what are called the Bretton Woods Institutions and there are three of them. The BIS, World Bank, and the International Monetary Fund. The latter two you are probably well aware of while the BIS is probably something you've never heard of before as there appears to be a blanket gag order on mentioning it's name in the media. I'm 57 and I've never once heard it mentioned on TV, heard of it on the radio, or read about it in newspapers. Considering the importance of what this institution does, you'd think it would be mentioned at least occasionally!

In the Basel accords is the agreement that banks are allowed to lend many times their capital. Currently it's 12.5% but that changes frequently. Just before the last recession it was 20 times (22 times for favoured banks) This ability to "multiply money" lets a bank that has $1 billion in capital create loans totalling $12.5 billion. In other words, they are allowed to create $11.5 billion in phantom imaginary money. What constitutes capital is a bit of a shocker. You would think that capital is cash but, it's not. Most bank's capital is actually debts due to the bank. Banks keep little cash and in fact only a tiny fraction of the money supply is actually bills and coins, the rest is imaginary money created as loans like I described above.

Run Forrest Run!

So now you know why so many people end up with nothing when there is a run on banks. Almost all the deposits are imaginary so those wanting cash have to share the tiny little bit the bank actually holds. If you're lucky you live in a country with "depositors insurance" (US and Canada for sure) that will cover up to a certain amount that is usually a couple hundred thousand dollars. That's not a sure thing though, the banks pay into the insurance fund but the amount is far, far, less than the total deposits. It can handle a couple of banks going under but any large bank run and it'll be exhausted before everyone get's their share. Even then you don't get cash, you can only receive a new deposit of imaginary money.

Verrry Interesting, But Also Stupid

You have to be an old fart or retro-TV fan to know that saying (Arte Johnson on Rowan and Martin's Laugh-In ). While banks are creating credit and expanding the "money" supply, they are not creating any money to cover the interest. If all the borrowers tried to pay off their debts it wouldn't work. Let's assume a 7% interest rate and simplify all the details just for clarity. At the end of one year people would owe $2000 x 0.07 = $140 in interest. Even carefully negotiating the paybacks so that the bank, which only has $100 in actual money, doesn't go bust, the debt cannot be paid off. In just one year the debt due to interest is 40% greater than all the actual money that exists.

The only way to keep this scheme going is to borrow money (create new credit) at a rate greater than the interest rate. When we achieve this it's called "Economic Growth" due to "Consumer Confidence. When we fail to keep up like this it's called a recession. To clear up the Orwellian terms: Economic Growth = Growth in Debt, Consumer Confidence = Rate at which people are conned into borrowing. Being "conned" refers to people being convinced by "Confidence Men" to willingly, though unknowingly, get ripped off.

Capital Idea!

According to the current Basel Accords (VIII 2018) banks are allowed to lend 12.5 times their capital. What exactly constitutes capital is detailed in part II, minimum capital requirements ( ). It's pretty convoluted as it assigns risk weights to various type of debts and the type of debtor. The really important part is on page 19: Claims on Sovereigns. A claim from a bank means you owe them money and a Sovereign is the government. According to Basel, Government debt with a rating of AA- or better is zero risk capital. No risk means the entire 12.5x multiplier can be used. Wrap your head around this: If a AAA credit score government borrows $1 billion from banks that entitles the banks to make $12.5 billion in loans. When you investigate the ratio of our money supply to government debt you find that a huge amount of our money supply was created from government debt. This is why government's keep borrowing and won't pay down old debt. If they pay the debt then the money supply HAS to shrink because bank's don't have as much "zero risk capital" so aren't allowed to have as much credit out there. If they don't keep increasing the debt then credit can't be created fast enough to cover the accumulating interest and you have a recession, depression, or downright collapse of the economy.

Even worse, those loans have to end up as deposits themselves (since it's all imaginary and can't be withdrawn as cash) which themselves become capital from which to create loans. It truly boggles the mind until you really stick it into your head that money is just an idea, not a physical thing. Even paper money and coins are only worth what we believe they are worth. In reality, paper money is just specially marked bits of wood that we fool ourselves into believing have value (Look up "Tally Sticks" which were the English currency for 800 years) Money really does grow on trees, though very little of it.

Spotting A Recession Before It Happens

To review, a economic boom happens when credit is easy to get and cheap to pay for. A recession happens when credit is expensive and not easy to get. Why this is true is fairly simple: To buy non-trivial things people and companies have to borrow money. If borrowing is cheap and easy we borrow lots and that lets us buy lots. Business booms, employment improves as companies hire more to meet the higher demand. All this borrowing increases the imaginary money supply letting people bid UP prices for things they want.

One prime example is real estate where the price of housing is set by how much banks are willing to lend. How many people could afford $1 million plus for a home in Vancouver if they couldn't get a bank loan? What happens to house prices when people can't borrow enough to pay the asking price? Supply and demand - if the credit supply is sufficient the prices go up, when it's not, they go down.

So as banks tighten up requirements and raise interest rates, less money is borrowed so there is less spending. When consumers buy less companies produce less and lower production means fewer workers needed. On top of that the cost of holding debt gets higher (When you get a new loan or renew your credit at the end of it's term) so people and companies are spending more on debt servicing which leaves less for  producing and consuming - which also means fewer workers needed.

The definition of a financial recession is when there are three consecutive quarters of negative financial growth. Or to un-Orwell it, when people pay off debt faster than they borrow for at least nine straight months. This is the "official" recession definition but it's really only important to the financial industry. The REAL recession starts long before the official recession. What is the real recession? When unemployment starts rising. After all, the start of an official recession hardly matters to someone that was laid off a year or two beforehand and can't find equal (or any) work. Take a look at this chart from the St. Louis Federal Reserve Bank's FRED date (Federal Reserve Economic Database).

Unemployment and Interest Rate Graph


The vertical gray bars are official recessions while the red line is interest rates and blue the unemployment rate. After the great depression banks were severly limited in what they could do so the recessions up to the late 1960s were hardly noticed by the general public who's debt load was miniscule compared to today. Lots of things changed in the late 1960s which undid most of the limits placed on banks so they couldn't create another Great Depression (Great Rip Off). Unemployment calculations were also changed at that time and when I purchased historical employment data from Statistics Canada (yes, its VERY hard to find and costs money) it came with a warning that unemployment rates after 1970 could not be compared to those before 1970 because what constitutes "unemployed" changed too much. If we still used the criteria from pre-1970 our unemployment figures would be significantly higher.

Knowing what you do, you should be able to spot the pattern. Interest rates go up and unemployment follows a while later (takes time for the new loans and refinancing to more expensive debt to accumulate). Invariably interest rates rise until there is a crash. There are NO crashes that aren't preceeded by interest rate hikes.

You'll also notice that rising interest rates don't always cause a crash immediately. The long period of higher interest rates from about 1994 to 2002 are a good example. During this period Bill Clinton was busy gutting remaining restrictions on banks and the banks could not create a recession or it wouldn't look like deregulating banks is good for the economy. They kept interest rates high enough to stave off hyperinflation but below the point where they would cause a recession. Once the deregulation was finished they kicked up interest the last couple of points needed to cause a recession (Happy Time for the really rich).

So how do you know when a recession is in the pipe? Look at unemployment. When it starts rising the REAL economy is in recession. We are earning less, consuming less, and producing less - it is receeding. Once the real recession starts the official recession follows in approximately two years (give or take 6 months). Just look at the pattern on the chart and it's abundantly clear.

So recessions are not caused by "irrational exhuberance" or "Tech Bubbles" or "Housing Bubbles" and they are not a random force of nature. They are "Credit Bubbles" created for the express purpose of controlling the economy to benefit the few.

The Bastids!

Now look at the interest rate line and you'll notice that the "tipping point" to create a recession has gotten lower and lower over the years. That is because out debt loads have steadily increased over the years. Now look at the last recession and try to remember all the excuses you heard about what caused it and why it was so much worse than prior recessions. How long was the interest rate kept high? How much longer was it held there than during the creation of previous recessions? That's right, rates were hiked and HELD on purpose to create a really bad recession.

I mentioned earlier that banks can loan 12.5 x their capital and I also mentioned that used to be 20x. Well, one of the speaches I saw during Baby Bush's reign talked about how they were making banks more bulletproof by requiring higher capital ratios. That's when Basel changed from 20x to 12.5x. What do you think happened at banks, who are always at the bleeding edge of their capital ratio in order to make the most money, when they suddenly had to find 7.5% more capital or go under? Foreclosures! Either they foreclose and liquidate assets to drum up capital or they go under. Now you know the reason behind all the "Predatory" mortgages and other shenanigans the financial system resorted to. Unlike what we were spoon fed, these were not the cause of the crash, they were a symptom.

Now the Bad News

Look at the most recent unemployment and interest rates. Look familiar? The next recession is being generated as you read this (If you're reading in early 2018). Exactly when the official recession will start is still not clear because unemployment is flat. My guess would be about one more year before unemployment starts a clear upward trend so that puts the next official recession about three years out. I wouldn't rely on that guess though since we don't know their intentions.

The last recession spawned activist groups like Occupy and it's only been ten years so the members have not "aged out" and died off. There is still a viable network that can be resurrected very quickly. If it were me, I'd make this recession a light one to let all the activists die off. Since I'm not the planner, I can only guess. We've seen outright greed override common sense many times before so the next recession might be a great depression.