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Bank On It: How Cash-Starved States Can Create Their Own Credit
An Article by Ellen Brown from Yes! Magazine
posted Mar 03, 2009
“He that will not apply new remedies must expect new
evils; for time is the greatest innovator.”
– Francis Bacon
Archive photographs from 1919 of the founding of the Bank of North
Dakota.
 On
February 19, 2009, California narrowly escaped bankruptcy, when Governor
Arnold Schwarzenneger put on his Terminator hat and held the state senate
in lockdown mode until they signed a very controversial budget. 1 If the
vote had failed, the state was going to be reduced to paying its employees
in I.O.U.s. California avoided bankruptcy for the time being, but 46 of 50
states are insolvent and could be filing Chapter 9 bankruptcy proceedings
in the next two years. 2
One of the four states that is not insolvent is an unlikely candidate for
the distinction—North Dakota. As Michigan management consultant Charles
Fleetham observed last month in an article distributed to his local media:
“North Dakota is a sparsely populated state of less
than 700,000, known for cold weather, isolated farmers and a hit
movie—Fargo. Yet, for some reason it defies the real estate cliché of
location, location, location. Since 2000, the state’s GNP has grown 56%,
personal income has grown 43%, and wages have grown 34%. This year the
state has a budget surplus of $1.2 billion!”
What does the State of North Dakota have that other states don’t? The
answer seems to be: its own bank. In fact, North Dakota has the only
state-owned bank in the nation. The state legislature established the Bank
of North Dakota in 1919. Fleetham writes that the bank was set up to free
farmers and small businessmen from the clutches of out-of-state bankers
and railroad men. By law, the state must deposit all its funds in the
bank, and the state guarantees its deposits. Three elected officials
oversee the bank: the governor, the attorney general, and the commissioner
of agriculture. The bank’s stated mission is to deliver sound financial
services that promote agriculture, commerce and industry in North Dakota.
The bank operates as a bankers’ bank, partnering with private banks to
loan money to farmers, real estate developers, schools and small
businesses. It loans money to students (over 184,000 outstanding loans),
and it purchases municipal bonds from public institutions.
Still, you may ask, how does that solve the solvency problem? Isn’t the
state still limited to spending only the money it has? The answer is no.
Certified, card-carrying bankers are allowed to do something nobody else
can do: they can create “credit” with accounting entries on their books.
A License to Create Money
Under the “fractional reserve” lending system, banks are allowed to extend
credit (create money as loans) in a sum equal to many times their deposit
base. Congressman Jerry Voorhis, writing in 1973, explained it like this:
“[F]or every $1 or $1.50 which people—or the government—deposit in a bank,
the banking system can create out of thin air and by the stroke of a pen
some $10 of checkbook money or demand deposits. It can lend all that $10
into circulation at interest just so long as it has the $1 or a little
more in reserve to back it up." 3
That banks actually create money with accounting entries was confirmed in
a revealing booklet published by the Chicago Federal Reserve titled Modern
Money Mechanics. 2 The booklet was periodically revised until 1992, when
it had reached 50 pages long. On page 49 of the 1992 edition, it states:
“With a uniform 10 percent reserve requirement, a $1 increase in reserves
would support $10 of additional transaction accounts [loans created as
deposits in borrowers’ accounts].” 4
The 10 percent reserve requirement is now largely obsolete, in part
because banks have figured out how to get around it with such devices as
“overnight sweeps.” What chiefly limits bank lending today is the 8
percent capital requirement imposed by the Bank for International
Settlements, the head of the private global central banking system in
Basel, Switzerland. With an 8 percent capital requirement, a state with
its own bank could fan its revenues into 12.5 times their face value in
loans (100 ÷ 8 = 12.5). And since the state would actually own the bank,
it would not have to worry about shareholders or profits. It could lend to
creditworthy borrowers at very low interest, perhaps limited only to a
service charge covering its costs; and it could lend to itself or to its
municipal governments at as low as zero percent interest. If these loans
were rolled over indefinitely, the effect would be the same as creating
new, debt-free money.
Dangerously inflationary? Not if the money were used to create new goods
and services. Price inflation results only when “demand” (money) exceeds
“supply” (goods and services). When they increase together, prices remain
stable.
Today we are in a dangerous deflationary spiral, as lending has dried up
and asset values have plummeted. The monopoly on the creation of money and
credit by a private banking fraternity has resulted in a malfunctioning
credit system and monetary collapse. Credit markets have been frozen by
the wildly speculative derivatives gambles of a few big Wall Street banks,
bets that not only destroyed those banks’ balance sheets but are infecting
the whole private banking system with toxic debris. To get out of this
deflationary debt trap requires an injection of new, debt-free money into
the economy, something that can best be done through a system of public
banks dedicated to serving the public interest, administering credit as a
public utility.
Some experts insist that we must tighten our belts and start saving again,
in order to rebuild the “capital” necessary for functioning markets; but
our markets actually functioned quite well so long as the credit system
was working. We have the same real assets (raw materials, oil, technical
knowledge, productive capacity, labor force, etc.) that we had before the
crisis began. Our workers and factories are sitting idle because the
private credit system has failed. A system of public credit could put them
back to work again. The notion that “money” is something that has to be
“saved” before it can be “borrowed” misconstrues the nature of money and
credit. Credit is merely a legal agreement, a “monetization” of future
proceeds, a promise to pay later from the fruits of the advance. Banks
have created credit on their books for hundreds of years, and this system
would have worked quite well had it not been for the enormous tribute
siphoned off to private coffers in the form of interest. A public banking
system could overcome that problem by returning the interest to the public
purse. This is the sort of banking system that was pioneered in the colony
of Pennsylvania, where it worked brilliantly well.
Restoring Michigan to Solvency
Among other advantages to a state of owning its own bank are the
substantial sums it could save in interest. As Fleetham notes of his own
ailing state of Michigan:
“According to recent financial reports (available
online), the State of Michigan, the City of Detroit, the Detroit Water and
Sewerage Department, the Wayne County Airport, the Detroit Public Schools,
the University of Michigan, and Michigan State University pay over $800
million a year in interest on long term debt. If you add interest paid by
Michigan cities, school districts, and public utilities, the cost to our
taxpayers easily tops a billion a year. What does Wall Street do with our
billion plus dollars? They decorate their offices like kings.”
Interestingly, the projected state budget deficit for 2009 is also $1
billion. If Michigan did not have to pay over a billion dollars in
interest to Wall Street, the budget could be balanced and the state could
be restored to solvency. A state-owned bank could not only provide
interest-free credit for the state but could actually generate revenues
for it. Fleetham notes that in 2007, the Bank of North Dakota earned a net
profit of $51 million on a loan volume of $2 billion. He comments:
“Last year, Michigan citizens paid over $5 billion
dollars in personal income tax. With a state bank like North Dakota’s we
could reduce this burden, fund new businesses, and restore our crumbling
water and sewer systems. And we don’t have to feel sorry about Wall Street
losing our business. They didn’t ‘earn’ the money they lent us. They
created it in computers and charged us interest to boot. Let’s follow
North Dakota’s lead and get free from Wall Street’s web.”
Taking the Initiative in California
California could do this as well. Robert Ellis is a Tucson talk show host
who once worked on Wall Street and has been involved in setting up several
banks and financial institutions. In January of this year, he proposed in
a letter to Governor Schwarzenegger that California could resolve its
financial woes by setting up a bank on the model of the Bank of North
Dakota. Ellis wrote to the governor:
“I admire your tenacity in dealing with California’s financial problems.
Your idea of using IOU’s was ingenious but there is a better way. The
State of California can charter its own bank and issue its own checks to
all state employees… . It can also pay all its vendors, contracts and
contractors through the bank… . Additionally, once the bank is
operational, you can fund your own state projects and you determine the
interest rate paid as opposed to being at the mercy of the banks you
currently deal with or the interest rates the investment bankers make you
pay to issue bonds. By doing this, you will put the state in control of
its own destiny and make it the benefactor of its own money.
“… What I am proposing is not new. It has been done by one other state in
the nation [North Dakota]. Why should you continue to pay the banks for
services and interest on loans when you can receive that interest for the
benefit of the state of California? Wouldn’t it be better if you could
fund your own infrastructure projects without having to get the approval
of independent banks or investment bankers? Additionally, you set the
interest rate on your own projects. You can even set it at zero if you
deem the project worthy enough.”
Ellis offered his services in setting up the bank, which he thought
could be chartered in a few short months. The Governor has not replied,
but some pressure from constituents might encourage a response.
Failing that, there is the initiative and referendum process pioneered in
California. It allows state laws to be proposed directly by the public,
and the state’s Constitution to be amended either by public petition (the
“initiative”) or by the legislature submitting a proposed constitutional
amendment to the electorate (the “referendum”). The initiative is done by
writing a proposed constitutional amendment or statute as a petition,
which is submitted to the California Attorney General along with a
submission fee, which was a modest $200 in 2004. The petition must be
signed by registered voters amounting to 8% (for a constitutional
amendment) or 5% (for a statute) of the number of people who voted in the
most recent election for governor. 5
As Gandhi said, “When the people lead, the leaders will follow.” We the
people can beat the Wall Street bankers at their own game, by moving our
legislators to set up publicly-owned banks that create credit using the
same banking principles that are accepted as standard and usual in the
trade by bankers themselves.
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Ellen Brown, J.D., wrote this article in March, 2009, for Path to a New
Economy, a collection of online articles for YES! Magazine, on economic
and financial solutions. Ellen developed her research skills as an
attorney practicing civil litigation in Los Angeles. In Web of Debt, her
latest book, she turns those skills to an analysis of the Federal Reserve
and “the money trust.” She shows how this private cartel has usurped the
power to create money from the people themselves, and how we the people
can get it back. Her eleven books include the bestselling Nature’s
Pharmacy, co-authored with Dr. Lynne Walker, and Forbidden Medicine. Her
websites are www.webofdebt.com and
www.ellenbrown.com .
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