A central bank, reserve bank, or monetary authority is an institution that manages the currency, money supply, and interest rates of a state or formal monetary union, and oversees their commercial banking system, and this is what is called the central banking system. This is the definition given by Wikipedia and it all looks so simple. But is it really?
Our central banking system is very crooked, be it of any other country too. It has its loopholes which I will be discussing in this blog.
The Start:
The problem has its roots from the time of election when political parties are competing with each other to muster the votes, and what else can do other than tantalizing the masses with big-big promises and more free stuff which are practically beyond their reach. So what are they going to do, they don’t have required funds, so they resort to Deficit Spending : Spending more than you have. For this, the treasury (referred to the government) has to borrow, so they issue bonds on which they pay interest. These bonds* are the national debt and the banks participate in the auctions to get their chunk of the national debt and earn profits through interests.
*These bonds suck out our future prosperity, cause they are paid by us indirectly through taxes to the government.
Currency Springs Into Existence:
Now the banks swap those bonds with the federal reserve at a profit, for which there is a fancy word called O.M.O : Open Market Operations. The federal reserve purchases those bonds by cheques with zero balance, by this what I mean is that they are simply creating currency. Though what is taught to us is that they create money supply, but you cannot call this money, because money has store of value and maintains its purchasing power for a long period of time. These are just numbers, so they should better be referred to as currency.
This process is repeated as follows: treasury issues bonds, banks buy them, through OMO they sell it to the federal reserve, which creates currency, which goes to bank, the banks again buy the bonds and the process goes on… and the by product of this is that the treasury is left with more and more currency & the fed is left with build up of bonds.
The Government Spends:
With that build up of currency at the treasury, the government then spends it on public expenditures like infrastructure, roads, hospitals & wars. This generates income for the employees, which they deposit a portion of it with the banks.
Money Multiplier:
The money deposited with the bank is not kept entirely with the bank. There is a term called Fractional reserve lending, or what you call Money multiplier concept, where the banks keeps a fraction of the deposit as reserve (in case if the depositor demands for it ) and the rest is loaned. Eg; below the initial deposit is 100 and reserve requirement is 10%
This process will go on till the deposit of 100 generates currency worth 1000. Money multiplier is fine, but what we need to understand is that this increased currency has no value, it is just numbers.
Here Comes Inflation:
This increased supply of currency will make things expensive, and suck the purchasing power of the economy leading to inflation. The sources say that 92-96% of the money in the economy is not created by the government, but by the banking system through this. We are simply left with numbers as the form of money.
Debt Ceiling Delusion:
In simple language it means that there is no end to debt. Period. We discussed about bonds previously and the interest it carries along with it. From where will they pay off the interest component? Even to pay off the interest they either need to make new currency or borrow more just to pay the interest component, this implies that there will always be higher debt than the actual currency in existence.
Keeping a ceiling on the debt will collapse the entire system, so even if they say that we should pay our debt and live within our means, it will lead to deflationary environment, because this system is designed this way, where there will always be huge debt, never ending debt and more currency (numbers) rather than the money.
(I am not saying that debt is bad, for a developing country like India, they need to take debt for future developments, but if you take example of The United States, the $19.39 trillion economy has debt worth $22 trillion!)
The Beneficiaries:
This system empowers and benefits those who create the currency and receive it first, like the government, federal reserve, big banks and other big private players. The normal public is the one that always suffers.
So we need to understand that the system being followed is entirely backed by debt and will lead to inflation. There was a reason why Gold standard system was removed, because then they wouldn’t be able to do these manipulations.
Had there been Gold standard system, the money supply would be in control and inflationary tensions would have been reduced.
Finlightened 