What You Absolutely Need to Know About "Their Paper Money"

Shah Gilani

Chapter One, on how money came into being, ended with, "Governments made legal tender laws to make it illegal not to use their paper money - backed by nothing but promises."

There's a partial truth in that sentence. Can you spot it?

Don't worry if you can't. You're not supposed to. It's part of an orchestrated deception.

It's the part about "their paper money." The truth is that governments, and by extension, the countries they govern, don't issue their own money.

The twist is, while government agencies print their currency's bills and stamp their coins, it's not always "their" money.

Countries throughout the free world don't actually own their money.

Guess who does?

The money that we think of as bills and coins is actually created and owned by banks.

Governments manufacture the physical medium we exchange, but it's not their money.

Here's that deception I was talking about: you're supposed to believe that the government, and by extension, a country, issues its own currency because you're supposed to believe in government's implied promise to back its money.

Governments print and coin their currency, so people trust it. But it's not their money.

Here's how the great deception works - and how banks create money, how they got governments to work for them and protect them, and how they created central banks to leverage their control of their government partners.

The early modern history of banking starts in 12th Century Venice and goes on to the establishment of the first central bank, the Bank of England, in 1694, and it is fascinating. But, we're going to uncover the truth about banks and central banks by unearthing the roots of the most powerful and deceptive banking cartel in the world.

The American model, which is in fact an alliance between America's big banks and the American government, is the hub around which most world banking systems revolve.

America's colonies had their own banks. Fractional reserve banking was widely practiced by all the banks in the colonies. So it wasn't long before America's banks overextend themselves - and imploded.

What made matters worse was that there were so many different currencies. Banks in different colonies - and different banks in the same colonies - were free to print their own bills of currency.

In 1781, before the U.S. Constitution was drafted, the Continental Congress granted a charter to Robert Morris, a member of Congress, to establish the Bank of North America, the nation's first central bank.

It was hoped that the new bank, which was granted a monopoly to issue bank notes, and became the official depository for all federal funds, would facilitate commerce and create some order out of fractured banking schemes plaguing the country.

But, this new Bank of North America was no different than any other bank. It was grossly undercapitalized, and, through the magic of fractional reserve banking, loaned out more than it had in reserves.

Its paper money was technically redeemable in specie; however the public lost confidence in the bank and aggressively began discounting its notes because of the vast quantity the bank had issued. The nation's first central bank had its charter revoked and reverted to a struggling commercial bank only two years after it opened.

Then along comes the Constitution.

The Constitution makes no direct mention of paper money or banks, but the Founding Fathers were intimately aware of banking problems in all the states.

To ensure that States wouldn't ruin themselves like banks were doing, in its address of the limitations on the power of the states in Article 1, Section 10, the Constitution says, "No States shall emit Bills of Credit."

In other words, the states couldn't issue paper money that wasn't redeemable in gold or silver. They couldn't just print money to pay their bills.

The question quickly arose: Could the Federal Government issue bills of credit?

While that debate raged, Alexander Hamilton, one of the nation's Founding Fathers, the Country's first Secretary of the Treasury, and a former aide to Robert Morris, came up with an extraordinary Constitutional end-around in order to pay the country's Revolutionary War debts,

In 1791 Hamilton's brainchild, the First Bank of the United States was chartered by Congress to lend money to the Federal Government so it didn't have to print money itself.

Bankers got the blessing of the government to create money out of thin air, not just by way of issuing credit to the public, by catering to the biggest borrower of all - the nation.

The government got all the money it needed from the bank by issuing bonds which the Bank bought with their freshly printed paper money.

But, banks being what they are, it wasn't long before the First Bank of the United States was in trouble.

Just like its predecessor, the Bank of North America, the new central bank was granted a monopoly on the issuance of bank notes. And just as before, all federal funds were deposited in the Bank. The public wasn't forced by legal tender laws to accept or use the Banks' notes this time, either. And like before, the Bank was supposed to redeem all its notes in gold and silver. Of course, the Bank was badly undercapitalized. And through the magic of fractional reserve banking, against no real reserves, it printed so much money that it quickly lost its purchasing power.

The Bank had an important effect on all the banks in the country, in spite of its problems, the debate about its constitutionality, and the expiration of its charter, twenty years later, in 1811.

The First Bank of the United States was believed to be the strongest, the best-backed and most trusted bank in the country. But if they wouldn't accept another bank's notes, for fear they weren't able to redeem their notes against the gold and silver supposedly in their vaults, the public viewed those other banks as suspect. In other words, the central bank forced other banks to be more restrained in their lending and note issuance practices.

Not long after the second central bank experiment had expired, banks were quickly back in the business of ruining themselves and their depositors.

And that meant it was time for another central bank.

In 1816 the Second Bank of the United States was chartered.

There were no surprises. The new bank was a mirror image of the First Bank of the United States, including their refusal to accept other bank's suspect notes.

However, a different problem quickly arose. To battle the new central bank, other banks began refusing its notes, in essence questioning whether the central bank has the gold and silver reserves that it said it had. It didn't.

The history of the Second Bank of the United States is no less colorful than the history of its predecessor. Political battle lines - which led to the creation of entirely new political parties - were drawn on one side of the banking issue or the other.

The Second Bank was bitterly opposed by President Andrew Jackson, who made the existence of the Bank and its power over the people a central issue in his campaign.

Jackson won, and in 1836 the Second Bank of the United States' charter expired, along with another central banking experiment.

What happened next in the United States set the stage for the conception and creation of the Federal Reserve System, the world's most powerful central bank. The Fed's "original sin" is evidenced by the fact that it won't call itself a central bank - let alone a central bank for all central banks.

Stay tuned. You won't want to miss the next chapter.

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Shah Gilani

About the Author

Browse Shah's articles | View Shah's research services

Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.

The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.

Shah founded a second hedge fund in 1999, which he ran until 2003.

Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.

Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.

Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.

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