The curse of 9 percent
Investing Safely

The curse of 9 percent

When I meet NRIs in the UAE to discuss their planning and investment needs, they often remind me of the fixed deposit rates being 9% back home. They feel that compared to the U.A.E. banks that offer only 3% per annum, the Indian FD rates are much better. Consequently NRIs in the UAE send a lot of money to India to avail of the ‘higher’ fixed deposit rates.

Have you ever wondered why Indian Banks offer fixed deposit rates of close to 9%, while the US and U.A.E banks offer around 3% per annum?

If the buying power of both currencies was equal, wouldn’t the rest of the world keep their money in Indian Fixed Deposits to get higher returns? Is that happening? I don’t think so.

The questions above have been bugging me for many years till I got into the industry and decided to investigate the reasons behind this. I found that the fixed deposit rates offered by banks in India as well as the U.A.E, or US for that matter are closely linked to the inflation rates in those countries.

  1. Historic inflation rates in India over the past 24 years have been hovering around 8-9% per annum, and
  2. The inflation rate in the UAE has been hovering around 3% over the last 10 years.

The Effect of Indian Inflation on money in India

Here is the part that most NRIs aren’t aware of. They earn their money in US dollars (as UAE dirham is pegged to the dollar). That means that their money in dollars is linked to a 3% inflation rate. If they send money to India and convert it to Indian Rupees, it is now exposed to Indian inflation rates of 8-9%.

The image below shows the effect of both inflation rates on the buying power of their money in each currency.

Historic inflation in India

Explanation

Assume you had US $100,000 (or equivalent in UAE dirhams) in your bank in the UAE. Also assume that you had the equivalent amount in Indian rupees in your bank in India (i.e. INR 63.35 Lakhs) at today’s exchange rate.

Rule of 72

The mathematical ‘Rule of 72’ illustrated on the above states that you can divide 72  by the relevant inflation rate to calculate when your expenses will double.

By that logic, living expenses in India double every 8 years, while living expenses in the UAE, exposed to 3% inflation double every 24 years.

This also means that your INR in India will halve in buying power by the year 2023, while your US $100,000 in the UAE will halve in buying power by 2039.

Which currency do you think you should keep your money in?
The currency that loses buying power 3% p.a or the currency that loses buying power at 9% p.a.?

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What if I told you
Money Basics

How banks create money

Did you know that by keeping your money in the bank, you are contributing to your own inflation?

It doesn’t matter if we are not in the U.S. Our currency is pegged to the dollar and for that reason alone, we are affected by the monetary policies of the United States of America. Moreover the way money is created in the U.S.A., is pretty much the same in other countries worldwide and the U.A.E. as well.

“I am afraid that the ordinary citizen will not like to be told that banks can and do create money …
And they who control the credit of the nation, direct the policy of Governments, and hold in the hollow of their hands the destiny of the people”. - (MCKENNA, Reginald) Past Chairman of the Board, Midlands Bank of England

Let’s imagine that a new bank has just started up and has no depositors yet. Investors have paid for the bank’s infrastructure and have supplied it with sufficient cash to meet the demand for cash withdrawals.

Typically, cash in the vault will amount to no more than one dollar for every 20 or 30 dollars that could be demanded from the bank. The bank has joined the central bank system, which permits the new bank to borrow cash from the central bank if it’s needed.

What if I told you

The doors open and the new bank welcomes its first loan customer. The customer needs $10,000 to buy a car. On approval, the bank creates an account for the borrower and types in that the borrower owes the bank $10,000. This $10,000 is not taken from anywhere.

It is created on the spot. The borrower does not take this money out in cash. Instead he writes a check on his account to buy the car. The seller then deposits this newly created $10,000 check at her bank. At a ratio of 9:1, this new $10,000 deposit allows the seller’s bank to create a new loan of $9,000. If a third party then deposits that $9,000 in another bank, it becomes the legal basis for a third issue of bank credit, this time for the amount of $8,100.

Like one of those Russian dolls, each layer of which contains a smaller doll inside, each new deposit contains the potential for a slightly smaller loan in a decreasing series.

Now, at any stage, if the money created is taken in cash and not deposited at a bank, the process stops. That’s the unpredictable part of the money creation mechanism.

But more likely, at every step, the new bank credit money will be deposited at a bank, and the reserve ratio process can repeat itself over and over until almost $100,000 of brand new bank credit money has been created within the banking system.

All of this new money has been created entirely from debt, and all transactions have been carried out with bank credit. None of the banks involved have needed to use any of the cash in their vaults.

“Thus, our national circulating medium is now at the mercy of loan transactions of banks, which lend, not money, but promises to supply money they do not possess.” (FISHER, Irving, 1922), Economist and Author.

What’s more, under this ingenious system, the books of each bank in the chain must show that the bank has 10% more on deposit than it has out on loan. This gives banks a very real incentive to seek deposits to be able to make loans, supporting the general but misleading impression that loans come out of deposits.

Now, it can’t be said that any one bank got to multiply the initial $10,000 of bank credit into $100,000 of bank credit. However, the banking system is a closed loop. Bank credit created at one bank becomes a deposit in another, and so on and so on.

In a theoretical world of perfectly equal exchanges, the banks would owe each other nothing at the end of the day, and the $10,000 created out of thin air as a loan by the first bank could indeed become almost $100,000 of new loan money in the banking system.

If that sounds ridiculous, try this. Actual reserve ratios can be much higher than 9:1. For some types of accounts, twenty to one and thirty-three to one ratios are common. There are also many exceptions where NO reserve requirements apply at all!

So…while the rules are complex the common sense reality is actually quite simple.

Banks can create as much money as we can borrow. Despite the endlessly presented mint footage, government-created money typically accounts for less than 5% of the money in circulation. Someone signing a pledge of indebtedness to a bank today created more than 95% of all money in existence. (GRIGNON, Paul, 2002)

What’s more, this bank credit money is being created and destroyed in huge amounts every day, as new loans are made and old ones repaid. Banks can only practice this money system with the active cooperation of government.

  • First, governments pass legal tender laws to make the use of national fiat currency mandatory.
  • Secondly, governments allow private bank credit to be paid out in this government currency.
  • Thirdly, government courts enforce debts as payable in this currency.
  • And lastly, governments pass regulations to protect the money system’s functionality and credibility with the public while doing nothing to inform the public about where money really comes from.

The Simple Truth

The simple truth is that, when we sign on the dotted line for a so-called loan or mortgage, our signed pledge of payment, backed by the assets we pledge to forfeit should we fail to pay, is the only thing of real value involved in the transaction.

To anyone who believes that the banks will honor their pledge, and that their loan agreement or mortgage is now a portable, exchangeable and saleable piece of paper, needs to think again. It’s an IOU. It represents value and it is therefore a form of money. This money the borrower exchanges for the bank’s so-called loan.

Now a loan in the real world means that the lender must have something to lend. If you need a hammer, my loaning you a promise to provide a hammer I don’t have, won’t be of much help. But in the artificial world of money, a bank is allowed to pass off its promise to pay money it doesn’t have, as money and we accept it as such.

Once the borrower signs the pledge of debt, the bank then balances the transaction by creating, with a few keystrokes on a computer, a matching debt of the bank to the borrower. From the borrower’s point of view this becomes “loan money” in his or her account, and because the government allows this debt of the bank to the borrower to be converted to government fiat currency, everyone has to accept it as money.

Again the basic truth is very simple. Without the document the borrower signed, the banker would have nothing to lend!
Have you ever wondered how everyone…governments, corporations, small businesses, families can all be in debt at the same time and for such astronomical amounts?

  1. Have you ever questioned how there can be that much money out there to lend? Now you know. There isn’t.
  2. Banks do not lend money. They simply create it from debt. 
  3. Since debt is potentially unlimited, so is the supply of money.
“If all the bank loans were paid, no one could have a bank deposit, and there would not be a dollar of coin or currency in circulation. This is a staggering thought. We are completely dependent on the commercial banks. Someone has to borrow every dollar we have in circulation, cash, or credit. 
If the banks create ample synthetic money we are prosperous; if not, we starve. We are absolutely without a permanent money system. When one gets a complete grasp of the picture, the tragic absurdity of our hopeless situation is almost incredible — but there it is.” (HEMPHILL, Robert, 1935), Credit Manager, Federal Reserve Bank, Atlanta.
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Money Basics

Money as Debt

Introduction

This topic is very important, and central to the theme of ‘Investing’. To understand the concept of ‘Money as Debt’, one needs to understand how the ‘International Fractional Reserve Banking System’ works.

The history of the Federal Reserve System in the US is also important to understand how the world economies work. The central banks of most countries follow very similar fractional banking systems that are governed by the Bank of International Settlements (BIS). The top bankers in the world run the BIS. Thus their fates are tied to the fate of the US dollar and the US economy.

“Each and every time a bank makes a loan (or purchases securities); new bank credit is created — new deposits — brand new money.”
(WALTERS, Graham F, 1939), Director, Bank of Canada

Over the years, the fractional reserve banking system and its integrated network of banks backed by a central bank has become the dominant money system of the world. At the same time, the fraction of gold backing the debt money has steadily shrunk to nothing.

Money used to represent VALUE – Money now represents DEBT

The basic nature of money has changed.

In the past, a paper dollar was actually a receipt that could be redeemed for a fixed weight of gold or silver. In the present, a paper or digital dollar can only be redeemed for another paper or digital dollar.

In the past, privately created bank credit existed only in the form of private banknotes, which people had the choice to refuse just as we have the choice to refuse someone’s private check today. In the present, privately created bank credit is legally convertible to government issued “fiat” currency, the dollars, the loonies (Canadian dollars) and the pounds we habitually think of as money. Fiat currency is money created by government fiat, or decree, and legal tender laws declare that citizens must accept this fiat money as payment for debt or else the courts will not enforce the obligation.

So, now the question is… If governments and banks can both just create money, then how much money exists?

In the past, the total amount of money in existence was limited to the actual physical quantities of whatever commodity was in use as money. For example, in order for new gold or silver money to be created, more gold or silver had to be found and dug out of the ground.

In the present, money is literally created as debt. New money is created whenever anyone takes a loan from a bank. As a result, the total amount of money that can be created has only one real limit – the total level of debt.

“The process by which banks create money is so simple the mind is repelled.”
(GALBRAITH, John Kenneth, 1975), Economist

Governments place an additional statutory limit on the creation of new money, by enforcing rules known as fractional reserve requirements. Essentially arbitrary, fractional reserve requirements vary from country to country and from time to time. In the past, it was common to require banks to have at least one dollar’s worth of real gold in the vault to back 10 dollars worth of debt money created.

Today, reserve requirement ratios no longer apply to the ratio of new money to gold on deposit, but merely to the ratio of new debt money to existing debt money on deposit in the bank. Today, a bank’s reserves consists of three things: the amount of government-issued cash that the bank has in its vault, the amount of credit it has with the central bank, and the amount of already existing debt money the bank has on deposit.

“Permit me to issue and control the money of a nation, and I care not who makes its laws.”
(ROTHSCHILD, Mayer Amschel), International Banker

Previous – How The Monetary System Works

Next – How Banks Create Money

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Investing on Savings Bonds
Money Basics

How the Monetary System Works

One of the most commonly asked questions to me is ‘How does the monetary system Work’. To understand this concept let’s look at the differences between ‘Wealth’, ‘Cash’, and “Money’. As simple as it may sound, people do not know the basic differences between these three terms.

Investing on Savings BondsWhat is Wealth?

‘Wealth’ is measured in ‘time’ or the number of months you can maintain your current lifestyle before you run out of money.

So, if your monthly expenses are $5,000 and your bank balance is $50,000, you are wealthy for 10 months.

What is Cash?

This question may sound silly, but most people equate money with cash. Cash is just the physical money you have in your wallet or at home. Money in the bank is not cash.

Money that is physically not in your possession is not Cash.

What is Money?

Now I am going to challenge your definition of money. If there is one idea you can take away by reading this post, I really hope it is this one. Think about it for a moment, if ‘cash’ is money in your possession, what is that stuff in the bank?

Money in the bank is ‘Debt’

How? If you want proof, ask your banker. Bankers call customers deposits in their bank accounts ‘Liabilities’. This means ‘they are legally bound to pay you back your money in your account as ‘Cash’, should you wish to withdraw it.

Next – ‘Money as Debt’

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