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Monetary Intermediation Cost Background
The Federal Reserve System (Fed) controls the money stock of the American dollar ($) and supplies liquidity to a group of banks based on a fractional reserve deposit banking system. This site has analyzed the Fed and determined that its monetary intermediation cost is 90% inefficient (1 - deposit reserve requirement) and on the order of 2% of GDP per year that could be more efficiently handled by a full reserve credit banking system, development of depositor owned institutions to exclusively hold demand deposits and direct issuance of new money creation, known as Seigniorage, to the American people based on a GDP index monetary standard.

The analysis below will show that the fractional reserve deposit banking system currently in use has been confounded with true credit intermediation resulting in unearned wealth transfer to the fractional reserve lending source and that there would be no monetary or credit intermediation loss with conversion to a full reserve system, reducing and/or eliminating the current wealth transfer disparity caused by the fractional reserve system.

Increasing returns to fractional reserve credit intermediation as reserve requirement reduced is shown to come from labor and capital to maintain system value in accordance with the Modigliani-Miller Financial Theorem.


CHART 1 DATA SOURCE: Fractional Reserve Monetary Intermediation Cost Impact Chart. The chart above shows the impact of fractional reserve credit intermediation. As the deposit reserve requirement is reduced, progressively less real credit is lent and repayment becomes progressively more unearned wealth transfer until with a 0% reserve requirement, repayment is entirely wealth transfer to lender since nothing real was actually lent.


CHART 2 DATA SOURCE: Chart data extrapolated from sample loan using Fed's 10% reserve requirement to 100% full reserve requirement. Increasing return to fractional reserve credit intermediation as reserve requirement reduced comes from Capital (Tractor) and Labor (Farmer) since it is known from M&M Theorem that leverage does not change system value the increased financial intermediary return as reserve requirement reduced must come from other parts of the system to keep the same value.


CHART 3 DATA SOURCE: Business cycle with leverage and monetary intermediation cost added using Excel Sine wave graph. The chart above shows the impact of fractional reserve leverage, which adds risk to the system in the form of increased variability of returns but does not change returns to the system, shown above as increased amplitudes of the business cycle. The compounding monetary intermediation cost of a central bank is also shown gradually increasing in size that is actually a reduction to system returns.


CHART 4 DATA SOURCE: Business cycle with compounding monetary intermediation cost added using Excel Sine wave on negative parabola graph. The chart above shows the impact of the compounding monetary debt intermediation cost, which mis-allocates system resources to the money creation source and reduces economic growth at a progressively faster rate as the monetary debt compounds.

A banking business model based on full reserve credit intermediation, time matched funding spread lending, is not a new concept. It has had historical support from at least five previous Nobel Prize winners, Milton Friedman, 1976, James Tobin, 1981, Maurice Allais, 1988, Merton Miller, 1990 and Frederick Soddy, 1921, a former Secretary of Agriculture and Vice President of the United States, Henry Wallace, at least one prominent European central banker, Mervyn King, retiring governor of the Bank of England and numerous distinguished economists and financial writers including Irving Fisher, one of the foremost economists of the first half of the 20th Century.

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Federal Reserve Monetary Intermediation Cost

Federal Reserve Summary/Abstract
The attached Federal Reserve Monetary Intermediation Cost paper puts forth the proposition that the monetary intermediation cost of the Fed is at least 90% inefficient (1 - deposit reserve requirement) and is on the order of 2% of GDP per year, compounded over 51% since the 1984, that could be more efficiently handled by a full reserve credit banking system, development of 100% depositor owned institutions to exclusively hold demand deposits and direct issuance of new money creation, known as Seigniorage, to the American people based on a GDP index monetary standard. Conversion to a full reserve monetary system is expected to improve the American economy by the approximate amount of the reduced monetary intermediation cost, on the order of 2% of GDP per year, improve the balance sheet of the United States on the order of $8.5 trillion as of fiscal year 2012 and restore on the order of thirteen to fifteen million jobs as shown below.

CHART 5 DATA SOURCE: Fed Annual Monetary Intermediation Cost to Economy 1984 to 2012. The chart above shows the annual monetary intermediation cost of the Fed to the American economy that could be saved by replacing the Fed's fractional reserve system with a direct issue full reserve system.


CHART 6 DATA SOURCE: Direct Issuance and First Use (Seigniorage) Money Supply. The chart above shows the impact of the Fed creating debt based money faster than economic growth, transferring wealth from the other sectors of the American economy to the banking/financial sector by virtue of its first use and control of the new money created.


CHART 7 DATA SOURCE: Direct Issuance and First Use (Seigniorage) Money Supply. The chart above shows the impact of the Fed creating debt based money for its first use and control as a percentage of the M2M Money Stock faster than economic growth, transferring wealth from the other sectors of the American economy to the banking/financial sector by virtue of its first use and control of the new money created.


TABLE 1 DATA SOURCE: Federal Reserve Bank Monetary Intermediation Cost Impact on Economy and Jobs. The table above shows the expected impact of conversion to a direct issue full reserve monetary system for the American economy.

The complete PDF paper can be viewed and/or downloaded from the link below:
Federal Reserve Monetary Intermediation Cost. The version posted was last modified March 9, 2014.
(Adobe Acrobat Required)

About the Author William Haugen
I have a Masters degree in Finance from Carnegie Mellon University, Pittsburgh, PA in 1983 and a Bachelors degree in Business from the University of Washington, Seattle, WA in 1981. I live in Dallas, Texas. If you have comments or suggestions, please email me at whaugen@flash.net.



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Version 1.2 © 2011 William A. Haugen
Last Modified: March 9, 2014.
Origination date of page November 7, 2011.
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