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"The Creature from Jekyll Island, A Second Look at the Federal Reserve" by G. Edward Griffin. is a great book.

But for something more up to date, see Special Privilege on Amazon.com

Here's the introduction for a taste of how it explains the monetary system in simple terms

INTRODUCTION

Tick, Tock...Tick, Tock

“The study of money, above all other fields in eco-nomics, is one in which complexity is used to disguise truth or to evade truth, not to reveal it.”

-John Kenneth Galbraith, 1975

Unless the United States of America substantially restructures its monetary system, a financial collapse of mammoth proportions is both foreseeable and inevitable. When this collapse will occur is im-possible to predict. Why it will occur, however, is already abun-dantly clear. It can be summarized in two simple words: Special Privilege. The nature and implications of these special privileges are summarized later in this introduction and explored throughout the book. Special Privilege puts forth the following proposition: politi-cians grant special privileges to the monetary elite (bankers, central bankers, and, by proxy, their favored borrowers). These special privileges offend the very essence of both democracy and free enter-prise. Furthermore, while these special privileges virtually guarantee a future monetary collapse, they temporarily put-off the timing of that collapse. The proposition that only substantial reform can save us from dire financial consequences (the seeds of which have already been sown) admittedly requires significant evidence and support. Special Privilege will provide it. The proposition that immoral, unfair, and unwarranted special privileges exist and are antithetical to every-thing we believe in, requires nothing more than recognizing what undeniably does exist and pursuing the rather straight-forward im-plications thereof (currently, not 1 person in 100 has such knowl-edge---yet, virtually all will grasp it, upon reflection).

Special Privilege should appeal to a broad spectrum of con-cerned Americans---including those not normally drawn to financial books. It is, particularly, for those who want to educate themselves on important issues that are not widely understood or discussed; for those who already sense that something is wrong but want to pin-point exactly what it is; for those who are not certain whether any-thing is wrong, but who are willing to suspend final judgment until they have read and evaluated a well thought out point of view.

THE NARCOTICS ANALOGY

The United States financial system can be instructively com-pared to a patient who is dying from narcotics addiction. One form of treatment is to provide larger and larger quantities of the narcotic. Under these conditions, the patient will temporarily function better but will face death or an even more painful cure in the future. Alter-natively, the patient can kick the habit, cold turkey----knowing that the withdrawal may be long and require painful adjustments and re-assessments. Many people, including the most powerful and influen-tial, receive substantial benefits from the “patient” in his current ad-dicted state. They recognize that the ill effects of increased addiction will not be felt until some undefined time in the future and that they will be forced to forego special privileges and/or benefits of contin-ued addiction during the cure period. Under these conditions, these people favor a liberal, ultimately destructive, continued flow of nar-cotics.

In our financial system, the narcotic is money, and our banking system is the mechanism by which it is created and distributed. Spe-cial Privilege focuses on the perversions to our society that emanate from a fundamentally flawed banking infra-structure; flawed logic that equates money to wealth; and the flawed conclusion that confi-dence in the system is an end in itself, regardless of any rational ba-sis for it.

Special Privilege presents a point of view that is irreverent to-ward current institutions. Both common sense logic and simple jus-tice dictate that we substantially reform these institutions. Further-more, the time to act is now. Festering root causes have been totally ignored for too long. So far, we have watched passively as the sys-tem deteriorates. Now even reforms that address core issues will re-quire significant dislocations in redefining institutions and policies.

Those who are complacently satisfied with the status quo may prefer to deny realities. Others who are blinded by the temporary nourishment they receive from the current system may be unaware that their actions are destroying it. Still others who recognize the situation for what it is may be content to enjoy the party while it lasts and to extend the curfew as late into the night as possible. Fi-nally, those who are closest to the money-creation process have a vested interest in keeping things as they are for as long as they can. However, they will also be among the very first to know exactly when to bail out---leaving the rest of us “holding the bag.”

THE HEART OF THE PROBLEM

The sales pitch of a bank boils down to this: “Bring us your money and we will pay you 5% annual interest for the right to use it. We can do this because we will lend it to borrowers at 10% annual interest. But any time you should want your money back, we will give it back to you, on demand, with accrued interest.”

This is a misrepresentation. As soon as a bank makes such loans, it can no longer fulfill its stated obligation to return deposi-tor’s money on demand. Money that is out on loan, quite simply, is not available to be paid back to depositors on demand. No degree of added complexity can negate this simple fact. Sophisticated deposi-tors realize that the money is not in the bank, yet they expect it to be there, if, and when, they wish to take it out. These expectations are, of course, self-contradictory. People accept this obviously unsound logic because they have been conditioned not to think about it. The Federal Reserve (“Fed“) and the Federal Deposit Insurance Corpora-tion (“FDIC“) have made it unnecessary for them to have to think about it.

The above paragraphs make multiple references to “money.” As important as money is, however, few people have a well-conceived, proper understanding of exactly what it is. Many people, for example, believe that the government issues our money. The truth, however, is that paper money is issued by the Fed, which is a private corporation (albeit, one that was theoretically incorporated to fulfill a public purpose). Originally, it was limited by the amount of gold in its vaults. Today, it can create (or destroy) as much money as it chooses, acting in secret, without restriction, and unaccountable to the American people. The second major component of our money supply consists of bank deposits (checking, savings, etc.), which are liabilities that banks create against themselves, limited only by their reserves at the Fed.

In other words, all money in our society is “issued” by private corporations as liabilities against themselves. It is the debt of the issuing organization. Money is debt. Unfortunately, many otherwise knowledgeable people are either unaware of this fact or are oblivi-ous to its dire implications. One such implication is the self-perpetuating cycle: if money is created out of thin air and (mostly) lent out at interest, there will not be enough to repay all those debts unless still more is created out of thin air and lent out at interest!

Until the 20th century, money was generally not “issued” by anyone. It actually existed in physical form. It was valuable, in and of itself, and not subject to whimsical, arbitrary issuance by fiat. It did not derive its value from the creditworthiness of an issuer. Paper money, in those days, was viewed, essentially, as nothing more than a “warehouse receipt” for real money (typically, gold). Fiat money that the Fed creates without limit, together with the checkbook money that the banking system pyramids on top of this fiat money, is the heart of the problem. Indeed, the money-creating special privi-lege, alone (if not revoked or restricted), guarantees the future sce-nario this book predicts. The only open question is “when.” In the aftermath of the bank failures in the early 1930s, a vocal minority of respected academicians, including Irving Fisher of Yale and Frank Graham of Princeton, argued in favor of 100% reserve banking and/or similar reforms. Such reforms would have removed the important money-creating ability from banks and moved us in the right direction. Unfortunately, special interests seeking to main-tain special privileges prevailed over these voices of reason. Simply put, the Fischer and Graham suggestions would have required that all demand deposits (checkbook money) be physically kept in the bank and not lent out. Today, however, banks are fractional reserve banks. They use a large portion of demand deposits to make loans; and no matter how one looks at it or how much one tries to compli-cate it, fractional reserve banks inspire us to have confidence in something that we must know, deep down inside, is absolutely un-deserving of confidence! Why do people accept such casual treat-ment of the most cherished of all commodities? Imagine, for exam-ple, this same process with regard to something as plentiful as water. Even then, depositors of water would have a natural tendency to want to know what the water borrowers are doing with it. Using the example above, everyone would realize that at the end of the proc-ess, if there were not at least 5% more water on hand than had been deposited, the depositors would be dissatisfied; and if there were not at least 10% more water than had been lent out, the bank would be dissatisfied.

That fractional reserve banks create and distribute money be-comes clear upon basic analysis. If, for example, a depositor makes a $1,000 deposit in a bank by opening up a checking account, that $1,000 is part of the money supply. It is a medium of exchange that is immediately exchangeable in some quantity for any other good or service in the economy. When the bank lends, say, $800 to a bor-rower, that $800 also becomes part of the money supply. The origi-nal depositors’ money, being available to him on demand, never ceased to be part of the money supply just because loans were made. Therefore, the loan has increased the money supply from $1,000 to $1,800. A fractional reserve bank, by virtue of merely making loans, increases the money supply. As John Kenneth Galbraith puts it, “the process by which banks create money is so simple that the mind is repelled. Where something so important is involved, a deeper mys-tery seems only decent.”

Actually, those who benefit from the system at everyone else’s expense do go to great lengths to mystify the process. Early 21st cen-tury man is woefully uninformed about money and how it is created. Most think that the government creates our money. Ironically, peo-ple of the 19th century were far more knowledgeable. They were understandably distrustful of the money-creating activities of banks. In any event, is it possible that such institutions as the Fed and FDIC have, somehow, changed things? If so, is the change good, bad, or very bad?

THE LENDER OF LAST RESORT

The Fed was instituted as a lender of last resort in 1913. Its primary, original function was to provide liquidity to the system whenever it was needed. Providing liquidity may be thought of as creating bank money (reserves). During very troubled times, this newly created bank money may be used to meet depositor demands for currency. At all other times, it is used to make loans, which cre-ates debt and creates money. Current wisdom argues that the Fed should virtually always provide liquidity to the system. Such reliable indicators of specula-tive excess as volatile financial markets, highly leveraged organiza-tional structures, unstable currency relationships, complicated de-rivative products, frequent taxpayer bailouts, and other indicators of “irrational exuberance” argue in favor of caution. All too often, however, when caution is indicated, it is pushed to the side in pur-suit of the big buck. History demonstrates that such behavior merely forestalls rather than avoids having to pay the price. To use a medi-cal analogy, giving plasma to an anemic person will increase circu-lation, but it will not increase the all-important oxygen-carrying red blood cells that are required.

The evidence suggests that providing more debt (money crea-tion) in a speculative environment adds fuel to a fire that is already out of control. People have been conditioned to the view, however, that pumping more money into the system can solve all problems. Hardly anyone ever argues for less liquidity, higher interest rates, or debt contraction. Whenever trouble brews, a chorus of voices be-seeches the Fed to ease, to accommodate, or to liquefy. “Ease,” “ac-commodate,” and “liquefy” are roughly equivalent terms. Each characterizes a set of policies whereby the Fed makes it easier for banks to lend. Often, people call for such a policy when the econ-omy is suffering from strains of overextension. The policy says, in effect,

“Ignore the realities of overextension by overex-tending even further; rescue us from the natural ad-verse effects of past over-indulgences by giving us another needle in the arm.”

The Fed, playing its (pretended) role of tough taskmaster to the hilt, often refuses to budge until some other supposedly directly re-lated problem is resolved. From this, the Fed may (incorrectly) ap-pear to be delicately balancing its options to either restrain or ex-pand the money supply. For example, the Fed will refuse to ease un-til Congress passes a “responsible” budget or until it is satisfied that inflation is in check. This, presumably, qualifies as restraint. If the budget has “only” a $150 billion deficit or if inflation is “only” 3%, this is not likely to be a bona fide reason to celebrate.

In any event, once a budget is finally passed, and in the ab-sence of any other supposedly related issues to be resolved, the Fed submits. What a perfect way to instill confidence. After all, the Fed did not cave in for weeks to those urging earlier easing. Now that the budget crisis has supposedly been effectively resolved, however, even the intransigent Fed recognizes the benefits of more debt. This charade is part of an approach that has been going on since 1940 or so. The name of the game is to inflate problems away. And the Fed, together with the banking system, in general, is the engine of that inflation.

THEN AND NOW

It may come as a surprise to the casual observer under the age of 60 that inflation is not a natural and necessary phenomenon. After all, throughout that observer’s lifetime he has known nothing else. He would probably be very surprised by the following fact: the pur-chasing power of a dollar in 1937 was roughly equal to the purchas-ing power of a dollar in 1802. Furthermore, throughout all the inter-vening years, the purchasing power swung back and forth---never rising above $1.75 and never falling below $.70. By 1960, that dol-lar was worth $.50, in 1937 terms; by 1976, it was worth $.25; in 1991, it was worth $.10; now, it is worth about $.08.

Until the mid 1970s, inflation was seemingly beneficial to the average homeowner. From roughly 1945 through 1975, the common man had the opportunity to borrow money for 30 years at a fixed low rate to buy a home. Under continuing and growing inflationary conditions, the value of his home went up at a rate that exceeded the interest rate he was paying. And all this time, commercial banks were making loans to productive enterprises. All in all, it was a prosperous, vital, growing America.

If a 20-year old skilled worker had only known in 1946 how the next 55 years would unfold, he would now be a 75-year-old multi-millionaire. All he had to do was work his trade and continu-ally buy a bigger and bigger house every five years or so (each time taking the largest mortgage his circumstances and the bank would allow). If he was, then, smart enough to sell that house around 1987, invest the proceeds in the stock market, and rent whatever lavish home he could, this person would now be living, very comfortably, in the lap of luxury. It has been widely acknowledged that buying a house during this period was among the best investments a person could make. But this observation misses the point. The goodness of the investment had less to do with real estate, per se, than it had to do with the ability to borrow money on a long-term basis, at fixed low rates during a period of inflation. Had our hypothetical 20-year-old skilled worker been offered similar financing terms to buy col-lector comic books, he would have also achieved millionaire status.

The scene has changed dramatically over the last 25 years. Banks no longer make loans primarily to productive enterprises. In-stead, from 1974 through 1982, roughly 50% of all money-center bank loans were made to lesser-developed countries (LDCs). When the folly of these loans became apparent, funds poured into other speculative enterprises. These included adventuresome loans for speculative (or fraudulent) oil and gas projects, speculative (or fraudulent) securities speculators, leveraged corporate buyouts fi-nanced with junk bonds, opportunistic real estate developers, highly leveraged hedge funds, and “fad” loans to whatever corner of the world happens to be deemed the next “hot spot.” During the 1980s and early 1990s one well known, high flyer---Donald Trump---was engaged, among other things, in building monuments to himself in both New York City and Atlantic City. Ironically, in the early 1990s during the height of Trump‘s own financial troubles, an electronic billboard at the entrance of his Taj Mahal casino in Atlantic City issued the following sage advice: “Bet with your head, not over it.” Could the banks have been unaware that lending one man billions of dollars for risky elaborate real estate schemes was a risky business, or didn’t they care? Actually, it was a little of both. Conspicuously absent in the orgy of bank speculation of the last 25 years, in any event, were good old-fashioned loans supporting productive enter-prise.

BANK “PROFITABILITY”

Once upon a time, the capitalist system’s central virtue was that it rewarded productivity. Those who produced value received value in return; those who produced very little received very little in return. Within that commendably moral framework, our limited re-sources were always efficiently allocated to the most productive available enterprises. All of this happened quite naturally. Everyone, wanting to receive as much as he could, produced as much as he could. Such was the way things were when productivity and profit-ability were compatible concepts. Over the last 20 years, most particularly with regard to bank-ing, “profitability” has become little more than sleight-of-hand ac-counting gimmickry. For example, if a bankrupt borrower is written-off by the bank, the bank’s accounting profit is diminished (as, of course, it should be). But, if the bank chooses to lend more at higher and higher interest rates to the same bankrupt borrower, the bank’s accounting profit is increased. What can be more perverse than this? The bank actually has a vested interest in not acknowledging a bad loan; and the only way to not acknowledge it is to make an even bigger loan to the bankrupt borrower. In this way, the bankrupt bor-rower can pay interest on the old loan and the bank can “book” prof-its rather than take losses writing off the bad loans. Reality is thus defined as whatever the banker chooses to recognize as reality. But, undoubtedly, somewhere beneath the recognized reality, there lurks a real reality with which we will have to reckon. Due to the level of reality denial over the past two decades, that day of reckoning may not be too far off.

This insane situation is truly mind-boggling. Aren’t regulators, examiners, and independent accountants supposed to see that this doesn’t happen? More often than not, these supposedly independent sources of assurance are nothing more than handmaidens to the bankers. In most cases, the latest audited financial statement of a recently failed bank bears little relation to the actual situation. How this can happen is best answered with the following rhetorical ques-tion:

“What possible motive can an independent auditor have for seeing things the way his client wants him to see things ---unless, of course, you consider the multi-million dollar annual audit fee?”

FDIC

In the 1930-33 period, several waves of bank runs and bank failures, together with a weakened economy, led to further govern-ment policies whose perverse effects are being felt to this day. One of the worst of these is the concept of federal deposit insurance. The most perverse element of deposit insurance is that it eliminates the very basis for investment decision-making. Investment should be made, first, where there is the least risk at a given rate of return. If there are alternative investments, each with the expectations of earn-ing 5%, money should flow (first, if at all) into the one perceived to be the safest.

With regard to our banking system, however, federal deposit insurance tells a would-be depositor that, from his standpoint, he should view all banks as equally risky since any risk that does exist will be borne by the government. Even if this were the only perversion brought about by feder-ally insured deposits, it would lead, inexorably, to a gross ineffi-ciency in the allocation of scarce resources. At some point, in the absence of regulations to the contrary, astute bankers will reason that by offering 6% to depositors while other banks are offering 5%, they can get most of the money flowing into their bank. With feder-ally insured deposits, the depositors can’t go wrong by putting the money in the 6% bank. From the depositor’s individual perspective, of course, this is, absolutely, the right thing to do. But what does it do to the system?

Generally, no one bothers to ask this pertinent question. For one thing, it virtually guarantees that money will flow to the banks that offer the highest return. And which ones might that be? At first, they will “only” be the most speculative banks. They are willing to pay high rates because they charge still higher rates to speculative borrowers. That unleashes negative forces that ripple through the entire system. But it gets worse--- much worse. How much insight does it take to recognize that an outright fraudulent banking element will be right behind the speculative element? His-torically, it has happened time and time again.

Investment, in a less speculative environment, takes place when there are reasonable assurances that productive gain will re-sult. Debt capital, under such conditions, seeks not only assurances, but guarantees. Fraud in such a setting is easily detected. As invest-ment becomes more speculative, there is a hope (not assurances or guarantees) that productive gain will result. A fertile breeding ground for fraud is thus established. Fraud flourishes in an atmos-phere where victims can be told with feigned sorrow, “Gee, we were hoping that this would all work out; but, as you know, in life there are no guarantees.” From a banker’s perspective, reduced require-ments for investment justification invite fraud. Fraudulent loans be-come the most convenient way to rip off a decaying system. By the late 1980s and early 1990s, the evidence grew larger with the arrival of each morning’s paper that the fraudulent element had appeared, in full force, during the prior decade. In 1980, the rise in federal de-posit insurance coverage from $40,000 to $100,000 per account in-dicated, in effect, that the system was promoting a government-insured pyramid scheme. While the banks were assessed for their participation in FDIC coverage, there was, initially, no attempt at all to equate risk to level of assessment. Most importantly, there was never a question that the federal government (i.e., the ordinary tax-payer) stood behind this coverage. The soundness of the system was no longer a real concern. All that mattered is that the Fed would res-cue money-center banks and the FDIC would rescue depositors. The message to bankers was clear:

“Throw all caution to the wind. Offer whatever in-terest rate you must to attract funds into the bank. There will always be plenty of borrowers at higher interest rates under the prevailing mood. And, if not, your friends, relatives, and partners are ready to take a shot.”

AT THE CROSSROADS

Such is the nature of the current state of affairs. Real issues have been ignored and hidden while we become more and more creative (and dangerous) in our ability to deal with symptoms and our ability to banish negative effects by legislating and inflating them away. During the coming major financial crisis, everyone will become acutely aware of, and alarmed about, the state of our finan-cial infrastructure. People will be forced to confront the fact that our system has severe problems. This book will have already explained where the real problems lie. The title begins to tell the tale: Special Privilege. If history is any guide, highly respected, powerful people who control our monetary system will put forth alternatives that do not remove their special privilege. They may deal, perhaps, with some of the worst excesses of the present system, but they will op-pose the real, enduring solutions that a democratic, free enterprise society requires: removal of the special privileges enjoyed by a very small minority of 100,000 or so while the remaining 289 million of us are forced to accept the adverse consequences of these privileges. Without books like Special Privilege, there is virtually zero chance that appropriate solutions will be reached.

There is, of course, no question that real solutions will require substantial education and even re-education of those who are, essen-tially, complacent victims of the current system. Appropriate reform will require a groundswell of popular opinion that recognizes the immorality, unsoundness, and dangers of continuing on the current path. Maybe nothing will happen until the inherent weaknesses of the system become much more obvious. In that case, in the interim, the establishment will merely promote non-solutions that temporar-ily cover up the cracks in the decaying infrastructure. Once these cracks are sufficiently covered up, they will immediately begin to widen under the surface until the next crisis uncovers them again. The ultimate crisis will occur when the situation is so thoroughly perverted that the defenders of the status quo can no longer resurrect confidence in the system. Throughout this book we explore the special privileges that politicians bestow upon bankers. Taken together, they are the root cause of the problems that exist within the monetary system and will ultimately cause it to collapse. They fall into six broad categories:

1. Money creation 2. Asset protection (discount privilege at the Fed) 3. Liability protection (FDIC coverage) 4. Rescue missions (bailouts and the like) 5. Accounting irregularities 6. Secrecy rules

This introduction has briefly touched upon some of these categories. The following pages describe each of them in greater detail, and the final chapter provides a concise summary. The List of Additional Resources presents a list of other resources that contain useful information about one or more of the special privileges discussed enumerated above and discussed throughout this book.

At times, some of the material might be somewhat challenging to one who is taking a first serious look into this area. However, much of the mystery arises only because of the purposeful misdirec-tion of those who would keep you in the dark about these issues. No less an authority than John Kenneth Galbraith explained it well in his 1975 classic entitled, Money: Whence It Came; Where It Went. He wrote:

“Much discussion of money involves a heavy over-lay of priestly incantation. Some of this is deliberate. Those who talk of money and teach about it and make their living by it gain prestige, esteem, and pecuniary return, as does a doctor or a witch doctor, from cul-tivating the belief that they are in privileged associa-tion with the occult---that they have insights that are nowise available to the ordinary person. Though pro-fessionally rewarding and personally profitable, this too is a well-established form of fraud. There is noth-ing about money that cannot be understood by the person of reasonable curiosity, diligence and intelli-gence. There is nothing on the following pages that cannot be so understood. And whatever error of in-terpretation or of fact this history may contain, there are, the reader may be confident, none that proceed from simplification. The study of money, above all other fields in economics, is one in which complexity is used to disguise truth or to evade truth, not to re-veal it.”

Going one step beyond Mr. Galbraith‘s accurate assessment: you can virtually count on various self-serving vested interests tell-ing you why the conclusions you have reached about money and banking are wrong. Don’t listen to them: instead, follow your own heart and your own mind. These self-appointed experts will try to explain to you--- the supposedly “unsophisticated”---why there is nothing to worry about and nothing to fix. They will tell you that the conditions that have unerringly produced financial collapses in the past are now well understood and under their control. Don’t believe them until you have at least looked at the evidence yourself. The is-sues are not nearly as complex as these people would have you be-lieve. A new enlightened majority that recognizes the nature and scope of the problem in our monetary and financial system must seek real solutions to the root causes.

As other powerful constituencies (e.g. multi-national corpora-tions) begin to recognize that the financial elite’s activities adversely affect their own control of their own destinies, they will, hopefully, enlist in the reform effort. Chapter 6 discusses some of the ill effects that inter-currency volatility and derivative transactions can have on multi-national corporations. Since financial elites maintain their lofty position solely through the exercise of totally unnecessary spe-cial privileges, at some point, people and corporations will, pre-sumably, step forward to object. After all, special privilege violates the basic tenets of a democratic, free enterprise society. To allow the current system and its institutions to continue is as immoral as it is dangerous. Furthermore, time is running out. There is no reason to wait. Tick, tock...tick,tock.