The Creature from Jekyll Island - A Second Look at the Federal Reserve by G Edward Griffin 1 of 5
The "Mandrake mechanism"
Also known as the money multiplier effect, the Mandrake mechanism is a term coined by Griffin in this book. Mandrake the Magician was a comic strip character from the 1940s. He had the ability to magically create things and, when appropriate, make them disappear. Griffin's view is similar to many other gold-standard supporters' critique of the fractional-reserve banking system and the Federal Reserve in particular: that it makes money "magically" appear from nothing.
In Griffin's view, the "magical" quality of this mechanism is really just a simple mathematical limit. When banks loan money, they don't actually loan existing money. Rather, they allocate money to loan, but they are limited by how much money they can create. The law basically says that, for each dollar a bank has on hand in one of its savings accounts, it is allowed to create another 90 cents to give out as a loan. (The dollar from the savings account is still there, and can still be spent by the person who owns the savings account.) This loan is then spent, and the recipient puts it into another bank, and that bank can now loan 90 cents times 0.9 = 81 cents. This can be repeated many times (depending on the demand for loans) until it approaches its mathematical limit of 10 dollars.
For example, when the Federal Reserve holds on deposit 1 billion in marketable United States Treasury security then the banks in the banking system, public and private, and bound by U.S. financial law, are able to generate 10 billion in new debt over time.
Search (Google the term) the term: "how money is created"
How Banks Create Money
The money that banks create isn’t the paper money that bears the logo of the government-owned Bank of England. It’s the electronic money that flashes up on the screen when you check your balance at an ATM. Right now, this electronic money (bank deposits) makes up over 97% of all the money in the economy. Only 3% of money is still in that old-fashioned form of real cash that you can touch.
Banks can create money through the accounting they use when they make loans. The numbers that you see when you check your account balance are just accounting entries in the banks’ computers. These numbers are a ‘liability’ or IOU from your bank to you. But by using your debit card or internet banking, you can spend these IOUs as though they were the same as £10 notes. By creating these electronic IOUs, banks can effectively create a substitute for money.
Every new loan that a bank makes in this way creates new money. While this is often hard to believe the first time you hear it, it’s common knowledge to the people that manage the banking system. For example, Sir Mervyn King, the Governor of the Bank of England from 2003-2013, recently explained this point to a conference of businesspeople:
“When banks extend loans to their customers, they create money by crediting their customers’ accounts.”
Sir Mervyn King, Governor of the Bank of England 2003-2013 (Speech)
And Martin Wolf, who was a member of the Independent Commission on Banking, put it bluntly, saying in the Financial Times that ”the essence of the contemporary monetary system was the creation of money, out of nothing, by private banks’ often foolish lending” (Article).
By creating money in this way, banks have inflated the money supply at a rate of 11.5% a year over the last 40 years. This has pushed up the prices of houses and priced out an entire generation.
Of course, the flip-side to this creation of money is that with every new loan comes a new debt. This is the source of our mountain of personal debt – not money that had been prudently saved up by pensioners, but money that was created out of nothing by banks and lent to people who could not repay. Eventually the debt burden became too high, resulting in the wave of defaults that triggered the start of the financial crisis.