Understanding the monetary system

For some years now, the monetary system has been discussed more and more frequently. Among other things, the euro debt crisis, which has been going on for years, has contributed to this. More and more people seem to understand that the foundation of our economy is the monetary system.

Money system explained

This is exactly the question we also asked ourselves many years ago. After all, a foundation must support any structure built on it securely and for the long term. In this case, it is the entire financial and economic system and even the economic sciences build their theories on it. But if the foundation collapses, the rest of the system collapses as well. The consequences for the normal population would certainly be more than unpleasant.

The monetary system causes the hamster wheel in which 99 percent of the population is forced to run. A hamster wheel, which seems to turn for most “Ottonormalhamster” from day to day even faster and faster!

Exactly therefore it is so important to become aware of the inadequacies of the prevailing economic order. Only if one has understood the errors and confusions of the conceptualizations and “secret”, system-immanent processes, one can realize financial liberty really effectively. Otherwise, one may not even notice that one has merely changed the hamster wheel and still has to run after it.

The foundation money system stands on several pillars. They are all closely interrelated and mesh like gears. A mistake in the money system is strengthened therefore by the other cogwheels still!


The monetary system is all about money. This is exactly why it is so surprising that hardly anyone has any idea of what money exactly is, let alone how it is defined. For the explanation of the monetary system, however, this is fundamental!

The most important and most elementary task of money is its function as a medium of exchange. It provides for the simple exchange of goods and services. Only the invention of paper money has made it possible for us to exchange our services with each other in an uncomplicated way and even on a global scale and to trade. As a result, you can acquire products and services that you would otherwise have to go to great lengths to obtain. Just think of the lime from Brazil, the cell phone from Korea or the car from India.

But money can have many other properties. For example, it can serve as a means of speculation and a store of value, as well as a motivator, a means of measurement and a means of distributing social justice. This diversity of meaning leads to confusion and not infrequently has problematic consequences.


Another component of the monetary system is what is called money creation. It refers to the process of how money is created and multiplied. From the experience of study we know that this process is one of the most suppressed and best kept “secrets” of the etablieten economic science!

The Giralgeldschöpfung (actually Giralkreditschaffung and/or Giralkreditvergabe) of the commercial banks (# 2): Here the money is multiplied and transformed into claims on money.

The production of coin money is carried out by the national central banks , such as Deutsche Bundesbank (#3): Coin money, however, has only a very small share of the total money supply compared with paper money and giro money.


Interest (in a broader sense, this also includes any kind of yield), occupies a central position in the prevailing monetary system. It goes hand in hand with the money creation just mentioned. However, money creation ( = lending) against interest can also lead to major distortions in the financial system.

In addition, interest becomes compound interest when it accrues interest on itself. Mayer Amschel Rothschild once called this mechanism the eighth wonder of the world. It implies exponential growth of both monetary assets and debts.


The monetary and economic system mechanisms and processes have created over the centuries a system in which a few have come to enormous riches. This is shown by the recently published figure from “the economy of the 1%” by Oxfam. According to this, 62 people in the world own as much financial assets as the poorer half of humanity! For these people, the capital gains generated year after year are so large that they could not be spent in a lifetime.

On the other side the economic and money system provides just also for the fact that 99 percent of the people are made to hoarders. The biggest clou is that most of them do not even notice how they are forced into a hamster wheel.

Some also call the ruling system the money system fraud and already prophesy the money system downfall or collapse. We would not go so far. Nevertheless, there are some concrete dangers lurking in the monetary system, which everyone should know already for pure self-protection absolutely.


The so-called fractal or partial system of fractional reserve refers specifically to the creation of money on deposit by commercial banks. Namely, the fractional reserve system allows commercial banks to create fiat money.

However, sight deposits (or book money) are not real money. It is merely so-called claims on real money. Today, most of the “money” in circulation consists only of these claims.


Capitalism did not get its name by chance. Rather, it expresses that capital – that is, money – is the substantial component within our economic system. Every student of economics eventually gets it drilled into his head that (money) profit maximization should be the most important maxim. Only in a second or third step does the welfare of people or the environment play a role.

That money is the most important good seems to be a basic fact. The explanation is relatively simple. Money is always superior to goods (and services). Through the already mentioned multiple properties, it is the universal tool to appropriate all goods and services and not least (financial) freedom.


We were also highly intrigued by the question of whether central banks are really what they officially embody. Independent and governmental institutions that have taken on money creation and money supply management for the benefit of the people. After all, how can a monetary system be fair on balance if it did not meet these basic requirements?

In our research, we came across numerous – supposedly government-owned – central banks that, on closer inspection, instead appear to be private. The best-known example is the Fed (Federal Reserve) in the USA. But also the Italian central bank (and many others) are rather private institutions (you can even read that in Wikipedia!).

But if central banks partly pursue private goals, they can no longer act 100 percent independently and in the interest of the state (= the people). In our book “Day by day in the hamster wheel” we have examined this fact in detail.


The accumulation of interest through the compound interest mechanism, already mentioned, is the main reason why the rich are getting richer. This small layer of rich and super-rich cannot in itself do anything about the fact that their bank account grows daily – after all, most of them have not worked for a long time!

This is the basis for the Monopoly system, the hamster wheel, in which the majority is caught. In addition, unchecked growing wealth and debt fuel the economy’s compulsion to grow. That this cannot mean anything good for the already weakened environment should be clear to everyone.


So as long as nothing is changed in this, the ruling system, economic crises will repeat themselves in similar patterns again and again. In the end, this can even lead to the downfall of the monetary system.

This is accompanied by ever increasing environmental destruction and the increasing consumption of finite, non-renewable raw materials. Public health is also directly related to our monetary system. Rising rates of burnout and depression show how the pressure to perform in the hamster wheel continues to intensify. In addition, the increasing division of labor and ever more complex production structures are increasingly distancing humans from their natural core.


Most people find themselves trapped in a hamster wheel with little way to escape it. Too many liabilities have accumulated and too little support is received from the system.

Because one thing is certain. We are certainly not here to spend the majority of our lives doing something we don’t enjoy. The opposite is true. Today – contrary to past generations – we have the opportunity to fully realize our abilities and even make a living from them. We call this process the path to financial freedom and self-sufficiency.

In fact, if we want to make a change and leave the hamster wheel, we have to take the scepter into our own hands. In this way, we can individually protect ourselves from collapse. In addition, there are already plenty of approaches for alternative monetary systems that can start on a collective level and create improvements.


You should realize that the prevailing monetary system has a certain half-life. It cannot possibly work in the long run and therefore must be “reset” again and again at regular intervals. That is why we experience similar crises over and over again.

These crises are thus inherent in the system – that is, they are caused by the design of the system itself and not by some greedy and particularly ruthless banksters. These groups are merely the catalysts that accelerate financial crashes.


So-called full money is a time-tested approach. It is the exact opposite of the fractional banking system. The full money approach would completely eliminate the so-called creation of money by commercial banks.

This would make it much easier for central banks to control the money supply. In addition, the Monetative demands that central banks and their chairmen be elected in their function.


There are also various approaches to monetary systems without interest. These initiatives have targeted interest as the central evil of the monetary system. They are primarily concerned with the exponential growth of credit and debt and the resulting compulsion of the economy to grow (with the harmful consequences for people and the environment already mentioned). The debt compulsion could thus be slowed down. Especially some complementary currencies do important pioneering work here.

After all, interest has many important functions within our economic system. For example, it can be a reward for not consuming one’s entire disposable income directly, but lending it to others or putting it aside for old age.


This includes, for example, digital currencies or cryptocurrencies such as Bitcoins, which can provide for direct payment transactions. This makes banks as intermediaries (mediators) almost superfluous and people much more independent.

We could not sum it up better than this interesting poem on the monetary system by Arno Hohensee. It is therefore the perfect introduction before we draw a final conclusion.


In conclusion, it can certainly be said that the monetary system has a split character. On the one hand, it is endowed with numerous problematic factors. On the other hand, it also offers the possibility for everyone to be financially free.

Capitalism and freedom are therefore not fundamentally mutually exclusive. Quite the opposite. It depends thus always on how one uses the acquired knowledge for itself!

With the help of the money system explanations on our site and our books, you can definitely build a solid foundation for your path to financial independence. After all, what are mistakes in the money system for one person can be useful for another.


One of the first things one reads in textbooks is the two-tier structure of the monetary and banking system. The first stage is determined by the central bank of a currency area and its relationship with banks; the second stage concerns the banking sector and its relationship with non-banks, the public or bank customers. The two levels are obvious, but they are associated with some misleading notions, for example, that money is created by central banks at the first level by lending it to banks, which in turn on-lend central bank money to their customers at the second level, or that they lend out their own bank money (Giralgeld) to customers on the basis of central bank credit. As will be explained in more detail in a moment, none of this applies in this way.

The two money circuits are separate and do not mix. However, the circulation of public money is technically linked to the interbank circulation in that cashless payments among non-banks are intermediated via the interbank circulation.

To the extent that banknotes and coins are still in use, cash forms a third monetary cycle. Cash is also central bank money. In today’s essentially cashless monetary system, however, cash is of only marginal importance. Within the framework of the existing reserve banking system, cash and account money (credit balances in accounts) must not be confused with one another, as happens in careless linguistic usage, especially with regard to the English ‘cash’, and even in official accounting standards.[1] In its origin, modern money is non-cash, as a credit to an account. In the context of the dual monetary cycle, this applies to both central bank money (reserves) and bank money (giro money). Traditional cash (coins and banknotes) is now only a residual technical change quantity that is exchanged out of a checking account and can be exchanged back in.

Since the 1920-60s, as cashless payment transactions have spread, giro money has increasingly marginalized cash. Cash has since ceased to be constitutive of the monetary system. Depending on the country, the share of cash in the total stock of money is now only 3-20% (of M1), with a further declining trend. 80-97% is giro money. Cash can therefore be largely disregarded in monetary system analyses (despite its current role as an effective hurdle against the central banks’ misguided negative interest rate policy).

If endogeneity is understood as money creation due to demand, possibly in conjunction with the postulate that this automatically creates an optimal money supply, this merely reflects misleading banking school doctrine. Modern money can be created at the free discretion of issuers, at any time and hypothetically in unlimited quantities written into the books. Hence, not only the demand for money tends to be unbounded and overshooting, but also the supply of money by banks and central banks, especially in the context of the self-reinforcing feedback dynamics of business and financial cycles.

If fiat money is considered endogenous and banks are seen as actors ‘in’ the economy, then the same applies to central banks. Or, conversely, if central bank money is considered exogenous and central bank actions are viewed as coming from ‘outside’ the economy, then banks’ fiat money must also be viewed as ‘outside money’.

If the same payments are made by an internal customer of the bank, i.e. from a current account at that bank, this does not involve any reserve transfer. The interest payment passively debits the payer’s current account, which deletes the relevant amount of giro money, and is in turn actively accompanied by a credit to the bank’s income account. The repayment of the credit amount is expressed in the paired deletion of the payer’s giro money (passively) and deletion of the bank’s credit claim against the customer (actively), which in turn means the same balance sheet contraction as in the aforementioned case.

If this is so, why do customers hold savings and time deposits at all? For customers, such deposits represent financial assets, mostly of modest size, but nevertheless a kind of short-term capital, also called ‘near-money’, because it can be reactivated promptly when needed. Savings and time deposit accounts can also serve as collateral for loans. In normal times, they also yield credit interest, also at a modest level.

Now, the perplexing thing about existing reserve banking is that the volume of reserves in interbank circulation represents only a fraction (a fraction) of the giro money in circulation with the public. In order to generate and hold a given volume of giro money in the circulation of the public, the banking sector needs a stock of reserves that is, in fact, only a small fraction of the amounts lent.

Cooperative Credit Issuance and Creation of Unaccrued MoneyThis principle has already been mentioned in the foregoing. It implies that banks must expand their balance sheets roughly in tandem, so that banks’ loans and liabilities (giro money) offset each other, as do outgoing and incoming reserve payments. This, in turn, implies that banks mutually accept each other’s transfers of giro money. In today’s computerized payment systems, this is virtually guaranteed, unlike in the earlier cash economy, where banks were often reluctant to accept other issuers’ private banknotes.

Distributed transactionsPublic payments are distributed across time and customers, and not all of the customers’ banknotes are transferred at once. This means that at any given time, only a small portion of the banknote money is in motion.

Old habits die hardIn light of how the current monetary system works, discussed so broadly, a number of time-honored paradigms become recognizable as obsolete or inapplicable from the outset.

The Piggy Bank ModelOne of the oldest banking models is expressed in the piggy bank model. It contains notions of the kind ‘bank balances arise from cash deposits of customers’, or ‘my money is in the bank’ or ‘… in my bank account’. The first variant is wrong today, the latter two do not get to the heart of the matter.

In today’s non-cash money system, customer balances have long since ceased to serve bank financing. In the reserve system with a divided monetary cycle, a bank cannot and does not need to make use of its customers’ credit balances, neither of sight deposits nor of savings and time deposits.[16] The banks do not use ‘our money’, but we do use bank money (= Giralgeld = sight deposits). Among non-banks, however, in the secondary credit markets in the circulation of the public, bank money undoubtedly serves as a lendable means of financing, and does so on a large scale.

Banks do not use deposits in their service, loan, and investment business with nonbanks; rather, they finance all such business with primary credit via checking accounts, i.e., with self-generated bank money. If there is a shortage of money or capital, it has no monetary causes, because modern money can be generated by banks at any time and in principle in quasi arbitrary amounts, provided that non-banks (non-monetary financial corporations, firms, public and private households) are willing to take on debt and banks themselves are willing to issue credit. Today’s banks are monetary institutions, pro-active primary credit issuers, and thus creators of their own bank money, the Giralgeld, which they also temporarily de- and re-activate, and eventually delete.

The multiplier model can still be found in almost all relevant texts, although even this model, to the extent that it could claim validity at all, has become obsolete as a result of the development of fractional reserve banking with a double money cycle. The model exists in many variants. What they have in common is that a certain amount of money (M) is lent by banks to customers via credit (Kr). The money is assumed to flow back to the banks, where it is in turn used for new credit issuance, and recurrently so. At each round, banks hold a certain reserve ratio (Res). The total amount of credit that can be issued in each round is therefore Kr = M (1-Res), and the total amount of credit that can be generated is Kr = M/Res.

Also, there is no variability in the money supply, neither expansion nor contraction due to deactivation and deletion of money.[20] The model assumes the money supply M as an exogenously given fixed quantity, instead of assuming an endogenous and variable money supply. The model sets M as a determinant specification, as is consistent with the monetary policy doctrine of transmission through reserve positions, from which banks’ credit issuance or creation of giro money is derived. In reality, however, causation or transmission runs in exactly the opposite direction from primary bank credit to fractionally re-financing central bank credit.

The leverage of a reserve position policy is supposed to be the reserve requirement, which most central banks still impose on banks. But how is the imputed transmission supposed to work if the proactive law of the trade lies with the banks and the central banks always serve the resulting small demand for excess and minimum reserves in the aftermath? From this point of view, minimum reserves are a completely meaningless instrument, except perhaps that it earns a central bank some interest income in normal times, to the extent that such income arises from reserve lending to banks.

The only interest rates a central bank can definitively set are its own on the fractional base of central bank money. Moreover, central banks can effectively influence interbank money market rates by narrowing or widening somewhat the quantity of available reserves through open market operations. However, the resulting effect is also small for the reasons mentioned above. Also from this perspective, a transmission of interbank money market rates to retail interest rates is not evident, or to put it more directly: largely fictitious, at least from the point of view of market-based quantity and price dynamics.

Where a clear effect of central bank interest rates on banks and the economy can be discerned, this effect is based on voluntarily conforming price administration by banks, namely where banks link certain lending rates – for overdrafts or mortgages, for example – to interbank rates such as the Fed Funds Rate (dollar), LIBOR (pound) or EONIA (euro). Ironically, this is an exercise in bureaucratic central planning, not at all a market-based pricing dynamic of supply and demand.

Some economists regard the giral money regime as a system as sophisticated as it is neutral. It functions and is otherwise of no further importance. Admittedly, the notion that the monetary system is ‘neutral’ is one of the more disconcerting tenets of neoclassical economics – all the more so given the effective exercise of power involved in the creation, allocation and distribution of money, an exercise of power that rivals markets and life forms and the power instrument of legal command.

The key problem in today’s system is out-of-control money creation. The central banks have lost control in the course of the spread of the giro money regime and, since around 1980, have also given up the claim to want to control bank money creation – as if the money supply were no longer an issue and as if a complex result of the economic process, such as inflation, could be controlled with short-term central bank interest rates.

But also the money and capital markets do not find a self-limiting ‘equilibrium’. In every market, there is a supply curve and a demand curve that act in opposite directions and thus in a limiting way. This is also true for money and capital markets. The only difference is that in these markets there is at the same time a delimiting positive feedback, which is superimposed on the negative feedback: increasing quantities and prices of financial assets, in spite of concerns, create additional demand instead of counteracting it.[23] This is what causes market failure in the form of excessive money creation, overinvestment and over-indebtedness, asset inflation, bubble formation and crises.

To some extent, this also applies to real business cycles. Even if overheated economic or industrial cycles, including inflation, have receded into the background since around 1980, half to two-thirds of modest nominal GDP growth regularly consists of inflation.

A widely cited IMF study identified 425 systemic financial crises for the period 1970-2007, on migrating hotspots around the globe, with increased frequency and severity. 145 of the 425 were banking crises, 208 currency crises, and 72 sovereign debt crises.[24] Bank money is certainly not the sole cause of such crises, but certainly the monetary system conditions the financial economy as it controls the course of the real economy.

Many economists downplay the importance of the monetary system. In neoclassical macro models, everything is expressed in monetary terms, but the monetary and banking system itself does not figure in them. At the same time, however, monetary policy is expected to make significant contributions to supporting economic growth and employment – a glaring contradiction between downplaying the importance of the monetary system and the lofty expectations placed on monetary policy. In contrast to earlier stages of economic development, the fundamental role of the monetary and banking system remains severely underexposed in contemporary economics. This is paradoxical in view of the enormous growth in the financialization of the economy, i.e. the further increase in the importance of banks and the financial sector.

In every crisis of a bank, even more so in a systemic banking crisis, it becomes clear that bank money is an insecure money. It is only a promise of (central bank) money, not money itself. When banks collapse, their balance sheets effectively lose their customers’ credit balances, causing payment transactions and thus the economy to grind to a halt. Bank deposit insurance (no more than a fig leaf) and government guarantees (never tested) serve to appease and are eloquent evidence of the insecurity of bank money.

The fiat money regime encourages overinvestment and overindebtedness to a far greater extent than previous monetary regimes. But it is not possible in the long run for banks and the financial industry to outwit the gravity of productivity and economic output. In other words, banks and other financial actors cannot artificially override the financial carrying capacity of an economy.

Random Thoughts

Our system is the debt money system. Banks create money by making loans. Just like that. Practically at the push of a button. Since banks want to make money on loans, they have an incentive to make lots of loans. Banks also prefer to make large loans for large projects, from which they expect high returns. Loans for smaller companies are less interesting.

Here, too, you can see the incentive to create debt in our system. And how difficult it is to control the amount of money in circulation. See the last financial crisis in 2007 / 2008. The banks issued massive amounts of credit and thus flooded the market with money. Much of this money was used for speculative purposes. It is well known how the story continued: The bubble burst, banks were left sitting on worthless financial products because they had speculated. The banks were rescued with taxpayers’ money – and then continued exactly as before.

Full money system

Under a full money system, banks would be forced to focus on traditional lending: Lending money that others lend. Quite boring. But it would be a way to put the financial sector in its place. A way for the financial system to serve the common good. Because this is the basis of a functioning economy.

In Switzerland, there was a referendum on precisely this topic in 2018: In the course of the so-called full money initiative, the proponents wanted to ensure that only the Swiss National Bank would be allowed to create money. The full money system was rejected.

Nevertheless, there are always initiatives for full money, such as the Monetative. I personally see in the full money system a solution and the monetary system of the future.

Advantages of cryptocurrencies over paper money

As a result, cryptocurrencies have several advantages. In the crypto universe, banks do not create the money and lend it at interest, but users (miners) receive money for processing payment transactions.

  • This allows users to mine cryptocurrency themselves, effectively becoming their own bank.
  • Cryptocurrencies eliminate the middleman (banks, etc.), allowing money transfers to be made directly from one person to the next. As a result, money transfers can be made across national borders in seconds and for low fees.
  • By using cryptography, digital currencies are generally more secure and harder to manipulate than in the paper money system. Transparency on the blockchain (transactions are visible to everyone) also makes corruption more difficult, which has led some countries to consider using the blockchain in public services.

Disadvantages of cryptocurrencies compared to paper money

  • If the Internet fails or the user does not have access to the global data network, no transactions can be made or forwarded.
  • If the cryptocurrency owner loses their private keys or accidentally deletes their wallet from their PC, they risk losing their digital money if there is no backup digital wallet or other protection.
  • Payment errors or transfers to the wrong address lead to the loss of digital money, because there is no central place to which the user can turn in case of errors. Crypto users should therefore always check the address carefully when making a transfer.
  • Cryptocurrencies are more suitable for computer-serviced users, the acceptance in traditional trading is currently still low.
  • The past shows that cryptocurrencies are also not protected from attacks from hackers, which can steal accounts or attack the system itself

Cryptocurrencies advantages

Cryptocurrencies are still in their infancy and sometimes suffer from scaling issues. Nevertheless, the advantages that cryptocurrencies offer outweigh the disadvantages compared to paper money.

The reason: cryptocurrencies grant access to financial services to billions of people who otherwise do not have a bank account. In developing countries in particular, nearly 60% of adults are excluded from the banking system because they do not meet the minimum requirements for an account.

In addition, cryptocurrencies serve as a means of preserving value and exchange in countries with a weak currency (Venezuela, Zimbabwe, etc.). Cryptocurrencies are also gaining ground among businesses and banks. At IBM, it is estimated that by the end of 2017, around 15% of banks will use blockchain technologies, as they make financial transactions more effective and cheaper.

In addition, of course, investors can also benefit from the possible increase in the value of cryptocurrency. However, it should be noted that cryptocurrencies are very volatile and can fluctuate greatly in price.


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