U.S. Government: A User of Money

October 9th, 2011
in Op Ed

By Guest Author Derryl Hermanutz

Like you and me, government is a user of money, not the issuer

Modern money theory (MMT) describes the mechanics and fiscal possibilities of a “fiat” or “soft currency” money system, as contrasted with a “hard money” or “sound money” system where the quantity of money is linked to the quantity of gold and a nation’s money supply is thus limited by that nation’s gold holdings.

Follow up:

I am not denying the virtues of an MMT fiat money system. I have argued repeatedly that a profit seeking system, like capitalism (and a growing economy generally), requires an expanding money supply. A fixed money supply makes it impossible for the economy as a whole to be “profitable”, because there is a fixed quantity of money and profit requires that you get out more money than you put in. As populations and economies grow they need more money just to maintain a constant level of money per capita or money per GDP, and holding money supply fixed in an economy that is trying to grow will create a persistent shortage of money. I believe a profit seeking system is better than the alternatives, and growth is the primary source of systemic profits, so the virtues of a flexible, expandable supply system like fiat money are clear to me.

The Fed, not the Government, is the Monopoly Issuer of Currency

However, the conventional formulation of MMT is making what I believe to be a fundamental and critical error by assuming that “government” is the monopoly issuer of currency. In fact, the Federal Reserve Bank issues about 4% of all US money as banknotes, which function as the “currency”; and the commercial banking system issues about 96% of all US money as loans of bank deposit money, which are “debt” to the borrowers (we won’t even engage the shadow banking system that creates trillions of additional monetary credits and obligations as derivatives). 96% of our money is issued as ‘loans’ by private banks. 4% of our money is issued as banknotes by the central bank. The US government and the US Treasury issues exactly how much money? $Zero.

Here is a good succinct expression of the conventional MMT position:

    “Today, with the US government the monopoly issuer of its own flexible exchange-rate fiat currency, public “debt” is – or rather should be – even less of an issue. Unlike in the immediate postwar period, the government is not subject to the constraints of Bretton Woods or a similar commodity-backed money system. It is free to utilize its fiscal capacity to the extent necessary to restore full employment.

    Government “debt” is nothing other than the accumulated net financial wealth of the non-government. Once the non-government is ready to spend, income growth will deliver stronger revenues, reducing the deficit. But the private sector needs to have its debt under control before it will resume spending at levels sufficient to sustain strong economic growth.”

This position recognizes that government “spends money into existence” via deficit spending, but that is identical to the way any other bank customer spends borrowed money into existence.  Like a homebuyer borrowing mortgage money to buy a house, government issues “debt” and gets money, which it spends into the economy. The money that the government spent becomes “money” (not debt) in the hands of its recipients, who earned it or were paid it or given it and who thus do not “owe it back”.

When one person “spends” money, that money becomes a net financial asset to its recipient. The borrower/spender still owes the money back, but the person who sold something to the borrower and now has the money does not owe the money back.  So for every dollar of government (and private) debt that remains outstanding, somebody out in the economy has a dollar of money, of “net financial wealth”.  However, as taxpayers, the private sector public is on the hook for repaying our government’s debts.

Private Savings and Government Debt:  A Zero Sum Game

So some people (savers) may have net “individual” financial assets from government deficit spending, but as a whole the private sector owes as much in taxes to pay principal on our government’s debts, as we have money from this source. There is no “net” financial wealth generated in this way. It is a zero sum system.

If we assume, as conventional MMT appears to, that government debt can grow without limit so we never have to repay the loan principal, then government can keep borrowing newly created bank money to pay interest on its accumulated debts and to roll over principal payments as bonds mature. I think we have reached the limit of the viability of this belief.

Issuing debt, which the government actually does, just as private bank customers like you and I do, is far different than issuing money. In our system only banks issue money. Our government and the rest of us in the non-bank sector issue debt, and the banks convert our debts to money. Whoever issues the money is monetarily sovereign. They are the “owners” of the money. Whoever must borrow money before he can spend beyond his earnings is NOT in control of his monetary destiny.  Creditors, not borrowers, decide who gets money and for what purposes.

Banks are the Government of the Economy

Borrowers are not economically sovereign because we are not monetarily sovereign. We can only “do” what money issuers lend us money to do. Bankers, not governments or private borrowers, decide what will be done (and who will be lent money to do it) and what will not be done (and who will not be lent money).  Money is the direct “governor” of the economy, and money issuers are the effective “government”.  And that is the banks.

The whole virtuous mechanics of MMT soft currency economics breaks upon the rocks of this reality, that our government is not the issuer of money but a user of money just like we are. Contrary to the position of conventional MMT, the end of the gold standard did not free the government to create as much money as it needs. It freed the banks to create as much money as borrowers were willing and able to borrow.

A System of Eternal Debt

As debt increases, interest payments to the banking system increase. Private sector earnings, and government earnings via taxes and fees, must increasingly be devoted to paying interest on the money we borrowed, rather than spending that money on economically desirable goods and services and government programs. We are not even paying down loan principal. We still owe the same trillions, even though we have already paid trillions in interest. We are essentially stuck in a system of eternal debt.

The greater our total debt becomes, the greater portion of our current earnings must be devoted to paying interest, which starves the real economy and the government of spending money, while enriching the banking system and the bankers who issue the money.  It is no coincidence that finance now ‘earns’ 40% of all US corporate profits.  It is inevitable under the 1913 system. And this monetary inequality can only get worse as long as the banks retain a monopoly of money issuance.

Only 4% of Money is Currency

Conventional MMT believes the government (and they lump the central bank in with the government, which is also wrong) is the "public sector" which is the currency issuer, while the commercial banks are included with the "private sector" which is the currency user.  Part of the confusion is conflating "currency" with "money" per se.  Only about 4% of US$ money is “currency”, which is cash, banknotes, the paper money in your wallet.  At least 96% of the money supply exists ONLY as accounting entries in banking system computers.  "Money", overwhelmingly, is bank deposit money, not "currency".

IF we had the "100% Money" system that Irving Fisher advocated in the 1920s and 30s as an ALTERNATIVE to the 1913 system, then government would in fact be the monopoly issuer of 100% of US dollars. Fisher advocated a 100% reserve system where government created all the money and lent it interest free to the banks, rather than allowing banks to create money based on their holdings of a "fractional reserve" of Federal Reserve Notes, which were in turn issued by the Fed based on the Fed's holdings of gold, which was the system that was legislated into existence with the 1913 Federal Reserve Act and the 1913 Bank Act.

In 1936 Fisher published his final pamphlet, “100% Money and the Public Debt”, laying out his rationale and his system for monetary reform. He writes,

One of the primary attributes of sovereignty is the monetary function. Professor Frank D Graham points out that President John Adams considered any private issue of money a monstrosity and a fraud on the public.”

The government is NOT monetarily sovereign, though Fisher and many others (including me and, I think, MMTers in general) think it should be. The system has not materially changed since 1936, yet conventional MMT assumes that somewhere in the interim the government regained its monetary sovereignty that it had forsaken with the 1913 legislation.

The Bankster Coup of 1913 and the Great American Ponzi Scheme

In our actual (1913) system the banking system creates the money and lends it to the government at interest in the tradition of the Medicis and Rothschilds, the great nation-indebting bond merchants of old. That was the banksters' coup of 1913, removing money issuing power from the government, and Fisher advocated government money issuance in the last Depression just as MMTers are advocating it in this one, for the same reasons, that a debt-based money system is arithmetically a Ponzi that requires constant addition of new debt to pay old debt plus interest, and depression happens when money supply growth stops. But the reality was in the 1930s and is now that the banks, not the government, issue the money.

The 1913 system makes the banking system, including the central bank, the monopoly issuer of US dollar money, and the government and the non-bank private sector economy are the money users. ONLY banks are allowed to issue money. The government and the economy are money users, not money issuers.

The Coinage Escape Clause

The single exception is coins, which are issued by government, but coins are only about one ten thousandth of the money supply. In 1996 Congress passed legislation enabling government to issue proof platinum coins of “arbitrary” face value, which means the face value of the coin is not related to its metal content.  Issuing large denomination proof platinum coins (i.e. trillion dollar coins) would make the government a significant money issuer, but at present the government is on the demand/user side of the money system, NOT on the supply/issuer side as conventional MMT assumes.

I have brought this point up repeatedly with MMTers. Just look at it operationally. We in the non-bank private sector are in the same situation for getting money as is our government. We can get money by earning (the government equivalent is taxing), or we can get it by borrowing. Neither of us gets money by "issuing" it. You and I do not "get money" by spending it, and neither does the government; but the banks "get money " by lending it, by creating deposits of loan principal. We can only spend money that we already acquired by earning it or selling something or borrowing it. We either earn/tax to get it from somebody who already has some, or we borrow it from a bank who creates the loan money as an accounting entry. That is our actual system. The government is NOT the sovereign issuer of the national money. The banks are.

The exception under current law is the sovereign coinage authority enacted in 1996.  And that has not been implemented.

For Money:  The Two Sides of the Equation are Banks and Everything Else

When you or I get a bank loan we sign a promissory note, promising to repay principal plus interest, and the bank 'buys' that "asset" from us by creating a deposit in our bank account. Our "debt" is the bank's interest bearing "asset".  The bank "issues" the deposit money.  We issue debt, our promise to repay with interest.

A bank's "asset" is the economy's or the government's interest bearing "debt".  The "divide" vis a vis money is not public sector vs private sector. It is banks vs non-banks.

When government wants to spend money that it hasn't already collected in taxes, it also issues "debt", just like we do.  Government issues "bonds" (or bills or notes: the terms apply to different maturity durations) which are promises to repay. The primary dealer (PD) banks bid for those bonds at auction. If a PD successfully bids $980 for a one year bond of $1000 face value, that establishes an effective yield of about 2% interest. The PD "pays" for the bond by creating a deposit of $980 in Treasury's account at that bank. Treasury THEN has $980 of "money" to spend.

Treasury, which is "the government", issues debt, and the bank that buys that debt issues the money.  Treasury cannot "spend" the borrowed money until AFTER a PD bank has issued the money to buy the government's debt. Treasury's bonds, like our promissory notes, are not "money" that can be "spent". They are "debt".  Banks create the money to buy our debts.  We cannot "spend" our IOUs.  Sellers demand that first we convert our IOU to money, then come back and we'll talk about selling something to you.  Treasury has no overdraft privileges either at private banks or at the Fed.  Our government, just like us, has to borrow money from a bank before it can spend beyond its earnings.

Repeating:  The Government does NOT Issue Money

Like you and me, the government "spends" money that it has earned or borrowed, but spending borrowed money into the economy is absolutely different from "issuing" the money.  He who issues money does not incur "debt" when he spends or lends that money.  Under the still operative 1913 legislation only banks are allowed to create money and then lend it out as their private property.  The banking system that issues our money "owns" the money.  The economy and the government are on the "user" side of the money system balance sheet.  The banking system stands alone on the "issuing" side, the supply side, the creating and owning side.  The government and the economy are on the demand side of the money system, the borrowing and using side.

Households, firms and governments who enjoy the privilege of issuing their own money would NEVER voluntarily be "in debt" in that money. We would be the "creditors", not the debtors.  In fact the banks are the creditors and the non-banks, including our governments, are the debtors. The fact that our governments are deeply in debt, and their spending is constrained by debt ceilings and other limits, does not “prove” that government does not issue money, but it certainly supports the thesis.

Follow the Money

The PD who bought newly issued Treasury bonds can then sell the government's debt to somebody out in the economy who already has money and who wants to buy an interest bearing asset (or to a non-PD commercial bank who can create deposit money to buy the bond from a "primary" dealer in the "secondary" market).  Or as in QE2, the PDs can sell those bonds to the Fed, in which case the Fed pays for the assets by creating deposits in the PD's reserve account at the Fed.

"Banks", whether they are central banks or commercial banks, are in the business of creating deposits to purchase assets.  "Assets", to a bank, are interest bearing debts.  Those debts may be "secured" by collateral like cars or real estate, but the actual asset is the thing that banks profit by, which are our monetary debts, the money interest we pay on the money debts the banks create for us in the process of supplying the system with "money".

Banks are in the money creation business. Their product is "money".  (See the central banker quote to this effect in the Appendix.)  Except for coins, banks enjoy an exclusive monopoly on the production of US$ money. Banks are only "financial intermediaries" between savers and borrowers after the fact, after some bank creates money as a loan and the borrower spends it into the economy, and the money recipient takes that money out of the economy and deposits the money in his own bank account at a different bank.

Financial Intermediaries

Irving Fisher advocated monetary system REFORM that would make banks actually what people think they already are: financial intermediaries who first have to get deposits from savers (or from the government) before they can have any money to 'lend'. As it stands, banks are deposit "creators" first and foremost, and only deposit receivers secondarily.

If government was already monetarily sovereign why would insightful analysts like Fisher have gone to such lengths designing alternative systems that make government actually monetarily sovereign?  If government was already exercising monetary sovereignty there would be no need for this MMT discussion group, because MMT would be the conventional financial paradigm and government would already be issuing rather than borrowing money and would have no 'debt'.

All member banks of the Federal Reserve system have reserve accounts at the Fed, just as all retail customers of Citibank have deposit accounts at Citi.  Citi customers can go to the teller window and ask to convert some or all of their deposit balance into "currency", which is banknotes.

In the US the Federal Reserve Bank enjoys monopoly issuance of currency, so US currency is Federal Reserve Notes.  Not "US Government Notes".  Not "US Treasury Notes".  Federal Reserve Bank Notes.  Lincoln’s United States Notes (“greenbacks”) were the last currency that the US government issued and spent into the economy debt free.

Before Citi can convert your deposit balance into "cash", Citi has to get cash from the issuer of cash, which is the Fed (not the Treasury), so Citi converts some of its reserve account deposit balance at the Fed into cash and armoured cars deliver it from the Fed to Citi banks.  Citi has converted (for e.g.) $1 million of its reserve balance into cash in hand. The Fed writes down Citi's account balance by $1 million and gives them $1 million cash.

Currency merely converts the "form" of money, from bank deposit money to cash, or from cash to a bank deposit. The "quantity" of "money" is unchanged in the conversion.  $1 million is "added" as cash in hand; $1 million is deducted from the deposit balance. You or Citi has no net change in the amount of "money" you posess, just a change in the form of that money.  The Fed is in fact the issuer of currency (not 'money' per se, but "currency") as conventional MMT says, and the commercial banks and the non-bank private sector and the government (i.e. everybody who is not the Fed) are "users" of currency.


"The government" does not issue currency. The Fed does. "The government" does not issue deposit money or reserve money as accounting entries. The commercial banks issue the former and the Fed issues the latter. And the Fed does not "give" money to the government any more than commercial banks 'give' money to their customers. The Fed is not even allowed to lend money directly to the government. The Fed can buy Treasury debt, but the Fed cannot buy debt directly from the Treasury. The government can only sell its debt to the primary dealer banks, and the Fed can then buy the government's debts from the PDs if that action serves current monetary policy goals. Directly funding government deficit spending is NOT a central bank policy and it is not even legal under current legislation.

The primary dealer banks are big domestic banks like JPM and big foreign banks like RBC. These are all PRIVATE banks. The government has to borrow money at interest from private bankers just like the rest of us out here on the demand side of money. We “issue” a bond or a note promising to repay principal plus interest, and the bank “issues” money to us.

That is the system as currently structured. Before government becomes the sovereign "issuer" of US$ money, monetary system REFORM is required (unless we go the proof platinum coin route, which is an immediately available option).

This is a critical issue for MMTers. If we assume the government already enjoys monetary powers that we want it to have, and believe it should have, but which powers the government in fact legislated away in 1913 and has not subsequently reclaimed, then we will find ourselves advocating government actions that the government in fact does not possess the current power to perform.

I am saying that the current reality is that government does not possess nor exercise monetary sovereignty, even though it could by issuing trillion dollar proof platinum coins as debt free money rather than the actual practice of issuing debt in order to borrow money from the private bankers who issue money. Under current reality banks, not government, issue our money. MMT policy prescriptions that begin with government eternally "spending money into existence" as if growing government debt does not matter, do not begin in reality and will not be viable. I hope we can clear up this issue so that MMT can become a coherent alternative to the existing monetary paradigm.


Graham Towers was the first governor of Canada’s central bank, the Bank of Canada, which began operating in 1935. Canada’s monetary system is substantially the same as the US system, as well as any other modern central bank money system.  During the Depression, which was a failure of the monetary system just like the post-2008 failure we are in now, there was heightened awareness of money and the money system, again just as there is now.  Towers gave testimony to a 1939 Royal Commission on Banking and Commerce about the nature and structure of the monetary system. Here are some key excerpts from the proceedings:

Page 223:

Question from Landeryou (SC from Lethbridge): "Ninety-five percent of all our volume of business is being done with what we call exchange of bank deposits – that is, simply book-keeping entries in banks against which people write cheques?"

Towers: "I think that is a fair statement."

Page 285:

Question from McGeer: "When you allow the merchant banking system to issue bank deposits – with the practice of using cheques – you virtually allow the banks to issue an effective substitute for money, do you not?"

Towers: "The bank deposits are actually money in that sense."

Page 287:

Question from McGeer: "But there is no question about it, that banks create that medium of exchange?" [i.e., bank deposits]

Towers: "That is right. That is what they are for."

McGeer: "And they issue that medium of exchange when they purchase securities or make loans?"

Towers: "That is the banking business, just in the way that a steel plant makes steel."

Fishing for Concessions

One of the infrequently heard members observes on p. 400 that "McGeer and the social credit people are circling around ‘debt-free money.’" McGeer affirmed that his purpose was to persuade the Committee that there is a costless (or at least lower cost) way of mustering the money (finance) to get men and materials into operation for important productive activities. (Towers freely acknowledged that although an "easy monetary policy" had been in place for several years, there was still plenty of under-employed labor and materials. He defined "easy money" as no need to impose bank rate restrictions or cash reserve requirements on banks – they had plenty.)

McGeer kept returning nonetheless to this question: Why should a government with the power to create money give that power away to a private monopoly? And especially, why should it then borrow from the banks and pay interest? Towers’ response: "Parliament can change the way the banking system operates if it wishes to do so."

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About the Author

Derryl Hermanutz has contributed (opinion and analysis) previously on topics related to theory of money and relationships between current events and economic history and philosophy.

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  1. Johnathan Email says :

    The author seems to make a distinction without a difference: If the Fed buys any/all debt from the Primary Dealers, then Treasury can sell/print all the debt/money it wants. The PD's will be happy to oblige, making a profit on each "chunk".

    The Fed is Treasury's printing press; how else could they ramp up $16 trillion (with a "T") during the Financial Crisis (according to Sen. Sanders audit)?

  2. Admin (Member) Email says :

    Jonathan - - -

    Glad to see you commenting here.

    I think you are missing the author's main point: If the Treasury were issuing currency then they would not go into debt as happens when the Fed issues currency or credit to fund the PD's that buy the federal debt. The author is arguing that debt is the wrong way to finance government operations.

    The author wants the government and the banks to exchange places. He wants the government to be the issuer of the currency and the banks to be the users, or, better stated, intermediaries for the users. He wants the government to stop having only the role of user and to stop paying interest on what should be (in his opinion) the government's money.

    If you go to the place that author takes you, then the discussion devolves into how the creation of currency can be controlled so that inflation is contained within acceptable bounds.

    Personally, I don't think the inflation problem is any worse with what the author proposes than with Federal Reserve system for creating money.

    Finally, the coin seniorage option that the author mentions has been addressed by a number of contributors on our blogs, including one analysis article that determined such action would not only not be inflationary but would actually have some deflationary effects that might require the issuance of more currency.

    I will apologize to the author in advance if he would have preferred to discuss your comment without my interference.

  3. Art Email says :

    Granted, the money in our pockets reads "Federal Reserve Note", the UST no longer directly issues non-interest bearing debt (money), and PDs can be viewed as rent-seeking oligopolists (though I think that's an extreme view; they're a fairly large and diverse group and they do fulfill some public services in return for the privilege).

    "[The MMT] position recognizes that government “spends money into existence” via deficit spending, but that is identical to the way any other bank customer spends borrowed money into existence."

    No mortgagee or borrower in any non-issuing sector of the system can instruct the Fed to debit and credit bank accounts at will. The USG is the largest daily financial transactor in the world. If it truly had to borrow first to finance such spending--as the person taking out a mortgage does to buy a house--the global financial system would likely freeze up. What's really happening is that some holders of deficit-spent dollars (as well as some credit transaction created dollars)are simply exchanging those dollars for an interest-bearing equivalent.

    And it doesn't take a lot of digging to see that, while nominally (i.e., via existing legislation), the USG may look like a mere user of currency, operationally, the reality is much different. As the first commenter noted, it appears to be a distinction without a difference.

    "This is a critical issue for MMTers. If we assume the government already enjoys monetary powers that we want it to have, and believe it should have, but which powers the government in fact legislated away in 1913 and has not subsequently reclaimed, then we will find ourselves advocating government actions that the government in fact does not possess the current power to perform."

    First, it essentially has those powers and exercises them every day. And second, just how critical an issue is it, given the operational realities? Should we work within the existing (or a slightly tweaked) framework to address pressing economic problems now? Or engage in a more philosophically-driven struggle that could take decades to succeed (if at all), and delay the implementation of policies that could have a positive impact on people's well-being today?

  4. Derryl Hermanutz says :

    Art wrote,
    "No mortgagee or borrower in any non-issuing sector of the system can instruct the Fed to debit and credit bank accounts at will. ...(the government) essentially has those powers and exercises them every day."

    Every bank customer enjoys the same power. I write a check against my deposit balance and thereby "command" my bank to debit my bank account and credit the account of the recipient of my checkbook money. My bank obeys my commands without question. If my account has insufficient funds to cover the check then my bank will tell me, like the Fed will tell the Treasury, to make a deposit "of money" before the check can be honored. Where will Treasury and I get the money? By earning/taxing or by borrowing it. My bank does not accept my mere command or my IOU as a deposit, and the Fed does not accept Treasury's commands and IOU as a deposit. First we have to have some bank "monetize" our debt, THEN we have "money" to deposit. Treasury and I are exercising our power to "use" money. The Fed and the commercial banks are exercising their power to "issue" money.

    Art wrote,
    "And second, just how critical an issue is it, given the operational realities? Should we work within the existing (or a slightly tweaked) framework to address pressing economic problems now? Or engage in a more philosophically-driven struggle that could take decades to succeed (if at all), and delay the implementation of policies that could have a positive impact on people's well-being today?"

    The current crisis is precisely a crisis of philosophy, a question of the legitimacy of the current operation of government and the monetary system. Before we can decide whether or not the operations are "legitimate", we have to get clear about exactly how those operations proceed under the current system. Most people, including MMTers, believe "the government" ultimately issues US$ money. I am trying to show you that this is not the case. In fact the banking system, which is separate from the government and has interests inimical to the interests of the government's "boss" which is citizens and taxpayers, issues all the money and government borrows that money and pays 100s of billions of dollars per year of interest on those loans of money that it could, and I say should, issue for itself debt and interest free. Private sector borrowers pay additional 100s of billions of dollars per year interest to the banking system that creates the money out of nothing as bank deposits. Bankers are still rich and getting richer. The economy is sinking into depression. If you accept that this is a correct description of the US monetary system do you, does Joe Citizen, believe this is a fair, acceptable, legitimate system?

    In order to "address pressing economic problems now", somebody has to spend a large amount of money into the US economy to get 10s of millions of unemployed Americans working again and earning incomes so they can buy the millions of empty houses that have been foreclosed and continue to make mortgage payments on the millions more whose owners owe more on the property than its deflated market value (i.e. underwater mortgages). Real estate is the collateral against about 70% of total banking system assets. Those "assets" are borrowers interest bearing "debts". If borrowers cannot repay, then banks have to foreclose and sell the assets to recover the money they lent. If the banks recover less than is still owed, then the bank has to pay that money out of its current operating profits or out of its capital. If the banking system lacks sufficient profits and capital to cover all the loan losses on deflated real estate, then the banking system is insolvent. Since Sept.15/08 the government has pledged 100s of billions of taxpayer's dollars to propping up an insolvent US banking system that is "too big to fail". Since Sept.15/08 the Fed has devoted many trillions more of credits to propping up the same failed privately owned financial corporations. Aside from a burst from Obama's stimulus spending, nobody is propping up or bailing out the American people. Only the privately owned banking system is enjoying extreme government and central bank support.

    In a free market capitalist system, a failed business fails, and more capable hands take over the business, or the entire line of business becomes obsolete and nobody takes it over because nobody can make it operate profitably because prices and/or demand for its products have collapsed (e.g. a buggy whip factory after Henry Ford). Successful businesses enjoy substantial autonomy to carry on their business however they choose, because their business "works". The assumption in free market economic theory is that their business works because it is serving the needs of the economy. The people who patronize that business are using its goods or services and paying prices that are profitable to the business.

    These principles are the foundation of the American system. The American people accept capitalism as their economic paradigm, even though capitalism generates significant inequality of outcomes. Americans believe it is "fair" that some people are wealthier than others, because some people "earned" more than others. Unearned wealth (stealing, monopoly, government favoritism) is not accepted by Americans as the legitimate outcome of competitive capitalist enterprise. The people's representative government is legitimate insofar as it enjoys the support of the people, as is clearly stated in the constitution. Bailing out failed banking enterprises at taxpayer expense so that their already megamillionaire managers and employees can continue to pay themselves lavish incomes while allowing 10s of millions of unemployed and unhomed Americans to languish in depression is neither an outcome of free market capitalism nor the behavior of a legitimate representative government.

    Americans across the nation are currently expressing their disapproval of this crony capitalism system via all the "Occupy Wall St" demonstrations. The current operation of the fiscal and monetary system does not meet the approval of the American people. The people want government to act in their interest, to bail them out if needed, to rein in what has become a predatory banking system, to punish those who broke the law, to recover illegally gotten gains. The American people want "justice". And yes, "justice" is a philosophical concept, the concept which is currently motivating all the political activism. The desire for economic justice motivated the American Revolution. Philosophy is not trivial. It is central to establishing and reforming the institutions that the people agree to be governed by.

    Perhaps Obama wants to be the party who spends large amounts of money into the US economy to get it working again, but he can't, because Americans are horrified at the prospect of adding additional trillions to the already nearly $15 trillion of government debt that they, as taxpayers, are on the hook for. American taxpayers are already paying 100s of billions of dollars per year in interest to bankers who created money to lend to government. Private sector American borrowers are paying additional 100s of billions of dollars per year in interest to the same bankers. I will repeat the question that the Cdn Member of Parliament asked Canada's central bank chief in the last Depression,

    "Why should a government with the power to create money give that power away to a private monopoly? And especially, why should it then borrow from the banks and pay interest?" The central banker did not deny that this is the current system, having previously stated that banks are in the business of producing money just like a steel plant produces steel. And Towers stated, "Parliament can change the way the banking system operates if it chooses to do so."

    Towers readily admits that banks, not government, create the money, and that if the government doesn't like this arrangement it can change it. I am advocating that we change it. You, Art, seem to be trying to get me to believe that the government already enjoys the money issuing power so that no reform is required and business as usual can lead to some benevolent resolution of the current financial collapse. I am saying that our current deadlock is exactly because government does not enjoy any such powers and until it actually exercises monetary power by issuing and spending debt free money the there can be no good outcome to the current debt crisis.

    The government and the private sector have both reached our debt ceiling. The economy, the mortgagor, the taxpayer, the indebted government, cannot "afford" to borrow any more money and pay any more interest to the bankers. Our power to spend is stretched to and beyond the limits of our incomes and we are monetarily constrained by our inability to borrow more money or to issue our own money debt free and spend that money. "Operationally", this is where we are at. I advocate tweaking or reforming the operations so that government in fact issues (at least some of) the money it spends rather than taxing or borrowing to get that money. You seem to be arguing that government is in some invisible and contradictory manner already doing what I say it should be doing, but outcomes speak louder than theories. The government has debt problems, just like the non-bank private sector. Unless you can explain how a monetarily sovereign government that issues its own money can have its spending power constrained by parties other than the government, then I cannot accept your depiction of the way current operations actually work.

    And the argument, that Congress controls the debt ceiling and thus "the government" is in this case constraining itself, is circular. If government was issuing money rather than borrowing it, the "debt" ceiling would be moot, because a money issuer does not incur debt by issuing money and by spending the money it issues. The simple fact that the government is in debt and the taxpayer is paying interest on that debt and government spending is constrained by limits to debt and the whole system is on the brink of collapsing into deflationary depression is the very reality that my thesis revolves around and that my prescriptions seek to change. If there was no government debt we would not be having this discussion because what I want to happen and what you assume is happening would already be in fact happening. There is government debt, generated by current operations of the current system, and we are having this discussion, because government is a borrower of money, a user of money, not an issuer of money. Until that changes in real life, I will continue arguing that the system needs to be reformed. And I will continue rejecting arguments like yours which claim that somehow under the currently operational Federal Reserve system the government comes out as a money issuer rather than what it clearly is, a money borrower.

  5. Mister D says :

    Every American should read this.

  6. Adam1 says :


    I don't think you actually understand banking operations. If you did you would realize why the US Treasury does not borrow money and why. At the very least it would be impossible for the Treasury to utilize "bank created" money.

    To understand how banks create money you must first understand what a fractional reserve bank really does. At the core of every bank is a payment system. The payment system is how a bank clears and settles payments (think checks) with other banks. The only "real" money in the banking system is used to do this - reserves.

    Now let me use an example of how the payment system is used to create money and loans. You go to the bank for a car loan. The bank checks your creditworthiness and underwrites the loan. It gives you a check. You pay a car dealer with the check. If the car dealer deposits the check at your banks (has the same bank as you do) the bank looks at the check and said yes this is a valid check and creates a deposit entry on its books in the dealers account (money is created out of thin air).

    If the dealer deposits the check at a different bank here is what happens... the bank creates a deposit entry on its books in the dealers account (money is created out of thin air). This bank now needs to clear and settle the check with the originating bank. The check gets passed through the payment system. In the end the originating bank will need to cover the check with reserves. It either has excess reserves or it can obtain them from the inter-bank lending market (Federal Funds Market) or it can obtain them from the FED.

    Banks pass around (and sometimes borrow) reserves everyday to clear and settle payments. Some of those payments are attached to private checking accounts and sometimes they are tied to loans. The point is that banks don't issue money they create deposit entries by passing around reserves. Fractional reserves baking is not about holding a fraction of your reserves before lending out money it is about use a fraction of the real money to operate a payment system. The fact that some nations require banks to hold reserves on hand is left over from pre-computer days; Canada has a zero reserve requirement.

    Now that I've explained how the bank payment system works lets look at the FED and the Treasury added into the equation. Reserves are held in private bank accounts at the FED. When a bank settles its payments with another bank it is the reserve accounts at the FED that get debited and credited. The compilation of excess reserves in these accounts constitutes the Federal Funds Market. The primary account of the US Treasury is held at the FED also. Any payment to the US Treasury MUST be done with reserves. The banks can not leverage their payment system to pay the Treasury because it exists at the FED. This means bank created money can not be used to fund the sale of Treasury Bonds - reserves must be handed over to purchase a US Treasury (or to settle a tax payment or to buy currency and coin).

    Taking a step back for a moment, banks use reserves to operate their payment systems (as well as buy treasuries; settle federal tax obligations; and buy currency and coin). The FED's primary purpose is to ensure their are always sufficient reserves in the banking system to ensure the payment system does not collapse or become endangered because of illiquidity. How does it do this? The FED sets a target interest rate. If that interest rate should try to deviate (upwards) from its target it knows that the system needs more reserves and they are added to the banking system via an Open Market Operation.

    So know we know that only reserves can be used to buy a US Treasury and that the FED has a target interest rate it must defend (or be in violation of its duty to ensure the health of the bank payment system). When the US Treasury issues a bond it drains reserves from the banking system. Should there not be sufficient EXCESS reserves the FED must add them keep its target rate. The FED is compelled to always ensure US Treasury sales are funded - regardless of the fact that it is legally prohibited from directly buying or funding the US Treasury.

    So why do we do such a crazy thing? Because during the gold standard years the FED would be forced to abandon its interest rate target if it didn't have sufficient gold to create new reserves... but in today's world the FED has infinite reserves and hence NEVER involuntarily looses control of its target interest rate.

  7. Admin (Member) Email says :

    @Adam1 - - -

    If you haven't read it Derryl has more recent article in which he more clearly defines the operation of the U.S. monetary system: U.S. Facing Insolvency by Ignorant Choice. http://econintersect.com/wordpress/?p=17123

    John Lounsbury

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