The Flip Side of Debt Free Money

July 15th, 2014
in Op Ed, syndication

Written by

Randy Wray's article - Debt-Free Money: A Non-Sequitur in Search of A Policy - which I can't help thinking was at least partly inspired by a monetary reform offline email conversation we had for a few days before this first came out on the New Economic Perspectives blog - points out the main shortcomings of debt-free money from the U.K's Positive Money group and the American Monetary Institute here in the U.S. (though he doesn't name this second NGO).

Follow up:

He and Ann Pettifor are right to worry that credit will be so constrained if restricted to what banks actually have on deposit (in which case, it might rightly not be called "credit" at all, but just lending-what-you-have) that growth would be throttled before it started.

He is also right to worry about over-centralization and about a Monetary Authority (as the AMI calls it) turning out to be either

  • (A) Just the Federal Reserve by another name; or

  • (B) A truly independent body so immune to outside pressure that it does not provide the economy with funds even when they are needed.

I don't know which is worse, though I suspect Wray, who believes the Fed is part of government already, would say B.

There are, however, other options which allow for true government issuance of money, yet are also independent of out-of-thin-air credit-money creation by banks, but with restrictions to prevent the destabilizing excesses that recur over and over, and lately each resulting in a larger crisis than the last (e.g. the S&L crisis was smaller than the 2008 credit crisis, etc. going backwards).

To set the stage, let's stipulate three virtues of any economic system:

  1. Simplicity - this may seem strange to economists, who seem to live for complexity, but if we are ever to sell this to the public that elects its political leaders, it must be based on simple principles that most will understand.
  2. Decentralization - As Wray points out, the central government or even a special committee can't anticipate overall monetary needs of the economy. And even the perception that the new Monetary Authority is holding back productivity would stir resentment.
  3. Redundancy - some flexibility is needed to change sources of money, or credit, which Greenbackers like me, Stephen Zarlenga, Ellen Brown, Bill Still, etc. maintain is not the same thing, and Wray and MMT do not.

We have a trillion dollar output gap right now, according to the CBO, and we've had it since 2008. One can quibble over exact figures, but that misses the larger point. The banks are not producing money, so government must fill the gap. Wray and the Modern Monetary Theory folks and Greenbackers agree on that much.

I am a Greenbacker in the model of president Lincoln. Lincoln introduced the first federal form of paper money, the first Legal tender, in fact. It was $450m in 3 installments (1862-1863), a form of debt-free money. Yes, originally it was supposed to be redeemable in gold, but in reality that never happened, and by the end of its circulation (Treasury burned the last $239m in 1996), it was not even considered applicable to the national debt, according to the Treasury's own Debt Report, Table III:

That's why the government debt didn't decrease by $239m when the stock was burned. It was as if that money never existed. Talk about government waste!

But the important point is that government did, could, and does issue debt-free money all the time. Coins are an example. Stamps are another, though for limited uses. Neither of these can ever "run out" save for the lack of metal or paper in the world.

Let's take an actual bill to show how this would work. No, not HR2990 - the bill crafted by the American Monetary Institute and put forward by former Congressman Dennis Kucinich. That's too laden down with other things, like abolishing fractional reserve banking and making the FRB part of Treasury. There's a much simpler bill that slightly preceded it, but still came after the Treasury burned its last stock. In 1999, then Congressman Ray LaHood (later Obama's Transportation secretary) introduced HR 1452 (Text of the State and Local Government Economic Empowerment Act).

Section 1 reads:

To create United States money in the form of non-interest bearing credit in accordance with the 1st and 5th clauses of section 8 of Article I of the Constitution of the United States, to provide for non-interest bearing loans of the money so created to State and local governments solely for the purpose of funding capital projects.

...and in more detail:

The Congress hereby finds the following:

(1) As of the date of the enactment of this Act, money is principally created in the domestic economy by banks through the process known as 'deposit expansion' under which credit is extended by banks to customers in exchange for the assumption of an obligation by each customer to repay the amount of any such credit with interest.

Now, the Bank of England and others have recently admitted that deposits do not create loans, rather loans create deposits, but in neither case, are loans interest-free, as this bill stipulates.


(2) The creation of money through the extension of credit and creation of debt, a traditional banking function, preceded the establishment by the Congress of, first, the national banking system and, subsequently, the Federal Reserve System.

This clause is pointing out that Congress was issuing credit even before we had our present day national banking system, and certainly before the Federal Reserve Act of 1913.  In fact, the Continental Congress was issuing money even before there was an America, via the Continentals.  And, as Stephen Zarlenga points out is his seminal work, "The Lost Science of Money," it was primarily British counterfeiting that devalued the Continental, not over-printing by the revolutionary Congress.

(3) The constitutional authority to create and regulate money does not limit the Federal Government to creating money through the production of coins or currency or the process of debt creation but, except for a brief period during the administration of President Lincoln, the Federal Government has not exercised such authority more broadly.

Here the bill dispels the somewhat common misperception that the constitutional clause "coin Money" means to makes only coins, money. This clause in Article 1, Section 8, contrasts with Article 1, Section 10, which allows only gold or silver coin to be produced by the individual states.

A fuller explanation may be obtained by reading University of Montana's Robert Natelson's article here: Paper Money and the Original Understanding of the Coinage Clause

The bill goes on to say how the government retains the right to create interest-free money, and why that would be such a cost-saver for the government and taxpayer:

(4) The creation of money by the banks in conjunction with the Federal reserve banks does not limit the constitutional authority of the Congress to create Government credit funds in the form of noninterest bearing credit to fund a legislatively approved program or prevent the Congress from creating such funds.

(5) The creation of noninterest-bearing government credit funds in measured or limited increments for the purpose of funding capital and environmental projects in the public interest--

(A) will allow projects to be built for 1/2 to 1/3 the normal cost; and

(B) will allow more necessary projects to be built at a lower cost to the taxpayers and at the same time build additional wealth in the communities where such projects are located."

You can read the rest for yourself, but it is clear that money can be created by Treasury, specifically citing the example of Lincoln, and that we OUGHT to do so, to avoid unnecessary interest rate costs (let us also remember that private banks charge above the prime rate, and particularly so on long-term bonds needed to pay for highway projects, where interest may add up to 50% of the cost, as the bill says).

Now, the bill gets a bit mealy-mouthed here:

  • (B) LOAN AGREEMENT- The money referred to in section 3(A) shall be created by having the Secretary of the Treasury and the Board of Governors of the Federal Reserve System enter into a Loan Agreement in accordance with the following requirements:

    • (1) The Board shall lend the United States Treasury an amount up to a total of $360,000,000,000 at the rate of not more than $72,000,000,000 per annum (on a cumulative basis) in each of the 5 years commencing 60 days after the date of the enactment of this "Act."

But, why is this loan even necessary?

President Lincoln didn't have a Central Bank (luckily!) but Treasury was able to issue money anyway. Why can't we do so now? It is because of the Federal Reserve Act and the outsourcing of our constitutional right to "coin Money" that's why.

Let's be accurate about monetary operations, but let's not overthink this either.

Debt-free money is easy to understand.

That's why it's become so popular, not only now, but also in the late 19th century, when the Greenback Party flourished and fielded 3 presidential candidates, including Peter Cooper in 1876. The Party later splintered due to defections to the Democratic Party and lack of viable candidates, but the idea was sound, then and now. Debt-free money worked, and was in fact our country's longest-lasting currency. In contrast, Modern Monetary Theorists like Randall Wray have had an uphill struggle convincing anyone beyond some economists and academics that their system works.

The American Monetary Institute has a deeper critique of MMT than mine here: AMI’s Evaluation of “Modern Monetary Theory” (MMT) but I'm content to let Thomas Edison have the last words:

If our nation can issue a dollar bond, it can issue a dollar bill. The element that makes the bond good makes the bill good.

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