The New Feudalism

Written by Derryl Hermanutz

The author is a student of economic philosophy and frequent commentator on the subject.  This essay was originally written as a discussion comment on Dirk J. Bezemer’s recent article “This is Not a Credit Crisis.”

Dr. Bezemer is certainly on the right track by beginning his discussion with an objective observation of the core of the problem, which is unpayable debt. It is astonishing to see the extent to which so many academics, economists, financiers, pundits, financial journalists, bloggers, advocates, government and monetary officials, and ideologues of the various persuasions, apply their versions of “magic arithmetic” to the numbers of money, believing that somehow the economy can pay the banking system MORE money than exists.

The Babylonians recognized that for every credit there is a liability. In our system, where money is created and issued by the commercial banking system as loans at interest, for every credit of a $1000 loan at 5% interest, there is a corresponding debt charged to the borrower of $1050. The banks create ALL of our money. $1000 was created but $1050 is owed. The banks do not want your economic production in payment, they want money. But the banks have a monopoly on the production of money so the only money that exists is the money they create as loans which they credit to the borrower’s deposit account. The money to pay the interest is never created, so unpayable debt increases each time more new money enters the closed system.

Playing with Marbles

The fantasists believe that by some magic arithmetic the money to pay interest will somehow manifest itself. They believe that normal arithmetic does not apply to money numbers. If banks have an absolute monopoly on the production of marbles, and for each 1000 marbles they issue they demand 1050 marbles in return, any child would tell you it is impossible to pay more marbles than the number that was issued. The child would ask if he is allowed to produce his own marbles to pay the interest and the banker says no, that is called counterfeiting and we enforce prohibition against that. The number issued by banks is all that exists. “More” marbles can only come into existence as more “loans” that demand payment of more marbles than were created. Adding more marbles in this way makes the arithmetic problem worse, not better.

Fantasists believe that “government” somehow creates the additional money that is required to make the money arithmetic “work”. But in nations like the US and Europe where money issuing is a private monopoly of the banking system, governments can only get money by issuing their own debt. Banks can create money to buy the government debt, but then the government owes the banking system principal plus interest just like a private sector borrower.

Monetizing Debt

Then central banks create the money, is the retort. But in fact central banks can only create money to buy debt, to buy “securities”. The debt is not eliminated, merely monetized. The central bank trades a piece of debt for some new money. Whoever owes that debt is still on the hook for paying it. Quantitative easing by central banks provides a “temporary” easing of money’s impossible arithmetic by essentially creating money a second time on the same debt. New money was created by a bank when the debt was originally charged to a borrower, then additional new money is created by the central bank when it buys that debt from whomever it is currently owed to.

Central banks “could” create free money, but they don’t.  (China, to their credit, may currently be doing this.)  Warren Mosler’s modern money theory (see here for example)  is all about using central banking to solve the debt arithmetic problem, but as of yet we are still stuck with the old impossible system.

Michael Hudson has been prominent in explaining the exponential nature of compound interest and the result that a debt-based money system like we use tends by arithmetic necessity toward infinite debt.

The Middle Path

There are several paths such a system can take. One extreme, the status quo, is toward debt peonage for the people and absolute tyranny by the money creators, a new feudal system ruled by plutocrats instead of kings. Another extreme, as advocated by Dr. Bezemer, is wholesale debt repudiation and starting over with a clean slate.

A middle path between the status quo march toward tyranny and a revolutionary debt repudiation is possible and probably the least destructive and most politically palatable.  There are many possible ways of pursuing a middle path but all of them involve government adding free or nearly free non-repayable, non-debt money into the system.

Current Asymmetry

The present system generates more negative numbers as debt than it issues positive numbers as money, so the present money system is negative sum.  But our real economy, the productive economy, is a positive sum value-generating enterprise.  Over time the impossible arithmetic of debt increasingly strangles the real economy, as we are seeing since the financial meltdown of 2008.  Our free enterprise, profit seeking, capitalist economy (the only kind of economy capable of unleashing the enormous human opportunities and wealth we have enjoyed) is being captured by the financial system that issues our money.

The solution is to add non-debt money to make the money system positive sum so it matches the economic system.  Symmetry needs to be restored.

Under existing legislation the Fed is not allowed to directly create money to buy Treasury debt.  Treasury writes bonds and auctions them to the primary dealer (PD) banks who then sell them to the public.  The PD banks pay for the bonds by crediting Treasury’s accounts at those banks, and these bank credits are the “money” that Treasury can then spend; just like when you or I borrow money from a bank and the bank makes the loan by adding a credit to our deposit account.  With QE2, the Fed then offers to buy Treasury debt from the public, and the Fed pays for its purchases by adding credits to the accounts of the bond sellers.  Both the commercial banks and the Fed have the power, under the 1913 Bank Act and the 1913 Federal Reserve Act, to create money in exchange for debt.  That is our money system.  And as has been noted, it generates net negative quantities of money vs. debt.

To make the system positive sum somebody has to have the power to add non-debt money into the equation.  Under current law nobody has that power.  This asymmetry has created an imbalance that has built to the current breaking point.

Permanent Zero Interest Rate?

One solution is that the Treasury could write perpetual bonds at 0% interest, pay a nominal fee to one or more of the PD banks to buy those bonds and sell them to the Fed, and the Fed credits that are written to pay for the bonds could then be cycled through the PD seller to pay for the bonds from the Treasury.  It’s a roundabout way of having the Fed create almost free money for the government.  The only ‘friction’ is the nominal fee paid to the commercial bank in the middle of the transaction, and whatever fees the Fed needs to cover its operating costs.

Perpetual bonds have no maturity date and can be redeemed, or not, at the discretion of the issuer, so Treasury would never “have to” tax money out of the economy to redeem its bonds.  As Mosler explains, increased taxation would remain as Treasury’s mechanism for withdrawing liquidity from the economy if price inflation gets too hot.

Government Intervention in the Free Market?

Once Treasury gets ‘free’ money in this way it can spend that money into the economy in myriad ways.  America’s most pressing “negative money” problem is overextended mortgage borrowers who now lack sufficient incomes to service their debts, so they are missing payments and outright defaulting.  Real estate values have decreased across the board by 20% or more, and about 70% of total bank assets are mortgaged real estate.  Most of the troubled mortgages are high LTV, meaning the banks lent more money than the real estate is currently worth.  So the asset side of the banking system’s balance sheets has collapsed along with real estate values and the system is now technically insolvent.

Without the extraordinary measures the government and the Fed have taken to support real estate and the banks, the banking system would have dissolved first in illiquidity due to the lack of loan payments coming in, then in insolvency when it became clear that liquidating their assets would not generate enough money to discharge their liabilities.

The banking system is bust and is being kept alive by the goodwill of the monetary and regulatory authorities.  So objections to free government money as “intervention” in the “free market” are groundless.  The free market banking system is bankrupt and is on government life support.  It’s time the economy got some of the same kind of support as the financial system is enjoying.

Hundreds of billions of dollars of credits and additional trillions of dollars of guarantees have already been provided by the government and the central bank to the financial system, so we have established the scale of the support America is prepared to offer to prevent a meltdown.  Money, Treasury’s new “free” perpetual bond money, needs to be injected directly into the economy where firms and households can earn it as incomes which is the money they need to service their debts and support their businesses and families.  New Deal style infrastructure reconstruction is one way of injecting these funds into the system.  Direct payments to American households of ‘solvency checks’, funded with free government money, is another option.

The New Feudalism

When “money” is not a binding constraint, as it should never be in a fiat money system where the money is just created as unlimited supply credit numbers and doesn’t have to be mined and refined like limited supply gold, the only constraints on economic prosperity are the capacity of the real economy to produce wealth.  With America’s labor employment and capacity utilization at low levels, there is ample room to expand the economy by spending/investing free money without generating inflation.

It is encouraging to see a vigorous renewal of interest in the classical liberal moral philosophers like Adam Smith and John Stuart Mill. Their elucidation of the mechanics of political economy illuminated the intellectual rebellion against the tyranny of land and rule by the landed aristocracy. Liberalism won. Kings no longer own nations.

Douglas Irwin has described the role that failure to monetize gold had in driving a severe recession into the Great Depression.  A new tipping point could be at hand if debt is not monetized in a way that provides relief to the productive elements of society and not just the financiers.

Our present generation is confronted with a new tyranny of money, ruled by a monied elite. The current possessors of money have no more right to own all the money and use that to rule us than kings of old had a ‘divine right’ to own all the land and use that to rule nations. Let’s hope our generation of rogue economists and intellectual rebels is equal to our predecessors in illuminating the nature of the problem and liberating our nations from this illegitimate rule.

Related Articles

This is Not a Credit Crisis by Dirk J. Bezemer

Did France Cause the Great Depression? by Douglas Irwin

The Deficit Commission and America’s Neo-feudal Economy by Michael Hudson (at Credit Writedowns)

The Government has a Printing Press to Produce U.S. Dollars at Essentially No Cost by Edward Harrison (cross post with Credit Writedowns)

We Must Prosecute Fraud by Washington’s Blog

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Paul Hanly
Paul Hanly

What a joke! (Not this article in particular, but the fact that there is such disagreement among commentators on what the Fed and Government actually do - the basic mechanics of QE, let alone the likely results. of QE) How can there be such uncertainty and dispute about whether and how the US government can create money and about the circumstances in which the government or Fed's actions increase the money supply? Isn't this a question about mechanics of basic transactions? Why hasn't this been made available on the public record by someone who actually knows? Why hasn't Bernanke or other such luminaries being asked durng their presentations to Congress? Frankly, such disputes being ongoing about the operations of the Fed and the government makes a mockery of all the debate about inflation and deflation. The fundamental mechanics of what the Fed and Government do in fact can't even be determined/agreed .

Sanjeev Kulkarni
Sanjeev Kulkarni

"It is astonishing to see the extent to which so many academics, economists, financiers, pundits, financial journalists, bloggers, advocates, government and monetary officials, and ideologues of the various persuasions, apply their versions of “magic arithmetic” to the numbers of money, believing that somehow the economy can pay the banking system MORE money than exists" Absolutely! My sense is that, money and currency has been used interchangeably which they are not. Currency including fiat currency is measure of stored value of money which itself is a function of current and potential future perceived wealth. Interest rates, inflation, Currency Supply [which is dubbed as Money supply M1, M2 M3 et al in Economics], currency rates etc etc are "dependent" variables.


Paul, The Chicago Fed has an online pdf called "Modern Money Mechanics" that lays out all the mechanisms of money creation in the commercial banking system ("the banks") and the central banking system (the Federal Reserve Bank; "the Fed"). It's no secret, and as John writes in his comment, this information is taught in 1st year Money & Banking courses. Most of those courses, of course, are geared toward people who will become bankers or otherwise work in the financial industry, so not a lot of attention is given to the macromechanics of the monetary system as a whole. Buy an introductory textbook, or read the Fed's free online pdf, and it's all laid out in there. Many people have noted that monetary terminology seems to be deliberately arcane and obfuscatory, because the system is quite simple but the way it is described is extremely confusing.

John Lounsbury
John Lounsbury

Paul - - - The problem of confusion has many sources. Let me try to give a couple: 1. There is confusion about what QE is and even Bernanke perpetuates that. He has been interpreted as saying he isn't creating money but simply buying Treasuries. If interest rates never change he would technically be correct because the money used to buy the Treasuries could later be reclaimed by selling the Treasuries. However, if interest rates rise significantly, the value of the Treasuries would be much reduced. For example, the Fed might be only able to get half of the purchase price back when they sell. If they bought $3 trillion in Treasuries and then bought the same back at half price they have, in net, created $1.5 trillion additional currency. In a fractional reserve banking system the resulting increase in liquidity is at least $10 to $12 trillion. This is the scenario that inflation bulls envision. 2. The Fed has practiced QE for many years, just on a smaller scale. Buying and selling Treasuries on the open market by the FOMC (Fed Open Market Committee) is the standard tool used by the Fed on a daily basis to maintain stable montery value/liquidity. This process is described in evry elementary Money and Banking text book. Many holding forth on the QE topic don't appear to even have that degree of understanding of what the Fed does and is doing. There is an interesting series of chat room Instablogs on Seeking Alpha (http://seekingalpha.com/instablog/432123-dialectical-materialist/116171-if-this-is-the-second-blog-on-qe2-i-get-to-call-it-qe2-2?source=commente) that is worth reading through to get a variety of commentary on what QE is and does. Some of the commentary is well informed and some is not, but the reader gets some idea of which commenters are logical and which are emotional. I suggest that you pay attention to the ones that are logical. And the logical commenters don't agree with each other. The reason being that FOMC activity on the grand scale being exercized has never been done before so the process underway is experimental. There are theories of how it will work, but the theories may well miss collateral factors of scale that are not apparent in the historical FOMC activities. Here is a short summary list I left in that "chat room": Hello guys - - - You are talking about some of the QE questions that are important. I'll add my understanding and await correction from others: 1. QE is basically printing money, plain and simple. 2. QE is monetizing debt. 3. QE is not inflationary until it is inflationary. Recognizing that boundary is virtually impossible until well after the fact. 4. QE may help push stocks up, but asset bubbles in a lot of other areas, especially commodities, are a bigger affect. 5. The bubbles produced by QE in the U.S. are also in other parts of the world as well as the U.S., sometimes more elsewhere, because our trade deficit continues to push dollars overseas. 6. All that being said, QE may be useful and far from the worst way to go. Deflation because of the failure to monetize can be devastating. Steve Hansen has been writing some good stuff on QE leakage into the rest of the world: http://econintersect.com/wordpress/?p=2206 and http://econintersect.com/wordpress/?p=2104 . Two other good articles are "Did France Cause the Great Depression" by Doug Irwin (http://econintersect.com/wordpress/?p=2242 ) and "The Myth of Expansionary Fiscal Austerity" by Dean Baker (http://econintersect.com/wordpress/?p=1912 ) There is no road map to the future, and in the current situation there isn't even compass. We are bushwacking with no map and no compass, just a bunch of economic theories all of which have been found wanting in one way or another. Finally, let me get to the point that Derryl was trying to address. He is arguing that the perpetrators of the crisis are being bailed out at the expense of the victims. He is implying the question: Why aren't the perps being penalized and the victims being bailed out? This is related to the points made by Washington's Blog: http://econintersect.com/wordpress/?p=3367 .


  1. [...] I know that many public members of your party who believe that the current administration will enslave us in liberation-theological pan-Africanist Marxism. If you allow the Fed to neglect unemployment, prepare for the banks to buy us in neo-Randian debt-driven feudalism. [...]

  2. [...] The New Feudalism  by Derryl Hermanutz [...]