by Guest Author Roger Erickson
Our seemingly endless drama over national debt, deficits, wage taxes, spending, inflation, individual and corporate entitlements, bank bailouts, tax write-offs, and public spending is enough to keep middle–aged women up at night. However, these issues are all complete shams, used only as “convenient truths” in political dramas. How so? Let me describe just one tiny part of what you won’t hear from Congress, or even FED/Treasury officials speaking in public. Listening to their public statements on currency operations is like listening to a troupe of ballerinas trying to discuss ballistics. It may be gripping theater for naive audiences, but it’s entirely a distraction from the important task of guiding public policy – which actually matters. As a consequence, what we get is fraud, innocent or not, where enough, incoherent politics successfully masks random and hidden policies serving no public purpose whatsoever.Nearly all of what follows is paraphrased, directly or indirectly, from often terse jargon published by Warren Mosler. The history of this confused topic goes back to BC China, John Law, our pre-revolutionary “Continental” currency, Abe Lincoln’s “Greenbacks”, FDR, Marriner Eccles, Beardsley Ruml and many, many others. That literature is too large to reference here, but interested readers may contact the authors mentioned, through GEI comments and/or through the editors.
Paraphrasing Clausewitz, it is impossible to understand all the details of modern monetary discussions without an overarching theory for how and why our fiat currency system now operates the way it does. Simply put, a currency system is a distributed bookkeeping tool for increasing the quality and pace of distributed transaction decisions in an organized group. Nothing more and nothing less. What are some of the key features of our current currency system? There’s too much to go over in one draft, so I’ll start with 3 key tenets of a fully fiat, floating-Fx, non-convertible currency: 1) loans create deposits; 2) loans create reserves; and 3) Treasury Securities are not “debt”.
Section 1 – LOANS CREATE DEPOSITS
Given the usual presumption that banks in a national, fiat banking system still “create money out of thin air,” it is necessary to defuse this semantic quagmire, by reminding readers of the different context for currency issuers and currency users within convertible vs. non-convertible currency systems. Reality is that when diverse banks act as middlemen for transactions, they credit the accounts of sellers while also debiting the accounts of corresponding buyers. Have they actually created new currency? No, the net always sums to zero. In our current system, only the US Treasury credits without any matching debits, and hence creates net, new financial assets.
Note the massive confusion from conflating bank debit/credit recording vs. currency creation by our Treasury! Many are totally confused over this simple fact. To view total confusion in action, see the middle sections of this alternative blog..
One way to bypass the nonsense? For many, debits/credits that sum to zero, but yet are denominated in currency … are termed endogenous instead of exogenous money. (It’s always amusing to see how easily gridlock caused by BS, is defused by additional BS. There’s a Dilbert cartoon specifically on this topic; “The great thing about absurd logic is that it fits any situation.”
There is a very condensed summary of all 3 tenets at Winterspeak, although, comically, the author actually gets “credits” & “debits” reversed, and doesn’t draw all possible conclusions. (See the comments!)
Many additional references may be found online.
Section 2 – LOANS CREATE RESERVES
Ask yourself why banks still monitor “reserves,” after we transitioned to a fully fiat monetary system? Post 1933, the answer is that the sum of private debits/credits at all banks must be registered with the FED, so it can track currency supply, as the sum of currency needs/surpluses from all banks.
What is a bank “reserve”? With the transition from a gold standard to a fiat standard, the prevalent semantic definition simply changed, though few noticed! We’ve grossly confused the meaning of “bank reserves” over the years, and we’re suffering from semantic drift across the electorate. Bank reserves used to mean – to everyone – financial assets held in reserve. Now, at least to bankers, it specifically means notations solely in the inter-bank settlement system run by the Federal Reserve bank – the only issuer of bank reserves. Most of that whole inter-bank settlement system involving “bank reserves” could go away if some key banking operations were simplified.
In primitive currency systems, currency was something people thought even the issuer had to first get, in order to issue. In reality, the root source of all currency always was and always will be the public will to both create it and to also accurately control supply of it. As such, a nation’s currency is ultimately backed only by public will and public initiative. Nowadays, bank reserves essentially mean a nation’s will to accurately track how much credit, currency & fraud that nation has in play at any one time. One recurring problem is that we’re trying to manage credit-access indirectly, largely by controlling currency supply. Mosler refers to this repeatedly, saying that “The liability side of banking is not the place to enforce market discipline.” An immediate implication is that both the credit-rating and fraud-regulating sides of banking are what should be more formally defined, tracked and regulated.
That outcome quite obviously fuses the inseparable topics of currency, credit rating and fraud. See William K. Black.
Any way that those 3 topics are parsed, it’s obvious that we can’t scale up a public currency system without a distributed credit rating system, and we can’t scale up a productive credit rating system without scaling up an effective, distributed fraud regulating system. Currency, credit and fraud control are 3 legs of the same stool supporting growth of public commerce.
What is the limiting function of bank reserve processing in our current system? Arbitrarily, only large “Primary Dealer” (PD) banks have full reserve account access at the FED. This just dates from the days of paper records keeping, when it was costlier for the FED to manage many vs. fewer accounts. That cost is now negligible, and working through PD delegates is a cost, not a savings to national commerce.
When large, PD banks make loans, they can always match them via access to currency reserves “virtually borrowed” from the FED, at its discount rate.
When small banks make loans, they must match them with reserves instead “virtually borrowed” from other, usually big, banks at higher rates, easily cartelized.
In both cases, interest paid on reserve acquisition is essentially a cost applied to tracking of banking activity by the FED and its intermediaries. This used to involve physical movement of actual paper/coin currency. It was the physical movement of currency that bogged down during the infamous banking runs of the Great Depression, not the will of the electorate to execute transactions. Basically, our national currency bookkeeping system proved inflexible and inadequate; therefore it crashed and was fundamentally redesigned in 1933. As with any system re-design, however, multiple bugs were left to fester, and some are still present today. They can and should be fixed, to further simplify our currency system, and thereby lower net economic drag slowing our rate of increasing adaptive output.
For example, some of Mosler’s suggestions are to simply open the FED window to any size bank, and to permanently lower to zero the cost of moving numerals between separate bank spreadsheets.
Section 3 – TREASURY SECURITIES ARE NOT DEBT
Ask yourself several questions. Why, exactly, does the US Treasury issue Treasury Securities? Have they always done this? When they did in the past, were the duration and rates always set at auction, or simply fixed? Finally, re-ask the fundamental question: Are Treasury securities a real “debt?”
In reverse order, the answer to the last question is no, they’re simply additional fiat credits from the US Treasury. Only the Treasury – as fiat currency issuer – credits without any debits, and hence creates additional currency. Where there’s no prior debit, there’s no debt, only additional fiat for which the only possible danger is eventual inflation or deflation. We depend on the U.S. Treasury to keep our currency supply within tolerance limits, neither too much nor too little. The purpose of a currency issuers budget is not to balance fiat, but to optimize economic growth. A fiat currency issuer should optimally NEVER have a balanced currency budget – i.e., a fixed currency supply. Currency supply should grow constantly with population & economic growth.
So why does Congress still require the Treasury to issue securities linked to currency creation? It simply has to do with an outdated method for handling excess banking reserves, i.e., a bug in the inter-bank settlement system. Here’s a quote from Winterspeak, with my additions [in brackets]:
Suppose the system as a whole has excess reserves? In this case, the Fed sells treasury securities, which enable banks to transfer [surplus] assets from their reserve accounts (at the Fed) to their treasury accounts (also at the Fed). The Fed sells treasuries not to “finance” the deficit, but to drain the system of excess reserves, so there will be overnight lending [to small banks without access to the FED window!], and thus, a non-zero interest rate. If the Fed did not drain extra reserves from the system, [large] banks would not lend [to small banks], and the overnight lending rate would be zero.
If that, to you, is no answer at all, don’t feel alone! If. instead, the FED simply opened its window to all banks, not just PDs, and then fixed it’s interest rate at zero, no bank large or small would have to pay to “borrow” bank reserve notation, and the FED wouldn’t have to worry about controlling the inter-bank interest rate. Voila! No need for Treasury Securities at all!
Twenty First Century Currency with Nineteenth Century Rules
You can’t make this stuff up! It’s like your aunt saying she has to cook small hams in a particular shape in her big, modern oven because that’s the way her grandmother cooked them in her tiny wood stove! Rote recipes can be adjusted as contexts change. Adapting group methods per altered context is the definition of group intelligence. Given the list of what our electorate and Congress actually are changing, they seem to have lost what little group intelligence they had. Right now, our electorate is the shooter, and individual citizens are the left foot in their own crosshairs! If you don’t like the group target, just insist that the @#$%&! aiming method gets changed! The sooner the better.
But what, you might ask, about draining those excess bank reserves from the inter-bank settlement system? Just do what Canada did, and simply get rid of reserve requirements. Banks will still have to report their licensed credit/debit/accounting decisions, which the FED can still track, but in a fiat currency regime, there’s simply no need to actually operate a parallel, inter-bank account system called “bank reserves”. Our current bank reserves represent a system bug that can be more elegantly addressed through more modern, more direct methods.
Our public confusion stems only from legacy accounting semantics from the brief and disastrous Gold Standard days, when the Treasury was required by law to “debit” its own accounts by a small fraction, and credit the account of some plutocrat hoarding gold, whenever it created currency for public spending. In reality, it was still crediting two accounts, its own and that of the previous gold owner. The matching, only fractional, purely semantic “debit” was some gold hoarder debiting their stock of gold. Note that crediting of Treasury accounts (currency creation) was eventually matched by some fractional degree of gold “debiting” from holes in the ground – i.e., gold mines. It was an arbitrary choice. It could have been silver, platinum, quartz, maybe even old arrowheads.
On a gold standard, a nation runs a constant deficit in the form of steady gold extraction from mines. During times when demand for gold changed to cause a surplus, we didn’t put gold back into mines. Instead, we belatedly adjusted the fractional currency value arbitrarily assigned to gold. Such a system invites massive opportunities for fraudulent arbitrage that distract attention from productive output, even more so than does the fraud rate we have today. Yet several relics of arbitrary gold standard habits are now tradition. They are slow and confusing to change, just when a faster pace is needed yearly in order to adapt to changing contexts. If we don’t re-examine why we started doing something, we don’t know when we can stop doing it, or when it transitions from utility to a complicating system bug!
Mosler sums things by saying that: “All government spending can be thought of as printing dollars, taxing (un-printing dollars), and [supposed] “borrowing” (shifting dollars from reserve accounts to securities accounts).”
It’s much clearer if you repeat that as creating currency, destroying currency, and shifting currency from reserve to securities accounts. Why so much to-do over so little?
Borrowing is the Wrong Term
Unfortunately, Mosler’s original jargon still mixes a key metaphor – “borrowing” – that immediately elicits inappropriate associations from the bulk of the populace – thereby opening the way for divisive financial and political arbitrage, based entirely upon semantic confusion. Since there is no lack of quick witted people more than willing to unproductively separate slow witted, disinterested or distracted people from their assets, it’s also clear that Roger’s General Corollary of Mosler’s Banking Law holds, “The policy side of public discourse is exactly the right place to enforce semantic discipline.” We have a few thousand defined professions. In each case, the operational side of profession-specific jargon is not the place to enforce market-coordinating semantic discipline. The policy-alignment side, however, certainly is.
Fraud, the Final Frontier
In his famous debt-deflation theory of depressions Fisher noted that private debt cycles always progress to “the development of downright fraud, imposing on a public which had grown credulous & gullible.”
Sounds familiar, but it’s not about public debt under a fiat vs. gold standard.
Under a fiat monetary system, public net currency issuance and private debt are necessarily out of phase, since one is issuer and the other user/saver of state currency. If a growing nation wants a growing number of distributed transactions to occur at an unhindered pace, then it is necessary to have an incessantly growing currency supply, which we erroneously refer to as public “debt,” even though it is not even a debt in any real sense of the term. A political decision to offer Treasury Securities on newly created currency does not make them a debt. It is simply a decision to create more currency. Do lobbies clamoring to lower what they disarmingly claim is public “debt” even realize that what they’re asking is actually to lower net private savings and cause a general shortage of currency for commerce?
Or is an outright semantic fraud – that Treasury Securities are public debt – the last indicator of a Fisher cycle depression coming on? Crooks have simply added yet another fraud to the colossal mortgage banking Control Fraud. Our public is credulous and gullible indeed, even in 2011.
Note: Even the halfway step of allowing the FED to simply pay interest on bank reserves would obviate the need for Treasury Securities, as Warren Mosler has also pointed out. Treasury would still have to create enough currency to meet the nation’s needs for ongoing transactions plus net private desire to save liquid assets in the form of currency. Nevertheless, it would be better to remove all identified system bugs, not just some.
No matter what adjustments we make in our fiat currency operations, would some frauds, known as Deficit Terrorists, still find something to call a National Debt? Count on it! It’s a perennially profitable virtual protection racket, shielding us from straw men. It’s run by grossly overpaid accountants trying to preserve and grow entirely undeserved financial siphoning rates. It is a tool of the rentiers and a fraud on the citizenry.
The only effective method of controlling this form of fraud is our group ability to discern frauds crying wolf. Otherwise, a foolish population and both its resources and operational coherence are soon separated, by extreme wealth disparity.
A Bum Debt Deal – The Morss Antidote by Elliott Morss
Bank Capital is Illusory by Raihan Zamil
Coin Seigniorage and Inflation by Scott Fullwiler
Understanding the Modern Monetary System by Cullen Roche (at Pragmatic Capitalism)
Money and Trading 101 by Stephanie Kelton
Aggregate Demand and Austerity by Scott Fullwiler
Investors: Looking at a Post Debt Ceiling Crisis World by Warren Mosler
A Congressional Card Game by Warren Mosler
From Stimulus to Austerity – What Role for Taxes? by ElliottMorss
Inequality, Leverage and Crisis by Michael Kunhof and Romain Ranciere
Is Ignorance Bliss? A Look at U.S. Income Inequality by Elliott Morss
Austerity Rather than Stimulus? Wait a Minute! by Elliott Morss