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.
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.
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:
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.”
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.”
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.”
Solve Debt Problems with Non-Debt Money by Derryl Hermanutz
Coin Seigniorage: One Solution to the Debt Ceiling by Joseph M. Firestone
Casting Sunlight on the National Debt Fraud by Roger Erickson
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)
Banks: Flawed Regulation by Amar Bhide
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