By J.D. Alt
Why do so many people—including the authors of most economics textbooks—believe the U.S. banking system creates the U.S. dollars we earn and spend and pay our taxes with? It’s because the U.S. banking system does, in fact, “issue” the great majority of the dollars we use—by making loans to businesses and citizens which are not backed by “real” dollars the banks have on deposit. What everyone overlooks, however (for reasons not entirely clear) is the fact that these new loan dollars are “made real” by the U.S. government’s solemn promise to convert them at any time, on demand, into actual, “real”, sovereign U.S. dollars. The U.S. government is able to make this promise because, by law, it can issue the necessary actual dollars by fiat (by simply “declaring” the dollars into existence.) A lot of people (again for reasons not entirely clear) don’t like to hear that last part. But it’s simply a fact of life: the cash dollar bills you get from an ATM machine are not printed up (created) by the banks—they are printed (or created electronically as needed) ONLY by the U.S. sovereign government.
This seamless transmutation of bank dollars into U.S. sovereign dollars has the unfortunate side-effect of hiding the real distinction between the two kinds of money—a distinction (I think) I’m now starting to get a handle on: Bank dollars are created specifically to facilitate the production and exchange of private goods and services. Sovereign dollars, in contrast, are created to facilitate the production of collective goods and services—and, furthermore, one of the PRIMARY collective goods the sovereign dollars create is the private banking system itself (which, as we have just noted, is made possible and viable by the promise of the sovereign-issued dollars.)
Both kinds of dollars represent a “debt”—but the debts they represent couldn’t be more different. Bank dollars represent an I.O.U. the business or citizen who received the bank loan owes to the bank. Sovereign dollars represent an I.O.U. the U.S. sovereign governmentowes to the citizens—specifically, in issuing its dollar, the sovereign is saying: “I owe the bearer of this dollar one dollar’s worth of cancelled taxes.” To repay their I.O.U. to the bank, businesses or citizens must use something (dollars) which they, themselves, cannot legally create—and for this reason they logically cannot spend more than they earn without getting into financial difficulty, defaulting on their I.O.U. and, ultimately, declaring bankruptcy. To repay its I.O.U. to the citizens, however, the sovereign has no such constraint: it does not have to create anything at all, but simply “cancels” a citizen’s or business’ tax liability—and it furthermore has the legal authority to create new tax liabilities to replace the ones that have been canceled, and to issue more of its I.O.U.s (sovereign dollars) as the need arises. The U.S. sovereign government, then, can, does—and, in fact, must—issue sovereign currency by fiat on a continuing basis to keep the whole monetary system (including the private banking system) rolling along. This fact, however, is hidden—and the hiding of it causes enormous confusion and dysfunction in our collective governance.
The obscuring of the distinction between sovereign dollars and bank dollars—and the fact that both kinds of money run simultaneously through the U.S. banking system without any distinction at all—gives rise to the confusing illusion that, in fact, only ONE kind of money exists—the bank dollars we see ourselves earning and spending and borrowing every day. The sovereign’s operation of issuing its fiat currency is, somehow, completely “invisible”. This concealed reality, in turn, gives rise to the even greater confusion that collective goods and services (those which are paid for by the U.S. sovereign government) must therefore, by logic, be paid for with the bank dollars as well (the only kind of money we think exists!) And how will the sovereign government obtain the bank dollars it needs to pay for collective goods? It must (obviously) collect them in taxes—or alternatively borrow them from the private sector economy.
Thus we imagine that, as a collective society, we pay ourselves to create collective goods and services by the following convoluted process: (a) banks make loans to private businesses and citizens, (b) the sovereign government converts those “loan” dollars to real dollars, (c) the sovereign then collects some of those real dollars as tax payments which it then (d) pays back to the citizens in exchange for the needed collective goods. A few moments of reflection should reveal why this imagined reality is, at its deepest level, impossibly illogical:
Step (b) acknowledges that the sovereign power, in fact, creates the “real” dollars by fiat (out of thin air)—however the quantity of “real” dollars it creates is implicitly limited by the willingness of U.S. citizens and businesses to borrow bank dollars. This, in turn, following steps (c) and (d), limits the quantity of dollars the sovereign can obtain to buy collective goods and services. By what logic, however, should the sovereign’s spending for collective goods and services be limited by what U.S. citizens and businesses are willing to borrow from banks for the purpose of creating private goods and services? If the sovereign government can, in fact, issue fiat dollars as needed (since they are only a promise to cancel federal tax liabilities) why should it be limited to issuing those fiat dollars ONLY to make bank dollars “real”? Why should it not, indeed, as a matter of course, issue sovereign dollars DIRECTLY to pay for the collective goods and services that American society needs?
Before considering the likely objections to such a “wild” suggestion, let’s observe how the confused and obscured configuration of reality just described sets the stage for two serious missteps in our collective governance:
First, many things which, by common reason, ought to be treated as collective goods and services (and therefore paid for by the sovereign’s direct issuance of fiat currency) are instead relegated to private, profit-seeking markets. This happens because of the obvious fact that if the sovereign collected enough taxes to pay for the needed goods and services, the citizens would have little money left for their private expenses! The second misstep occurs with needs which are treated as collective goods and services because (a) they’re essential to society’s survival or prosperity, while (b) private markets see no profit in producing them. Spending on these collective goods are skimped to the very minimum because of the belief the sovereign cannot be allowed to “borrow” beyond some theoretical percentage of its expenditures. These two missteps in public governance—generated by our confused construction of monetary reality—are colloquially known as “privatization” and “austerity”.
An example of the first misstep in the United States is higher education (and increasingly preK-12 education as well.) The most basic of common senses should tell us that a great collective benefit is obtained when every young adult citizen receives a secondary education—whether college or trade-school—as a matter of course. In the U.S., however, since it is obvious the sovereign government cannot collect enough taxes to pay for college or trade-school for every young adult, secondary education must be treated as a commodity provided by private markets—and paid for, by the way, with the “loan” dollars created by banks. The serious long-term social damage being done by this misguided perception is evidenced by the fact that the “value” of education itself is now being questioned! What will America gain if increasing numbers of young adults decide to enter the job market, and begin families, without any special training or skills beyond what they learned in high-school? And for those who do choose to borrow the bank dollars to acquire some special skill, what benefit does America gain when they begin their careers forty thousand dollars in debt?
The second misstep (austerity) is exemplified by the U.S. national and regional infrastructures—roads, bridges, electrical grids, water and sewer systems, etc.—which we collectively use and depend upon every waking and sleeping moment of our lives. The American Society of Civil Engineers has recently calculated this public infrastructure requires $3.6 trillion worth of maintenance and repair over the next six years—just to maintain the operational capabilities it has today! Again, the sovereign U.S. government is obviously not going to collect an extra $3.6 trillion from tax-payers to pay for this work—nor is private industry going to borrow the bank dollars to do it either, since they cannot make a profit in doing so. According to our confused and convoluted monetary logic, the only option available is for the sovereign government to borrow the $3.6 trillion from the private markets. But how can we, by logic, allow the government to do that when we know the government can never collect enough tax dollars to repay what it has borrowed? We are placed, then, in a kind of existential dilemma wherein the actual resources necessary to repair and rebuild our collective infrastructure are available (and waiting), but the U.S. sovereign government can’t tax or borrow enough dollars to employ those resources to accomplish the needed work.
With each of these examples I seem to be suggesting that direct sovereign spending—the issuing of sovereign fiat dollars to pay for collective goods and services—ought to be buying things which, by any measure, seem astronomical in “cost.” $3.6 trillion is the bill for just repairing our infrastructure. Modernizing our infrastructure to meet the pressing needs we face in the near future—flooding coastlines, water shortages, non-fossil fuel energy systems, for example—will cost at least that much again, and likely much more. The current student debt for higher education tops $1.2 trillion. After retiring that out of hand, what would be the further “cost” of paying for a secondary education for 21 million college students every year? The numbers seem staggering—and what would be the result IF Congress directed the U.S. sovereign government to simply issue the required dollars, by fiat, and SPEND them?
Well, one set of results would be that our young-adult citizens would stop dropping out of the skilled labor market, we’d get our bridges repaired and maybe a good start on preparing for and mitigating against rising sea-levels. Another set of results would be that a very large number of teachers, educators, bridge repairmen and flood-control engineers (to name just a few) would get paid new fiat dollars for their services—perhaps, in aggregate, lowering U.S. unemployment by several percentage points. What would the objections be to these results?
The primary objection, of course, is that issuing and spending all those new sovereign fiat dollars would dilute the value of U.S. currency, creating hyperinflation, sky-rocketing prices, and economic chaos. But shouldn’t we ask the simple question: What is the difference between the banking system creating new money by issuing “loan” dollars, and the sovereign power issuing new money by fiat? Framed by this question, it’s easy to see that the issue of inflation, in fact, has nothing to do with who is issuing the new dollars, but whether the new dollars issued are actually put to a use that results in the creation of new goods and services. Historically, every instance of hyperinflation has arisen because citizens have been paid a great deal of “money” without producing anything they can spend it on.
Inflation, then, cannot logically be a de facto objection to direct sovereign spending for collective goods. So long as the spending employs unused resources that are actually available—labor, materials, energy, technology—and so long as it contributes to the production of new goods and services that people can actually spend their new dollars on, the only things “threatening” us would be social progress and a level of prosperity our myopic confusion about “money” cannot even dream of.
If I was President I would say, “That’s it on the predatory banking system, and on the hoarders of wealth. There are two acres of arable land per person in this country and more resources than anywhere else on the planet. We have long since paid in full for America and each one of you is now free of tax obligations, free of mortgage and fiat debt obligations. You are free. Take your share of land and resources and work together to create a new social design that includes everyone as a valued member of our human family. Create something that doesn’t ‘require’ jobs for your existence, instead provide each other with free health care, free education, a healthy food supply, and just and wise local government. Build your economy, if you want one, upon the bedrock of a stable and secure population of truly free people. All laws are cancelled. You must make your own laws based on social agreements with each other. All wars are cancelled and we will maintain an army for defense purposes only in case some group decides to invade. That’s it. My job is done. I’m spending the rest of my term on vacation. Now pull yourselves up by your own bootstraps since you now have something to tug upon. I love you. Bye”
Trish, thanks so much for the beautiful piece of poetry! The idea that we’ve “paid in full” for America is….an interesting thing to contemplate! I don’t want to look at the past, though–it’s not pretty, how we “paid” for it all. Actually, if there was a neutral arbitrator, She could easily decide we needed to give it all back. But we could take small steps to redeem ourselves, right? I am in love with your idea of the” bootstraps we now have something to tug upon!” It is exactly those bootstraps I’m looking for…! Thx again. JDA
This is an elegant argument for the government to issue “debt-free” money for public purpose expenditures while requiring the market to issue credit subject to competitive forces for money expansion for private purposes. I have argued for the discussion of “public money for public purpose and private money for private purpose” for some time. This is why the “trillion dollar platinum coin” idea was such a worthwhile concept for discussion – it was centered on that hypothesis.
Of course the determination of the actual working mechanics is not trivial. Ultimately this system would have similar control issues to our current one: How do we get the amount of money needed for expanding an economy without creating so much that the economy is inflated?
As you point out, the increase in money needs to avoid creating “a great deal of “money” without producing anything they can spend it on”. If the amount of money is kept in balance with production of an economy, currency valuation remains quite stable. That’s great in theory but not so easy in practice. If taxation is used as a primary means of draining monetary excess the execution becomes problematic because taxation is a political process – and the political process has been assigned to the domain self-absorbed elected individuals.
I think you have moved the discussion forward with this article. Let’s hope it continues.
We already issue your version of “debt-free” money, they are called US dollars. All money is a liability of the issuer. Reserves are a liability of the Govt, as it owes you that amount of tax payment or Govt service. All T-securities are a liability of the Govt as they owe X amount of reserves.
T-securities are not debt in any meaningful sense.
Isn’t any financial liability a debt owed? Isn’t any financial asset a claim on debt?
So, perhaps we should better classify debts as those requiring interest and those that are “interest-free”.
That implies the popular term “debt-free money” would be more correctly called “interest-free money”.
Of course we are conflating the terms “credit” and “money” in this discussion, but in a practical sense they fulfill the same economic purpose in a fiat world.
I would argue that we should not be arguing. 🙂
“Isn’t any financial liability a debt owed? Isn’t any financial asset a claim on debt? So, perhaps we should better classify debts as those requiring interest and those that are “interest-free” ”
Yes, in a sense. But what you are missing is the most important part. When you and I have debt, we need to use our assets (bank deposits) to pay off our liabilities.
The Federal Govt pays off its liabilities (T-securities) with its own liabilities (reserves). And its the only entity that can do that.
“That implies the popular term “debt-free money” would be more correctly called “interest-free money”.”
That sounds good in theory, but there is a problem. Now that the Fed pays interest on reserves, all Federal Govt liabilities (save cash) pay interest, so if we were to use your definition, then there is no federal Govt debt-free money (save cash). So that definition is a little problematic.
I believe you should take some time and research the many commentaries throughout history and especially modern history regarding the creation of money and who is in control of that process. You will find enough evidence supporting the idea that who controls the issuance of money controls governments and society at large. Private banks create money in order to benefit private banking and those in control of it. The creation of money by sovereign governments can always be made to benefit public good first and foremost. I do not believe that will ever be the case when the vast majority of it is created by private interests.
Its just a matter of politics. If every single person in the USA understood MMT, do you really doubt that Govt spending would not be used for the “benefit public good first and foremost.”?
Its not a matter of fundamentally changing the system. The foundation is already in place, its the ignorance and apathy of the voting public that is holding us back. Which is of course what the MMT project is all about, trying to educate the populace so we can actually take advantage of our national financial freedom.
so… if the soverign creates money by fiat, then the soverign is the true creator of ALL wealth, and then it can just create more money to create more jobs to create more wealth for the governed! Right?
But what does the soverign do with the wealth it creates? Something government wants the governed to ignore!
That something is detrmined by the TAX CODE as 99.99% of the governed, who are the true creators of ALL wealth and jobs, are used by the soverign for the benefit of those in control of the money!
All economists simply champion the interests of the .01% who know government is not about the people!
Always and everywhere government is about the money and who gets to keep the most! Something always determined by government, however organized no matter what its called!
Jim, I believe you misconstrue the nature of fiat money. Fiat money and wealth are NOT the same. I’ll give you a very simple example. Lets assume you have 100k in your pocket and a nice lot is for sale in your town for 100k. You like the lot and it is wealth. You can exchange your money for the wealth but the money, the fiat money is not wealth in and of itself. You can have the wealth represented by the lot or keep the money. You cannot have both. Back when gold was used for money, money was indeed wealth too but in this era of fiat money the very nature of money has changed. That is the very hard point for people to get into their heads. Fiat money is a basically free commodity to the issuer of the money which in our monetary system is the central bank. MMTers will argue that the CB is a part of the govt but they clearly serve banks and not the people of the nation as clearly shown in the Feds QE programs that fixed the bank problems but left main street dangling. Banks do not and cannot add money to the economy. For every loan they make they take back an equal amount plus a little more called profit from interest. The alternative is for banks to operate without profits which would keep the money supply constant. The CB is the only institution that can add money to the economy. The govt is self constrained by the bean counter rule that spending must equal the sum of taxes plus treasury sales. This points up the fundamental problem with our monetary system. The CB can issue fiat money but does not have the tools needed to control the money supply, ie spending and levying of taxes. They govt has those powers but not the power of issuing money except by coin. The T$ coin issue was a very serious notion to consolidate the taxing/spending/issuing powers under one roof. So in conclusion we should either give the CB the prerogative of setting the national budget and levering of taxes or the govt should take on the responsibility of issuing money into the economy and curtail that power at the CB. It should be noted the govt did exercise its basic right to issue money other than coin until 1971 when the issuance of US Notes was stopped.
Whenever you pay your taxes from your bank account, money has to be subtracted from your banks account at the central bank. Straightforward enough to see why tax obligations can’t be met with money purely created by banks.
But, how do things exactly “work” in Euroland? Since the “ECB only lends money into existence” wouldn’t all checking accounts at the ECB allways be overdrafted to begin with?
Good exposition. However, I’m always at a loss on how to explain the difference between looking at the system with MMT eyes and what it was like under the gold standard. How would you fit this idea into what happened economically say 100 years ago?
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The only thing I think might be a little confusing to some people is your distinction between bank money and sovereign money. Here you’re distinguishing based on how the money/IOU is originated (whether by private debt or government IOU ‘debt’). The confusion could arise because other people talk about a distinction between bank money and government money but they’re making the distinction based on the form it exists in (whether bank account balances or cash, etc.). You can see the difference because plenty of government-originated sovereign money exists in the form of private bank deposits; the relationship is just that the bank owes you a balance because the central bank owes them a balance of reserves.
For instance, here is a part of the Bank of England piece on modern money creation:
“Broad money is made up of bank deposits — which are essentially IOUs from commercial banks to households and companies — and currency — mostly IOUs from the central bank. Of the two types of broad money, bank deposits make up the vast majority — 97% of the amount currently in circulation. And in the modern economy, those bank deposits are mostly created by commercial banks themselves.”
And for example, the Positive Money people often misquote this and state that 97% of money in the economy is created by private banks, which is your money origination definition, but the BoE is just talking about the form that money is existing in (bank deposits vs. cash). So the people misquoting this are missing the bolded sentence and the word “mostly” (which I’m not sure how much is actually originated by private bank loans, I’ve heard more like 65%-75%). All bank deposits are IOUs/liabilities *of the banks* as the BoE states , so the difference is whether the assets they’re matched against are private loans (IOUs *to* the banks) or reserves at the central bank (depending on how the money was originated).
Just thought I should bring this up as a potential case of ambiguous terminology as we all try to refine how we understand and explain these concepts.
“Of the two types of broad money, bank deposits make up the vast majority — 97% of the amount currently in circulation. And in the modern economy, those bank deposits are mostly created by commercial banks themselves.”
This is actually a dated figure. It doesn;t take into account the relatively large changes in this percentage that have come about as a result of QE.
Here’s an example (assume no spending goes to banks, and banks dont pay any taxes nor buy T-securities):
The Govt spends $1 trillion, this adds $1 trillion of reserves to the banking system. Which leads to the banks crediting $1 trillion worth of bank deposits to the recipients of the spending.
During the same period, the Govt taxes $500 billion and issues $500 billion in T-securities, both of these activities reduce that amount of reserves and bank deposits.
So the net effect on the number of bank deposits its zero for the period.
During QE, the end result is as if the Govt never issued the T-securities in the first place.
Say the Govt does $500 Billion in QE for the period. The Govt would still have added $1 trillion in bank deposits and reserves, but they would have only removed $500 billion worth of reserves and bank deposits.
In our example, with no QE, the Govt would have added zero bank deposits for the period, so the banks would have created 100% of the bank money in the period. But with QE the Govt would have caused $500 billion worth of bank deposits to have been created. As you can see, this is quite a different situation.
Well QE is almost entirely affecting the monetary base (reserve balances) and not broad money (private bank deposits). Or are you saying in your example that private citizens are buying treasury bonds at auction and holding them directly, rather than through bank or bank-like intermediaries that have reserve & security accounts at the central bank? I’m not sure it works like that, or if so, that’s not a majority of QE’s activity (almost all appears to be asset swaps between reserve & security accounts at the fed, and thus having no impact on broad money).
“Well QE is almost entirely affecting the monetary base (reserve balances) and not broad money (private bank deposits). ”
The only way for QE to not have an impact on private bank deposits, would be for the Fed to have only “bought” T-securities from financial institutions that have accounts at the Fed (banks mainly). This is not the case.
“Or are you saying in your example that private citizens are buying treasury bonds at auction and holding them directly, rather than through bank or bank-like intermediaries that have reserve & security accounts at the central bank?”
No, I am not saying that.
If you buy a T-security (not through TSY direct), then the bank debits your bank deposits, and you get a credit in a securities account at the Fed. Your bank’s reserves are debited an equal amount also.
The amount of private bank deposits and reserve deposits go down.
Now, if the Fed “buys” your T-security, your securities account gets debited, and your bank deposit gets credited (private bank money). Your bank also gets its reserve account credited.
The amount of private bank deposits and reserve deposits go up.
This is how QE adds to the supply of private bank deposits in conjunction with the reserve impacts. But if a bank is doing the buying and selling of T-securities itself, then only the number of reserves change.
So reserves go up
“I’m not sure it works like that, or if so, that’s not a majority of QE’s activity (almost all appears to be asset swaps between reserve & security accounts at the fed, and thus having no impact on broad money).”
This is exactly how it works. As for the composition of who is “selling” their T-securities, I don’t have time to look that up for you, as it doesn’t really matter. I’m just giving you the accounting and operations.
“As for the composition of who is “selling” their T-securities, I don’t have time to look that up for you, as it doesn’t really matter.”
I think this is precisely what matters. I don’t actually know the figures, so it would be helpful if you could share yours. I’m just going off of what I believe all the MMT economists state, and what has seemed to be backed up by the evidence of outcomes: that QE is not pumping money into the broad economy because the Fed is buying securities from the financial institutions (banks and bank-like entities) who have reserve accounts for the asset swap to take place into.
Your claim is that private individuals who have managed to buy treasury securities directly (well, done on their behalf through their bank) are now having their bonds bought back by the fed (voluntarily by both parties), injecting reserves back into their bank and thus their bank increasing their private accounts. This could be potentially increasing the level of effective aggregate demand in the economy as it liquidates private savings (the Fed certainly wishes QE would directly stimulative in that regard). Or at least there must be some reason that anyone would agree to sell off their treasuries, either so they can use the cash to spend or chase even higher yields somewhere else. Where have you found the breakdown for who is on the selling side of QE?
Auburn Parks, in your example of the government spending $1 trillion, you write
Taxes don’t figure into it; taxes destroy currency in the system. According to former Deputy Secretary of the Treasury, Frank N Newman in Freedom From National Debt (2013):
MRW-
If you go through the accounting, the end result is the exact same when the Fed does QE as it would be if the Govt never issued any T-securities at all.
Stephanie and Scott lay out it in a great way in this post here:
http://neweconomicperspectives.org/2013/12/krugman-helicopters-consolidation.html
Auburn Parks,
I think I owe you an apology. Frank Newman also wrote on page 18 of the print version of Freedom From National Debt:
One-layer-of-confusion that this post does not go into is the distinction of money-as-debt or money-as-property. I think this confusion is a result of the method of most money supply increase–debt expansion.
I think that most MMT supporters will agree that there are three sources of new money: Bank Lending, Government, and Counterfeit. New money created by bank lending is all debt. New money created by Government can be debt or simply printed. New money by Counterfeit is all printed. Notice that not all new money is debt–some new money is something else.
Now we can not distinguish printed money from debt money. Both sources result in the same product–money. I will suggest that the commonality in product is simply “property”. All new money becomes someone’s property when first accepted as the result of a transaction. For example, a worker for the Federal Government receives a money payment at the end of a week. This money payment has a value of one weeks completed work. This payment is now the property of the worker. It is the responsibility of the worker to find future value from this property.
I think that the confusion of money-as-debt or money-as-property underlays much of the discussion of macro-economic policy. I believe that further exploration of this layer-of-confusion would be very productive.
The flaw in our current system of economics is that there are “private” interests. Once we rid ourselves of this evil concept and design a new system based on “public” interests only, all will be well.
been done. failed.
Thanks for the information. I am always glad to be taught by those who believe they are in the know. Unfortunately, the lesson such tutors think they are teaching is not the lesson their students receive.
Another great post, J.D.
For a large portion of the population, there seems to be a growing view that there can be no positive government involvement in anything. Randy hit the nail on the head in his series of posts last year discussing the need for a new moral (emotional?) connection to these ideas, rather than just facts. Facts don’t win when the response is “yeah, but we can’t give that power to the government as they’ll abuse it and we’ll lose our freedom”.
It seems this has to be tackled head on.
What if we believed in ourselves? What if we believed in our form of government? What if we believed we could really do good together and not harm ourselves? We do so for the military and they’re pretty darn good at what they do. Why? Because we told them money was no issue and they have to be the world’s best.
So what if we took this same approach in education? In the infrastructure that will enable the next generation to prosper? In research and technology that will solve medical and environmental challenges? In…
J.D.,
Good article.
I think there is a very simple gedanken experiment that can be performed to illustrate the money/debt issue. Suppose the federal govt decided to discontinue Fed Notes and make “Blue Dollars” the official sovereign currency of the state and will replace Fed Note dollars one for one with the new blue dollars at any US Govt Post Office. The currency in circulation can be replaced and banks would face a short fall of about 19T$ in cash which they could only get by borrowing it from the Federal Govt, an action that would point up the national status as not being an indebted nation as normally supposed.