By J. D. Alt, author of The Architect Who Couldn’t Sing, available at Amazon.com or iBooks. Originally published at New Economic Perspectives
“Reserves”—that esoteric term in money-talk that postures to explain everything but explains nothing at all—have been much in the news of late. The Wall Street Journaleven tried, recently, to explain what they are! They didn’t do such a great job. That’s unfortunate because, properly explained and understood, Reserves hold a big key to the political befuddlement—especially acute in the present election cycle—about what we can “afford” to accomplish as a collective society. This includes “paying for” real solutions to the five, money-intensive, life-defining dilemmas America now confronts: (1) climate change (2) healthcare (3) student debt (4) early child-hood care and development (5) affordable housing. It is therefore well worth the effort, I think, to attempt an explanation of “Reserves” that might actually be grasped by the collective consciousness of our political dialog.
To accomplish that, I need a good metaphor to get started. Since I’m an architect, what comes to mind is exploring the structure of a building to discover what is holding up what—and discovering in the process, perhaps, some rooms with surprising views. It’s a strange edifice (I warn you) that often seems unnecessarily complicated. But, observed with patience, it has its own peculiar beauty and logic— and, in the end, it’s this strange beauty and logic that reveals what we can, in fact, do about the five dilemmas just listed. So, hold onto your brain-handles. We’ll go slow and easy, so no one gets lost.
Sovereign Fiat Money
Without going into the history of the term, let’s simply begin by saying that in America today “Reserves” are the sovereign fiat money issued by the U.S. government. They are also the only official, “real” U.S. dollars that the federal government will accept as payment for taxes, fees, or fines owed to the government—which is why, by definition, they are America’s fiat money.
Having started with that statement, it may seem odd to you that the U.S. government, itself, issues the very thing that it wants to get paid with. You might ask, “If that’s the case, why doesn’t it just issue the money to itself,and leave me out of it?” As it turns out, that might not be a totally ridiculous question, though the answer might not be the tax-freedom you’re hoping for. Reserves—modern fiat money—are strange things indeed, but they do, in the end, have a structure that can make sense out of the world.
One of the strangest things about Reserves—even fascinating—is that you can’t get your hands on them. They exist only as digital entries inside America’s central bank—created and cancelled by keyboard strokes on an electronic balance sheet maintained by the U.S. Federal Reserve (the “FED”).
Reserves, then—even though they are the “real” U.S. fiat dollars—are not the “money” American citizens and business borrow and spend every day. That money comes in two other forms: Federal Reserve Notes (the cash dollars we have tucked in our wallets) and bank-dollars which is the money we have on balance in our demand bank-accounts (checking and money-market accounts). What is the relationship between these other forms of money, that we actually useevery day, and Reserves?
The relationship is very simple: Federal Reserve Notes (cash dollars) and bank-dollars are claimson the Reserve dollars posted on the electronic balance sheet at the FED. So, while you can’t get your hands on Reserves, you can make a claimon them when you actually need them. This is not something you need to worry about accomplishing—it happens, automatically, as needed, when you spend your cash or write a check.
This happens because of the way the central bank is structured. Every private bank in the Federal Reserve System has its own Reserve account at the FED. In its Reserve account, each bank keeps track of the “real” sovereign U.S. fiat dollars it is in control of. (Remember, these are just digital entries on the electronic balance sheet—very much like the scoreboard at a basketball game.) The FED can debit Reserves from one bank’s Reserve account and credit them to another’s, “keeping score,” if you will. The FED can also simply “issue” newReserves and add them to one account or another—again, with keystrokes—in exchange for another asset (collateral). Importantly, the U.S. Treasury also has a Reserve account at the FED—which is the spending account for the U.S. federal government: Not only does the federal government expect to be paidwith Reserves, it only makes payments, itself, with Reserves.
At this point, you’re no doubt asking one big question: WHY? Whyis it set up like this? Before we look into an answer to that question, however, let’s make sure we understand how the structure of the building we’re exploring actually works.
Exercising Your Claim on Reserves
Here’s an example of how you can exercise your claimon Reserves: Let’s say you owe Uncle Sam $1000 in taxes. Uncle Sam demands that you pay him with Reserve dollars. How do you do that? You write a check from your account at Bank-A to Uncle Sam for $1000. At the end of the business day, Uncle Sam presents the check it has received to the FED for “clearing.” In the “clearing” process, the FED debits $1000 from the Reserve account of your Bank-A, and credits $1000 Reserves into the Treasury’s Reserve account. Your check is “cleared” (cancelled), $1000 bank dollars are debited from your checking account at bank-A—and your taxes are marked “PAID”.
Here’s another example: You write a $1000 rent check from your bank-A to your landlord who uses bank-B. What happens? At the end of the business day, the landlord’s bank-B sends your check, deposited by the landlord, to the FED for “clearing.” During the clearing process, your claimon your bank-A’s Reserves is exercised: $1000 Reserve dollars are debited from your bank-A’s Reserve account and are credited to the Reserve account of the landlord’s bank-B. Your check is cancelled and, lastly, $1000 bank-B bank dollars are credited to the landlord’s account, while $1,000 bank-A bank dollars are debited from your account.
In each case, from your perspective, it appears that you are simply using the bank dollars in your checking account to pay someone—the government or your landlord—$1000 dollars. Hidden from you is the other operation in which your bank dollars exercise their claimon Reserves at the FED, causing the actualpayment to be made with Reserves— “real” U.S. fiat dollars.
Who Creates Bank-Dollars?
There’s one more thing we need to understand before we get to the question about whythings are structured this way: If the U.S. government’s central bank—the FED—issues Reserves, who issues the bank-dollars that are the claimson the Reserves? As the name implies, they are created by private banks—but by what process? The FED has a lawful mandate to simply issue Reserves by “fiat”—out of thin air. But what is a private bank’s mandate to create bank-dollar claims on the “real” money created by the FED?
The key is to see that a private bank can only issue claimson the Reserves that reside in its ownReserve account at the FED. Because this is key, it is useful to have a quick understanding of how each bank acquires, in the first place, those Reserves it can create claims on: The FED issues the Reserves (with keystrokes) and credits them to a bank’s Reserve account in exchange for some collateral provided by the bank. Coming up with this collateral is a necessary component of becoming licensed as a federal reserve bank. The FED stipulates what the collateral must be. Once the Reserve account is established, the bank can begin to issue the bank-dollars which are claimson those Reserves in its account.
A bank “issues” its bank-dollars by making loans to individuals and businesses. When bank-A loans you, say, $10,000 to make home-improvements, it credits your bank-A checking account (using keystrokes, of course) with $10,000 bank-dollars. These are now yourclaims on the Reserves bank-A holds at the FED. You then write checks to various contractors and vendors, and those checks are presented for “clearing” at the FED where your claimson Bank-A’s Reserves are exercised.
This little example seems to suggest that a bank must be careful not to create more bank-dollar claimsthan it actually has in its Reserve account to meet those claims. As is famously known, however, banks create many morebank-dollars than they have in Reserves. How can this be? Doesn’t that mean the “clearing” process at the FED will break down—that eventually you’ll write a check on your bank-A account, only to find that it can’t clear because bank-A’s Reserves have already been tapped out by other claims? There’s a couple of reasons why, in modern times, this cannot happen (if everyone keeps their fingers crossed).
The first reason is that banks have come to understand that, on any given business day, only a tiny fraction of the bank-dollars they’ve issued will make claimson their Reserves at the FED. The remainder—the vast majority—will remain passively silent in their various checking accounts, or in checks written but not yet deposited. Also, if a given bank (Bank of America, for example) is used by a large segment of a local, regional, or perhaps national population, the recipients of many checks written will deposit them back in the samebank—in which case they do not go through the FED’s clearing process at all, but simply result in a tally on the bank’s own bank-dollar balance sheet. A final “also” is this: if banks in the federal reserve system stay, more or less, at the same “scale” of operations, during the FED’s clearing process any one bank should be credited, from other banks, about the same number of Reserves as it’s debited.
The second reason banks “safely” create manymorebank-dollars than they have in Reserves is because the FED has put in place, and operates, a number of fail-safe “mechanisms” which ensure that, every business day, the clearing process will always be successfully completed. Your check on bank-A will alwaysclear (assuming you have sufficient bank-dollars in your account to cover it.) For our purposes here, we don’t need to know or understand the details of the fail-safe systems the FED operates—except one: As a last resort, the FED can, and will, simply issue newReserves, as necessary, and credit them (in exchange for collateral) to the Reserve account of whatever bank comes up short in the clearing process. It hasto do this—otherwise the whole structure collapses.
Okay, Now We Can Ask WHY?
Why is our modern fiat money system set up this way? Why not just have a single “money” that we all use—the government, the banks, all of us—and be happy with that?
It would be nice to say the answer is because well-intentioned and forward-thinking people thought a Reserve/ bank-dollar system would best serve our needs. The real answer, however, is that under the circumstances of history, it was the best solution that could be cobbled together that all the stakeholders would agree upon (and using the term “agree” is being generous).
In the century leading up to the Federal Reserve Act of 1913, America struggled mightily with its money system. These struggles became a crisis after the Civil War. Basically, there were three problems:
- The “value” of money was suspect.
There was no national currency—only bank-dollars issued by different banks around the country. While these dollars generally promised to be exchangeable for gold, the amount of gold held by each bank to back up its promise was often suspect. Merchants had to be concerned which bank-dollars they were being paid with. This was a significant impediment to national commerce.
- The “clearing” process between banks often broke down.
Transactions written on an account in bank-A and submitted for deposit in bank-B were often not accepted by bank-B if it was suspicious that bank-A might not be able to back up the promises of its bank-dollars. In the 1800’s there were a series of banking crises in which this “clearing” process between banks broke down, resulting in severe economic distress.
- There simply wasn’t “enough” money!
As things unfolded after the U.S. Civil War, this turned out to be the biggest problem of all. The civil war had been paid for with Abraham Lincoln’s fiat money— “greenbacks” that were printed and circulated to buy everything from mules to musket balls. A great many debts were racked up during the war—mostly to big banks on the East Coast. When the war ended, these East Coast banks refused to accept the greenback dollars as payment for the debts. They demanded to be paid, instead, in gold.
The only problem was there was not enough gold in the country to redeem the greenbacks andunderwrite the need for an expanding money supply the new post-war commerce was demanding. The result was that southern and western farmers were unable to sell their crops for “dollars.” Instead, because of the lack of money in the system, they were forced to begin selling their crops for store credits. This began the era of the corrupt “crop-lien” system with its “furnishing merchants” who, over time, put the farmers so deeply in debt they were forced to become sharecroppers on what had once been their own farms. This, in turn, precipitated what nearly became a successful grass-roots political revolution over the issue of “money and, ultimately, led to the Federal Reserve Act of 1913. (Please read “The Populist Moment” by Lawrence Goodwyn.)
The Federal Reserve System—Solving the Three Money Problems
Creating the U.S. Federal Reserve banking system was a long and hard-fought political battle. In the end, the Reserve/bank-dollar system was created because it was the only structure everyone could agree upon that solved the three money problems just described:
- Private banks could still issue their own bank-dollars—a prerogative they fought tooth and nail to maintain—but now, since the different bank-dollars were all claims on the sameReserve dollars, they could be treated equally in the marketplace. As intended, today it is impossible to distinguish between one bank’s bank-dollars and another’s.
- The risk and uncertainty were removed from the “clearing” process for transactions between different banks. That process was now conducted, at the end of each business day, by the FED itself—with the guarantee that every legitimate check or bank transfer cleared. Interstate commerce was free to blossom, and the epidemic of bank crises essentially came to a halt.
- Large as these first two benefits were, the third benefit was, by far, the most significant: The most important fact about the Federal Reserve system is that it was structured and put in place to enable the money supply that served American Enterprise to expand—as necessary—to meet the needs of what it was decided American Enterprise wanted to undertake and accomplish. After the post-Civil War money crisis, all stakeholders understood a simple fact of logic: If the labor, materials, energy, technology, and ingenuity exist to undertake and accomplish something—and it is desirable that it should be accomplished—it makes no sense to say that it can’t be done because there isn’t enough “money” in the system to pay for the doing of it. “Money,” in other words, is not a limiting resource. To say that, as a collective society, we don’t have enough “money” to do something is makes as much sense as saying we don’t have enough “numbers” to count something.
The Federal Reserve System, then, was cobbled together to solve these three problems. No one claimed it was the perfect solution. There were many compromises made to reach consensus in in the U.S. Congress. The banking interests didn’t want politics and the government to run the show. The government didn’t want the bankers to have exclusive control over something that the common good, ultimately, depended on. The FED, then, became a partnership—partially under the banker’s control, partly under the control of the federal government.
That’s the introductory tour of the edifice we’re exploring—a look at the big pillars holding up the roof. In PART 2, we’ll explore some of the rooms and activities that accommodate the needs of the “big partnership” that lives under that roof. It’s a partnership not of people, but of interests. The bankers represent the interests of private enterprise, the federal government represents the interests of public enterprise. Together, they comprise what I think of as The American Enterprise.
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Thank you for this, Yves! Lovely stuff. Looking forward to part 2.
+1. And my congrats to J.D. Alt for this educative explanation so well written that an orangutan like me could understand
Yes, I’m all in for more of this kind of analysis as well.
As always, good stuff from JD (even if he can’t sing).
However, what should happen if the private financial enterprise hierarchy begins to exercise control over the now fawning federal government, so much so that they choose to obfuscate reality. There’s a emanating narrative that would have it -we don’t have any of the problems (on your list) and/or we did, the credit card is maxed-
I sincerely appreciate the work you all do. I just wish it would fall on more mainstream ears.
This includes “paying for” real solutions to the five,
I think he missed the crumbling infrastructure, minor things like bridges, airports who don’t even rank on listings, waterworks, public transit and roads etc. etc….
It seems to me Alt is being very expansive, and inclusive, with the above quote.
Falsely claiming a shortage of funds to accomplish something, say Med4all, is the same thing as giving an industry, say the medical industry, a monopoly.
Not to mention retirement crisis.
“If the labor, materials, energy, technology, and ingenuity exist to undertake and accomplish something—and it is desirable that it should be accomplished—it makes no sense to say that it can’t be done because there isn’t enough “money” in the system to pay for the doing of it. “Money,” in other words, is not a limiting resource. To say that, as a collective society, we don’t have enough “money” to do something is makes as much sense as saying we don’t have enough “numbers” to count something.”
So, I need to visualize what has happened. Models, metaphors, diagrams. America had ‘resources:’ land, virgin forests, water, mineral and oil deposits, beavers and buffalo. And, desperately ingenious people, originally millions of immigrants. To exploit these, i.e., to turn it into something that can then be carted away and use to create stock markets, financial instruments, and off-shore banking accounts, we needed to create a fiat money system. So far, so good.
What happens, now that the land and waters have been poisoned or blown away, the forests have been clear-cut, the oil is becoming scarce, and the refuse from other mining activities, gold, uranium, silver, have polluted their environments, and we have turned against immigrants because ‘too many people?’ And, the money into which all these irreplaceable natural resources and low cost labor have been transmogrified is in the hands of a few billionaires?
Turning against immigrants is the last thing America has done.
Herman Daly has claimed we couldn’t even rebuild the infrastructure we have currently if it was all destroyed (it’s not all destroyed of course, this is a hypothetical*) but we had the same raw resources and knowledge we do now. We’ve just used up too many virgin resources that can’t be replaced, we couldn’t replicate what we have.
* this hypothetical should give one pause as we could build buildings to better withstand earthquakes etc. and we aren’t, we build with earthquake safety to save the people in the buildings (good of course) but not to save the buildings as well. We must think: “we can always rebuild”
I don’t think he missed it. He did say:
The question is really who gets to determine and define what is ‘desirable’ to accomplish.
“The question is really who gets to determine and define what is ‘desirable’ to accomplish.”
Exactly! Which is obscured by partisan politics claiming ” we can’t afford this or that program” so the question of desirable or not is avoided.
In my opinion this is where MMT gets most of its resistance from as it lays bare the truth that it is simply a matter of deciding what is in the common good.
And the other day M. Pettis finely explored the posibilities and limits of “keystroke money creation” depending on the state of the economy: demand constrained, supply constrained, the current account and savings, plus overloaded or not with badly structured debt. That was a good guide for policymakers.
well, kickbacks are very desirable
The People’s Money?
Nope, it’s actually, except for mere coins and paper bills, the BANKS’ MONEY since only depository institutions may use fiat in both physical form (coins and paper bills) AND inherently risk-free account form at the Central Bank.
In other words, we persist with an inherently unjust, unstable, obsolete Gold Standard banking model.
The greedy banksters in the early 1900s knew they had a stability problem. Because their own behavior was screwing up their own profits. The only way for them to tame the losses it was to spread them thin. Make money the people’s money and ask them to guarantee a functioning banking system. So everybody benefited. That is until it became difficult to make money from your own individual efforts, your labor and cleverness. When technology eliminated competition and there were far fewer investments that had a reasonable return. There must be a word for this historically continuous phenomenon whereby a system just gets worn out. A prize hen that quits laying eggs because none of them are as good as the first one, so why bother? Does it ever occur to anyone that money (if it is doing its work) should actually be continuously devalued in order to keep up with progress. And that progress should continuously make everything cheaper. When things don’t get cheaper it’s for certain that somebody is skimming. Even with the concept of sovereign money, available whenever it is needed, governments and rich money-obsessed people who control them all freak out when money seems to have less value even though it has heroically created a rich and technologically vibrant society. The very stability that the greedy private banks were desperate for to begin with. They themselves turn against the progress that saved them.
or more accurately, their less than brilliant shareholders
I’ve been reading JD Alt’s work since the GFC, I think where he is headed with the title ‘The People’s Money’ is that by demonstrating how money is created (keystrokes) it should be the people’s money, not the bank’s money, it is a sovereign right, a public good and right. It’s just that does not work as a public good at the moment (with all the retoric on balanced budgets/surpluses etc) and the power the private banks have the moment. He wrote some interesting stuff on the platinum trillion dollar coin to demonstrate that money is a sovereign right. Lets see what comes in the Part 2 etc.
I loved this potted history, but I am really wondering about the role in all this of the destruction of the Bank of the United States under Jackson.
I don’t know, but the HipCrime Vocab blog just wrapped up a nice 8-part summary of the history of paper money, with a lot about the U.S. Something might be there.
(Oh, look — part 4 about the pre-revolutionary colonies. Why didn’t I see that when I was looking for it? Part 5 does Ben Franklin.)
Jackson did it for Augustus Belmont who commanded it for NM de Rothschild. This is well known history. It also was the entrance of the de Rothschild dynasty into America and the rise of NYC as a financial power.
Jackson knew what money is (as opposed to credit) and even based his entire presidential run on the headline issue of getting Americans to understand it’s creation.
The description above is pretty good but also revisionist in places. To me there are a few hard questions to ask.
1. Debt expands faster than the economy, always has, always will (see M. Hudson). But what does this imply for debt-based money? Without a periodic mechanism to write down debt eventually money is untethered from the underlying economic activity it represents, so money erodes its main role (debases against goods and services), see #2.
2. Money stores labor so it can be transported across space and time. But money that took no labor to produce does a poor job of reliably storing labor. Jerome Powell is the object lesson. The USG needs to keep the lights on, and with >$1T annual deficits to finance the demand for US Treasuries is weak with the $ at these levels. He could try Capitalism, you know, where the market determines the price of money. Instead, deus ex machina, he hits Ctrl P and adds $750B per year to the Fed’s balance sheet. Repeat. There is no need to ever repay this “debt” since it is sequestered on his magic balance sheet. By 2025 the Fed balance sheet will need to be >$15T. Free money for all. Apparently in unlimited quantities. Few stop to notice that the unit called the USD stores less and less labor as a result. Post-Bretton Woods, with no anchor and everything floating against everything else, the fiction works well enough. You don’t need to outrun the bear, you just need to outrun your hiking partner. The Chinese read this playbook and now have $40T in debt money against $2T in equity in their banking system. But where does this race lead? It’s a race to have the worst balance sheet, not the best. No need to have good productivity and good infrastructure and sound finances, just print money and we’ll all be rich. In a currency war nations attempt to become richer by making their citizens poorer. And where else does it lead? Oh, to zero (or below zero) interest rates. That leads to #3:
3. ZIRP. NIRP! Let’s start by considering there is no such thing as NIRP, it doesn’t exist. The correct term would be “confiscation of principal”. This of course disqualifies the underlying from being called “money” any more. And both ZIRP and NIRP break money in another way: time preference. You agree to forego consumption today by lending your money to someone else for one year. If you are not paid for that sacrifice and risk you have just done one thing: you have broken capitalism. If capital is not paid for risk there is no more capitalism.
I think the answer is a blend of the state theory of money and the barter theory of money. We’ve only had monopolistic legal tender laws in place for less than a century, maybe we should let many monies proliferate. Again. State money is like monoculture: extremely efficient but fragile. A plantation of genetically-identical pine trees is super easy to manage, but one bug or virus and the whole thing comes down.
But the barter ‘theory’ of money is a lie.
Remind me why gold has served as money for 5,000 years. Because the coins had the face of Constantine stamped on the front? Could be, but I doubt that was the only reason. Seems to me the stamp served as the state’s assurance of the quality of the offer but people understood it was the scarcity of the underlying that created the value. This of course fell over once the state put less and less of the scarce element in the coins.
And glad to hear refutations of where the state theory of money has brought us. See my OP.
“Remind me why gold has served as money for 5,000 years.”
Simple: it hasn’t. Certainly not as a universal custom. The ‘New World’ didn’t use its ample gold as money. The Japanese backed coinage with rice, etc.
And five thousand years? Have you not read any of Hudson’s work? Sumerians were using credit long before coinage existed. Similarly the Ancient Egyptians literally never used coinage until the Greeks took over.
Money requires acceptance.
In Julius Caesar’s time I could go anywhere in the known world and ask someone to agree to receive gold as payment. The answer would be Yes please.
Today I can go anywhere in the world and ask someone to accept gold as payment. Mechanics aside: the answer is Yes please.
Try that with an assignat; a Continental; or a French franc. Or a Sumerian clay tablet.
The point is: money is money. It can be used to extinguish a debt. Credit is something else. They mix and intertwine in complicated ways. Credit without limit is reaching an event horizon. What happens now? Banks pay people to borrow? Remind me why a bank would be interested in staying in operation as a going concern.
Ever hear about the 110% mortgage? When desperation or mania strikes the banks can do some funny things.
Outside money works outside where inside money doesn’t. That doesn’t mean outside money is ‘better’ or should replace inside money. Horses for courses.
I actually doubt that, but again, it’s cultural. You’re literally just blowing right past one of my points. Try crossing the sea in 0 AD and getting a Mesoamerican to accept your lump of gold. At absolute most they’ll throw you some bread as thanks for the new bit of jewelry you brought them.
If civilization were to end tomorrow and you were wandering the Mad Max/Fallout wasteland, no one is going to care one iota about the heavy, useless gold you’re carrying around. What they very likely will be doing, however, is conducting their business with some sort of credit marker to keep track of obligations.
“The point is: money is money. It can be used to extinguish a debt. Credit is something else.”
No it isn’t. Again, see Hudson. See Graeber as well.
Sorry, no hotel or restaurant or pretty much anyone would take gold. Neither will service providers going from shoe repair shops up through law firms. I challenge you to walk around Manhattan and try to pay for stuff with gold.
I won’t take it. Huge hassle, doubts about purity, ability to not get ripped off when you try to convert into money which is what is useful.
“Money requires acceptance”
and it’s utterly worthless without that acceptance.
a dollar…or a large round stone…only has value, because a sufficient number of people Believe it has value.
destroy…or even weaken…that belief,and it’s just rag paper or a large round stone(or one’s and zeroes….can’t get much more abstract than that)
my feedstore people have never heard of MMT…but they are beginning to understand that “but how will we PAY FOR it?!!” is only trotted out if whatever IT is will primarily benefit ordinary people.
if IT is war or wall street, “Paying For It” is never a problem.
if erstwhile teabillies are arriving on their own at that awareness, the Machine should be very worried.
“they are beginning to understand that “but how will we PAY FOR it?!!” is only trotted out if whatever IT is will primarily benefit ordinary people.”
And along the same lines, only if whatever IT is will primarily benefit ordinary people is the “inflation!” bugaboo trotted out. Countless $trillions$ for banks, for hedge funds, for the mil-industrial-security complex, for the medical-pharmaceutical-industrial complex, for the wealthy, for bloated salaries for the upper-middles, for everything under the sun… all perfectly neutral, no inflation worries. BUT but moment we start talking about a modest UBI for ordinary people, BAM… “OMG! Hyperinflation! Currency collapse! Can’t do it!”
It’s not entirely a lie. Credit money was always used within each jurisdiction but it was never any good in the next jurisdiction. For foreign trade, paying foreign mercenaries etc., barter-proxy commodity monies were developed. These were of no interest to most people but merchants accumulated a lot of them, and as they gained more political power they tried to have the credit monies replaced by them. Since that was disadvantageous to most people they had to make up a lot of lies about it, some of which are still widely believed.
I always treasure the fact that the current Palace of Westminster, seen in thousands of movies and TV shows, only exists because the previous one was accidentally destroyed when they were trying to burn all the tally-sticks that had been rounded up, and that had been a key part of the English economy for centuries.
State money is like monoculture: extremely efficient but fragile. OpenThePodBayDoorsHAL
If State money is fragile, it’s because only depository institutions may use it except for mere coins and paper bills. Hence the DEMAND for fiat is artificially suppressed. And, of course, because the Central Bank is allowed to create fiat for private interests such as the banks, etc.
Do you propose to fix that and allow everyone to use fiat in inherently risk-free account form at the Central Bank or Treasury itself? Along with, of course, the abolition of all other privileges for depository institutions?
Who would argue against addressing all five, money-intensive, life-defining dilemmas America now confronts?
Who wouldn’t agree that spending whatever it takes to address the five, money-intensive, life-defining dilemmas America now confronts is most important and desirable?
Only those who stand to lose money if that happens that’s who.
I’m not so sure that they fear loss of money (since they would still have more than I could ever spend) so much as the power that they exercise over others who lack money. If the “life-defining dilemmas” were to be solved collectively, how could they otherwise continue to coerce the poors to do their bidding?
Yes, every policy dispute is really just an argument about who will be in charge.
Btw, bad link to original article?
Is this what was meant? http://neweconomicperspectives.org/2019/10/the-peoples-money-part-1.html#more-11600
Thanks, fixing…
I absolutely believe the industrial revolution saved capitalism. It was dying by the 1870’s and frankly, without the easy debt to growth, it would have died in the poor nutrition, food shortages and short lifespans people were given.
Part of capitalism’s problem since 2001 has been the huge amounts of debt to grow the ponzi-scheme, which if allowed to collapse in 2008 would have led to a return of food shortages, lack of nutrients and essentially make Kenya look comparable to most “western countries”. The debt is unstable and prone to wild fluctuations. Sadly, really since the black death when the monarchies more and more relied on banking debt to service commercial needs, people have become addicts to capital accums rather than conservation like they should be thinking.
Sometimes things need to get worse before they can get better… I would rather there not have to be a ‘Jackpot’ in order for things to get better, but at this point I don’t really see many other possibilities. I just can’t imagine at this point something miraculously saving modern globalized capitalism.
Does anyone know How the book “the creature from Jekyll island” rates on the conspiracy meter in these regards ?
It’s off the charts. The central point of that book, that private bankers wanted control of all money creation in the US, is actually true. It was called the Aldrich Plan. But it died in Congress. Twice. Precisely because it was privatized.
Griffin has done more damage to the public understanding of central banks and fiat money than probably anyone on the planet with his stupid book.
Ben Bernanke is famous for his study of the Great Depression and here it is discussed in the Wall Street Journal.
https://www.wsj.com/articles/SB113392265577715881
“Theoretically, neither deflation nor inflation ought to affect long-run growth or employment. After a while, people and businesses get used to changing prices. If prices fall, eventually so will wages, and the impact on profits, employment and purchasing power will be neutral. Borrowers suffer during deflation because their debts are fixed in value, but creditors benefit because the dollars they get back will buy more. For the economy as a whole, deflation ought to be a wash.”
What has Ben Bernanke got wrong?
He thinks banks are financial intermediaries.
This is where the “debt doesn’t matter” nonsense comes from – the belief that banks are financial intermediaries.
Great post. I am very grateful to see posts like this. I wish multi-part posts were all issued at once. Getting it bit by bit like a spiderman comic is frustrating, and frankly, the format of this blog is like a plate of spaghetti. Love the blog, wish it were easier to fund stuff. Often I don’t even bother to try to find responses to my comments.
Took me a day to read and digest what J.D. Alt wrote here. His concluding paragraphs reminded of the underlying message in Tina Turner’s intro lyrics to her performance of “Proud Mary”; i.e.,”Rolling Down The River”:
You know, every now and then
I think you might like to hear something from us
Nice and easy
But there’s just one thing
You see, we never ever do nothing
Nice… easy…
We always do it nice… and rough
So we’re gonna take the beginning of this song
And do it easy
Then we’re gonna do the finish rough
This is the way we do ‘Proud Mary’
And we’re rolling… rolling…
Rolling on the river
I’m not sure that this article accomplished its primary goal, to demystify Reserves. It’s even somewhat self contradictory in that it defines Reserves as being the only real US money while at the same time rightly explaining that these Reserves do not circulate in the real economy. Taking a step back, the only money people care about is bank-created credit money – that is the “real” money that circulates from bank to bank as transferrable liabilites of a bank to an account holder. Taxes are paid through the transfer of this liability, not to another private account holder, but to the Treasury’s account at the Fed using the same Reserve transfer process that is used in any other private-to-private transaction.
Reserves are an archaic accounting entity that the banking system uses to keep track of the transfer of these liabilities from bank to bank and as a regulatory entity in an attempt to limit unsustainable creation of money by banks. Banks are the only creators of this credit-derived real money that used in the real economy. Reserves are a Fed-created backstop that supports the lending decisions of banks and are created reactively to the will of the banking industry, not proactively.
Reserves are a Fed-created backstop that supports the lending decisions of banks and are created reactively to the will of the banking industry, not proactively. Stewart
And that should be abolished since it constitutes fiat creation for the private welfare of the banks, etc. and not for the general welfare.
Instead the Central Bank should be forbidden to create fiat except:
1) for the monetary sovereign, e.g. US Treasury
2) as an equal Citizen’s Dividend.
Also, we should have an additional but risk free payment system, besides the inherently risky one that must work through private depository institutions, consisting of inherently risk-free accounts at the Central Bank or Treasury itself for all who desire them
That way, and with the abolition of all other privileges for depository institutions, such as deposit guarantees, the banks can no longer hold the economy hostage via a single payment system that must work through them.
I like these ideas very much.
But – what if we take this a little further:
when citizens have their FED accounts with reserves supported by assets, what would be the implications of citizens then being able to create their own credit, just like private banks do?
Is this a super-democratic, anarchistic idea – or is it the ultimate libertarian dream, each individual as their own sovereign?
I can’t really imagine how this would work. As Wolf Richter says, “A bank cannot create money.” This is true because he follows up with “The banking system can create money.”
Private banks create useable credit, aka money, because they each work at a large scale with many customers, and because they work together.
If we consider a small-scale transaction, say someone taking out a loan to buy a refrigerator:
1) The bank (Bank_A, say) grants the loan, credits the customer’s checking account
2) The customer writes a check to the appliance dealer, receives the refrigerator
3) The dealer presents the check, Bank_A pays the amount then and there, out of its assets.
The customer sees this as a credit transaction, but to the bank and the dealer it’s very near cash on the barrelhead.
The reason credit aka money can be created is that more than one private bank is involved. In almost all modern business transactions, the dealer deposits the customer’s check in another bank (Bank_B), and the “cash” payment becomes an immediate transfer from Bank_A’s reserve account to Bank_B’s reserve account. Notice that once Bank_B receives the money, Bank_B might use that money to fund spending by its own borrowers. If they’re hot on issuing loans and making money, they probably do.
So we get to the situation that Cameron Murray described in his blog article concerning “Game of Mates” In its daily business each bank surfs on the net flow between withdrawals due to spending by its borrowers, and deposits due to spending by other banks’ borrowers. As long as this flow never exhausts the bank’s reserves, the process can be frictionless. No matter how big the total amounts are, as long as the net difference is small enough.
It’s by working the balance between its loans and its deposits (other banks’ loans) that a private bank can “create credit”. If an individual isn’t doing that kind of business, I don’t think they can create effective credit.
Thank you! A succinct and clear summary that is actually useful and dispels obfuscatory jargon.
Speaking of “things we can’t afford:” There’s maybe a category missing?? Or am I making a category error by offering that “ending the Imperial war economy and its massively destructive and wasteful expenditures “ ought to be right up there with health care and child care and the other Top Five that Alt enumerates?
Great post. Can’t wait to see Part 2.
Just one question. I thought Lincoln’s “greenbacks” were fiat dollars and so were not redeemable in gold, or in anything else for that matter.
Fiat is backed by the authority* and power of government to tax and to punish tax evasion.
*In the case of Christians, this is God-given authority per, for example, Romans 13:1-6.
I am not sure that taxation and tax evasion applied at that time. But in either case, there was no connection between the greenbacks and gold.
Better than the abridgement, read Lawrence Goodwyn’s “The Democratic Promise.”
Alt’s Part 2 is up on MMT’s website. In it he describes what he will discuss in the next and final part of his essay. The main takeaway is this:
“There’s not anything further we really need to see on our tour of the Federal Reserve money system. We’ve observed all that’s necessary, I think, to now have (in PART 3 of this essay) a meaningful discussion of what’s REALLY important: why we can, in fact, as a collective society, “afford” to pay ourselves to undertake and accomplish what’s necessary to actually address the five, money-intensive, life-defining dilemmas America now confronts: (1) climate change (2) healthcare (3) student debt (4) early child-hood care and development (5) affordable housing. Please feel free, by the way, to add to this list—but before we argue priorities, let’s understand and agree that we unequivocally DO have the financial resources, as a democratic society, to confront them.”
MMT has finally capitulated. I have had a running gun battle with them for years. I have long held that our money supply is unlimited. Because I would not eat my words the man in charge at MMT’s site banned me in a shower of personal insults. But now cooler, wiser heads are speaking out. We do have an unlimited supply of money and you can read all about it in Chapter 12 of my book, Faction-Free Democracy. Go to my site by that name and you will find a link that will take you to Chapter 12: An unlimited supply of money. I discuss how we should use it to create a new system of economics which I call “democrato-capitalism,” as opposed to our present system: “tyranno-capitalism. Democrato-Capitalism works for the common good, Tyranno-Capitalism works against it.
Two quibbles on an otherwise very well-written piece.
1) Federal Reserve Notes are not claims on reserves. They are outright liabilities of the Fed, just as reserves are. That’s why a bank’s reserves don’t just include their deposits at the Fed, but also include vault cash.
2) At some point you’ll have to explain why every other country in the world runs a reserve-based banking system, even though they have entirely different monetary histories from the United States. That all banking systems follow the same design suggests that there are deep economic principles at work. At the very least you’ll want to discuss banking systems with longer histories, such as the British and French systems.