The recent Public Banking conference held in Philadelphia offered a message that is at once so simple – but also so bold – it is hard for most Americans to pause long enough to understand how profoundly their thinking had been corralled by the masters of finance – in ways far, far, far more insidious and powerful than even the latest financial crisis suggests.
To understand what has happened, however, you first have to take a minute to shake a few cobwebs out of your brain about “money” – and how it is created and by whom and for whose benefit.
Money is “created”? Yes, obviously so – or did you imagine there is some fixed pile of “money” some place that exists once and for all and for all times?
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Think about it: If that were true, it would be impossible for the economy ever to change and grow. If the “money supply” were not increased over time, the original economy of, say, 1776 – which served about 2.5 million Americans – would still define the amount of “money” we would have to work with today.
(And yes, going back further, if money were not increased – i.e. “created” – the amount that existed even in a far smaller economy prior to 1776 would be all there was and is, even down to today.)
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Once you realize money must be and is regularly created and expanded, then the interesting questions begin to occur – like “How is it done?” and “Who benefits from it?”
Step One: Most people think of “money” as something real, something that is kind of like gold or silver or anything that has intrinsic value. Allowing for a very, very few minor exceptions, that is simply not what “money” is.
“Money” in the real world is a piece of paper (or electronic version of the same) that is a promissory note – a promise to pay you – that legally must be accepted by anyone to whom it is given to settle a debt. Behind this promise is the federal government in two very big ways: First, the government itself stands behind the promise as the party that will pay what it says it will pay on the piece of paper. Second, the government ensures that everyone must accept this promise if the piece of paper is handed over when you buy something or settle a debt.
So, money is a promise to pay? Yes and that is all it is – but that is huge, especially when backed and enforced by the government.
Once you fully grasp this simple truth, things get very, very interesting:
Some “authority” must have the power to issue or authorize the issuing of “promises to pay that must be accepted” – i.e. to “create” money. In the United States that “authority” is called the Federal Reserve (“the Fed”).
And yes – because the economy does, in fact, get bigger over time – the Federal Reserve Board must have a way to create more money (more promises to pay) as time goes on. It does this all the time. In the modern era, it does it via computers issuing – literally out of thin air, via nothing more than accounting entries – promises to pay that are called “dollars.”
The Federal Reserve uses these to buy up securities owned by banks – and then these newly created “dollars” are deposited in the banks’ reserve account at the Fed.
Again, yes, created literally out of thin air. (Otherwise the money supply wouldn’t expand and we would be back in 1776 …)
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Now things start to get very interesting indeed: Banks have the legal right to lend more than the amount of “dollars” they actually keep in their vaults or at the Fed (their reserves) – roughly ten times more these days. So, for instance and simplifying a bit, let’s say that Bank A has $1,000 in deposits. So long as it keeps $100 on reserve, it can lend out $900 to the public.
But this is only the beginning and here’s where the real action is and how the game is played: that $900 is now multiplied throughout the banking system. Note carefully the word “multiplied.” Bank A loans the money to individuals, businesses and perhaps other banks. Then, these people deposit the money in another bank (or they spend it and someone else deposits it in another bank). Though in the real world, it would go to many banks, for simplicity assume for the moment it all goes to Bank B. Now, Bank B has $900 in “new” deposits and (keeping 10 percent in reserves as required) it can now lend out another $810. And if this is deposited in Bank C, in turn that bank can keep 10 percent and lend out $731 ($810-81). Ultimately, when the process is completed the initial $1,000 permits the creation of (again, yes, out of thin air) $10,000.
(Ten times as much is not a magical number; it is what the Federal Reserve Board currently allows for transaction accounts of more than $71 million [it is 3 percent for $11.5 million to $71 million, and zero for accounts of less than $11.5 million. It could be more; it could be less.])
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Let’s stop for a moment, however, to consider something far more important: I started out this little essay by saying that “the recent public banking conference offered a message that is at once so simple – but also so bold – it is hard for most Americans to stop long enough to understand how their thinking has been corralled by the masters of finance – in ways far, far, far more insidious and powerful than even the latest financial crisis suggests.”
The above has, in fact, all simply been background for the big story: Think again about the fact that the Federal Reserve Board (like any central bank in any country) simply “creates money” out of thin air or authorizes it to be created by banks (by, among other techniques, setting or altering the amount banks have to keep on reserve).
Moreover, it can also decide what interest rate it will demand for the money it lends out when banks need additional reserves to meet requirements – including, if it likes, zero or near zero. (Currently banks can borrow short term from the Federal Reserve Board at three-quarters of one percent – i.e. 0.75 percent.)
Why, you might ask, doesn’t the Federal Reserve Board simply “create” money (as it does all the time) and lend it at 0.75 percent to the government (rather than let the banks do it) to pay for important public goods and to settle its debts? (Our bridges are falling down; not a bad thing in which to invest.)
The answer is: It certainly could do that, in theory. In fact, it has been doing something close to this recently using a fancy term, the origins of which I won’t bother you with. The term is “quantitative easing” – but all it means is that the Federal Reserve Board “creates” money and buys up government bonds from the banks – and, then, the banks in turn lend to the government and the government pays its debts (or buys airplanes, or schools, or bridges and roads, or anything it decides it wants to buy or spend money on ….).
The banks, of course, make a nice profit on this as “middlemen” between the Fed and the government.
If you have been watching closely, you will now begin to see why the Public Banking conference’s message is pretty dramatic: What is the big deal about deficits when the economy is stagnating? Why doesn’t the Federal Reserve Board simply “create money” (as it does all the time anyway) and lend it to the government via the banks and then have the government put people to work by investing the money (building bridges and roads and schools, for instance)? Two things then happen: the economy gets going and more tax receipts come in to help pay off the debt (of newly created money). Yes, of course, if this went too far, inflation could become a concern. So, it is important not to go too far.
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Even more interesting – much more interesting! – if the law were changed – or we acted as we did in part during World War II and, for instance, Canada acted between 1938 and 1974; – it would be possible for the Fed to lend directly to the government, bypassing the bank “middlemen” who make their profit by selling bonds to the Fed and investing the money in the government.
Moreover – watch this very, very closely – since by law the Federal Reserve Board turns over almost all its profits (i.e. all interest) to the government even now, the loans would cost the government literally nothing if things were done in the simple, straightforward way (or if a “public bank” were set up that operates just the way private banks are run today, including making profits for the owners – who in this case would obviously be the public – i.e. the government).
(One rough estimate offered by the Public Banking people is that had the United States done what they are talking about over the last 24 years, the amount saved on interest payments on the national debt would have been roughly eight trillion dollars – and the economy might also have been moved out of recession. Whatever the number might be in a careful statistical analysis, it is very, very large indeed.)
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There is a rough parallel in all this with the way student loans used to be handled and are handled now. For a substantial period, the banks provided some loans to students that were guaranteed by the government, adding a mark-up for their profit. In 2010, Congress decided to eliminate the middleman and the government now simply makes the loans directly at lower cost.
But, of course, we don’t allow ourselves to follow the straightforward path outlined above or suggested by the student loan program changes. Indeed, to even suggest the Public Banking strategy is to suggest a horror of horrors, since one of the biggest money makers for the banking industry would be on the chopping block.
And the banking industry – especially its Wall Street branch – plays a very powerful and rough political game opposing anything or anyone who tries to “uncorral” the thinking of the public.
Nonetheless, that is the direction that was opened up for serious discussion at the Public Banking conference. First steps first, of course. We currently have one “public bank” in the United States, the 93-year-old Bank of North Dakota. Since 2010, seventeen states have considered legislation to create banks based in one or another way on this model. Ellen Brown, the leading theorist behind the movement – along with many participants – urges the value of such banks on their own terms in that they help small businesses, farmers, home-owners, students and others.
But, down the line, the big payoff is to get us thinking much more carefully about the way the world really works, and why. Once you start thinking about how money is created and who gets to use that power and for what purpose, some very, very interesting questions indeed begin to follow.
To be sure, the story gets more complicated when you bring in global trade, finance, the Chinese, and so forth: A serious move in the way posed by the Public Banking people would have major implications for global finance, and the role of the US – and the US dollar – in the global system.
But this, too, is one of the purposes of taking such proposals seriously – and the importance of starting a far-reaching new debate not only about money and the US system, but the fragility of the entire superstructure of global finance these days.
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(By the way, one estimate is that roughly 25 percent of the world’s banking systems allow central banks to extend credit directly to governments; another 37 percent allow short-term advances. These include some of the fast charging so-called “BRIC[S]” countries such as India and South Africa, as well as Malaysia, the United Arab Emirates, Israel and Japan.)
If you want to have some fun with this – before you get angry at the rip-offs – take a look at the video of 12 year-old Victoria Grant explaining the same thing for Canada. There is a reason why it went viral and has been seen by more than a million people.