Column by tzo.
Exclusive to STR
Where does U.S. “money” come from? If you’re not sure, the answer that follows may surprise you a bit.
The process begins with the Treasury Department creating a bond. Treasury bonds represent the Federal government asking for loans. When a Treasury bond is “bought,” what is really happening is that the “buyer” is loaning “money” to the Federal government, to be paid back with interest (or not, as is the case with many bonds and bills today).
The Treasury “sells” bonds to buyers (gets loans from creditors), with Japan and China being the largest players, accounting for over 40% of U.S. debt issue. But what happens to the bonds not purchased by anyone (the loans the government is asking for that no one wants to give)? Well, the Federal government gives the Federal Reserve Bank a call and asks them if they would be interested in buying some bonds. The Fed always agrees to do so, and when the Fed accepts the bonds from the Treasury (gives the loan), it lists the bonds on its books as an asset.
The Fed assumes the government will make good on its promise to pay back the loan. This is based on the belief that the government’s power to tax the people is sufficient collateral. You and your children are the collateral for the loan.
Because the Fed now has an asset that it didn’t have before receiving the Treasury bond, the Fed can create a liability that is offset by its new asset. This is how the banking system in this country operates. The liability that the Fed creates is a Federal Reserve check, which it gives to the Treasury in exchange for the Treasury Bonds.
The translation of what has occurred so far is this: The Fed has loaned the government “money” by “purchasing” Treasury Bonds.
And where did the Fed get the “money” to loan to the government? They created it out of thin air. That is what the Fed does.
This country’s “money,” Federal Reserve Notes (FRNs), are backed by Treasury Bonds, and those Treasury Bonds are purchased with and paid back with FRNs. Think about that.
The “money” was created by the very act of the Fed offering the Treasury a loan, and the Treasury accepting the loan. The Federal Reserve’s check is endorsed by the Treasury and is deposited in one of the government’s accounts. The government can then use the deposits to write checks against, to pay for government expenses.
The translation of what has occurred so far is this: The Federal government creates, out of nothing, as much “money” as it wants.
The above process tries to shroud it all in mystery, with its understanding restricted to those who have studied and understand the great and complicated “monetary sciences,” but it is all very simple. The government has a printing press, and it prints up all the cash it wants to spend.
Then it gets even more interesting, because this starts a process by which even more “money” is created out of thin air. Magical!
This new “money” enters into circulation and finds its way into the hands of people who take the FRNs and deposit them into banks. These deposits become reserves for a bank, and for every FRN that becomes a bank reserve, approximately ten more FRNs worth of loans can be lent out by the banking system. Again, think about that.
Fractional reserve lending, the mechanism by which today’s banking systems operate, allows commercial banks to create ten times more “money” than they have on reserve. Where does all this “money” come from? The banks create it out of thin air. Magic! The banks lend “money” they do not actually have in aggregate; and they get to charge interest on it as well.
Spectacular magic! Pure alchemy! Sheer genius!
Just get a load of this equation: $1,000,000 in deposits turn into $10,000,000 in loans at, let’s say, 5%. Banks therefore receive $500,000 in interest on that $1,000,000 of deposits, a cool 50% profit! And sometimes they even pay out 2% to their customers who gave them the “money”! Those magnanimous geniuses!
And if the loans default, how much do they really “lose”? That’s right! Zero!
OK, to recap: The Federal government asks for loans, a portion of which are given by the Federal Reserve Bank. The Fed gives the FRNs to the government. The government pays back the debt with those same FRNs. The FRNs are IOUs from the government to the Fed.
This is U.S. “money.” Federal debt. Citizens pass it around as if it were real money, because they know eventually it can be sent back to the Federal government as payment for taxes or other debts owed.
The Federal government currently has about $16 trillion worth of IOUs floating around in the world (never mind the approximately $202 trillion in unfunded liabilities), and the amount is rapidly increasing every year.
Why doesn’t the government simply print up $16 trillion and pay off the debt? Because in order to acquire $16 trillion in FRNs, it must ask the Fed for a $16 trillion loan. Which it would then have to pay back with interest. Do you see the inherent problem here?
This is why I have placed the word money in quotations throughout this article. Because money is something distinct from debt. The United States does not have money, it has un-repayable debt. There is a difference. If you don’t believe there is a difference between money and debt, then you must believe in magic.
And those kind of fantasies can only last so long in the real world.