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     Jul 27, 2011

A very secret agent
By Chris Cook

There is a charade playing out in Washington at the moment in respect of the completely meaningless "debt ceiling" which the US maintains as a relic from the days of the gold standard.

We are told that at the US Treasury's account at the Federal Reserve Bank there will soon be no more taxpayers' dollars, and therefore the Fed will soon be unable to make any more payments or issue any more cheques on behalf of the Treasury. The money has run out.

This is nonsense. It is a myth, and moreover it is a myth that Federal Reserve chairman Ben Bernanke exploded in his recent

testimony to a US congressional committee.
Congressman Sean Duffy: We had talked about the QE2 with [congressman] Dr [Ron] Paul. When - when you buy assets, where does that money come from?
Ben Bernanke: We create reserves in the banking system which are just held with the Fed. It does not go out into the public.
Duff: Does it come from tax dollars, though, to buy those assets?
Bernanke: It does not.
Duffy: Are you basically printing money to buy those assets?
Bernanke: We're not printing money. We're creating reserves in the banking system.
But ask yourself the question: if paper money is not being printed, then what exactly is being created? What are these "reserves" to which Bernanke - and indeed the Federal Reserve Bank's very name - refers?

Bernanke is unwittingly exploding two foundational myths which underpin mainstream economics.

Myth 1: tax and spend
The tax and spend myth is that "tax-payers' money" is first collected by the Fed and then spent, or lent.

Bernanke blew that one away when he told the committee that taxpayers' money was not involved when the Fed was busy easing quantitatively. The Fed created 1.6 trillion somethings, which banks accepted, either for their own account or a customer's account, in exchange for the Treasury Bills they owned, and these somethings were, and still are, deposited with the Federal Reserve Bank as a custodian of ... "reserves".

Many US citizens will be old enough to remember "Greenbacks": paper promissory notes issued by the US Treasury for circulation as currency. These work exactly the same as the familiar Federal Reserve Bank notes that now constitute US notes in circulation - ie both may be presented in payment of taxes or of other debts. So Fed notes are in every sense Greenback "look-alikes".

Bernanke confirmed the staggeringly simple reality that not a single taxpayers' dollar is actually spent or lent when the Fed follows the Treasury's instructions to credit any account, anywhere, for anything. This is because the Fed is creating - as an agent on behalf of the Treasury - an exact "look-alike" of a Treasury IOU or promissory note. ie the Fed is simply pledging the Treasury's credit by creating tax credits.

So what happens when taxes are paid? When a dollar of tax is collected by the Federal Reserve Bank on behalf of the Treasury it does not become a deposit that adds a dollar to the Treasury's credit balance at the Fed. Instead, a Treasury credit for $1's worth of tax is canceled by the Fed as agent for the Treasury and the national debt shrinks by $1. It's exactly as though an obsolete $1 note is torn up or burnt. Or another way of looking at it is that it is what happens when a Frequent Flyer Mile is redeemed against a flight.

In other words, Bernanke's somethings are tax credits, and therefore a form of equity, not debt: they are for all the world equivalent to a $1.00 redeemable preference share issued by US Incorporated. When the Fed creates these tax credits on behalf of the Fed it creates an asset - not a liability - that it holds in reserve as custodian for the recipient banks as a "deposit".

The Fed owes nothing to anyone as a result: the creation of these dollars creates credit not debt - the Fed cancels them against payment of taxes, and transfers them between clearing bank accounts upon instruction.

Once this simple but fundamental point is realized - that the Fed is the agent of the Treasury, and not a banking counter-party as conventionally assumed - then there is a paradigm shift.

US dollar "fiat currency" is not a debt of the Fed: it is simply a tax credit that is created and spent by the Fed on Treasury instructions. "Taxpayers' money" has in truth never been anywhere near a tax-payer.

This myth of tax and spend arises out of credit creation by the central bank. The myth of fractional reserve banking arises out of credit creation by private banks.

Myth 2: fractional reserve banking
This myth is that banks receive deposits from customers and then lend them out again, retaining a fraction in reserve, which enables them to lend out a multiple of their reserves funded with money from the Fed.

The truth is that private banks do exactly what the Fed does: they create tax credits in the form of Treasury IOU "look-alikes", and these tax credits are then deposited in the banking system by the recipients. Banks create tax credits not only when they lend at interest, but also when they spend, by crediting the accounts of suppliers, staff, management, shareholders, and sellers of assets.
This private bank credit creation is not restricted by bank reserves as is the myth, but by the capital "cushion" they are obliged by banking regulators to retain in order to absorb defaults by borrowers.

Private banks create these tax credits, and then charge borrowers for the use of them. The key point is that the tax credits are not the loan: they are the things that are loaned, or the object of the loans. Deposits of privately created tax credits are simply accounting entries in the banking system, which are distinguishable from the tax credits created by the Fed only by the set of books in which they are recorded

A national equity
The US national debt is in truth - like all national debts - a complete and surreal fiction: it is a national equity, the greater part of which is interest-bearing either as claims over public or private revenues.

At least two-thirds of the quasi tax credits created by banks came into existence as mortgage loans, and are therefore backed by claims over the productive value of the US land and buildings which they fund. Much of the rest consists of claims over the value of US assets which fund the productive capacity of US corporations. The remainder - which provides the credit necessary to finance the circulation of goods and services in the US - is based upon the magnificent productive capacity of the US people.
Only by liquidating US Incorporated could this National Equity ever be redeemed.

The debt ceiling
The debt ceiling is a myth because there is no need to borrow to finance public expenditure and the creation of public assets. As Ron Paul points out, the Fed - which is ludicrously receiving interest from the Treasury in order to pay it right back again as profit - could actually waive or tear up the US$1.6 trillion Treasury debt it has bought through quantitative easing (QE), and it would make precisely no difference other than to reduce the National Debt at a stroke by that amount.

As the great US inventor Thomas Edison put it in 1921: "If our nation can issue a dollar bond, it can issue a dollar bill. The element that makes the bond good makes the bill good."

A very secret agent
Once the truth of the hitherto secret - or at best, completely obscure - agency relationship between the Fed and the Treasury is understood, then the world view changes. The sun of the Treasury does not go around the Earth of the Fed: it is the other way around. The Fed is servant, not master.

There is no shortage of dollars because every dollar's worth of productive capacity - public or private; productive people or productive assets - in the US is the capacity to issue a dollar credit, which reflects the increase in the US national wealth which underpins the US national equity.

President Barack Obama and his government should get busy creating national equity by instructing the Fed to create and issue the necessary finance for the creation of a new generation of US infrastructure; the transition to a low carbon future which the US can, and should, be leading; and in increasing the capacity of the US people to do so.

Naturally, the financial process of putting the US back on its feet in this way should not be managed by the dead hand of the state, but by the entrepreneurial US private sector with a partnership stake in the outcome, and under the watchful eye of the people's representatives.

What is the president waiting for?

Chris Cook is a former director of the International Petroleum Exchange. He is now a strategic market consultant, entrepreneur and commentator.

(Copyright 2011 Asia Times Online (Holdings) Ltd. All rights reserved. Please contact us about sales, syndication and republishing.)

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