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.
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