I recently questioned
conventional wisdom as to the relationship between
the US Treasury and the Federal Reserve Bank, and
indeed the very basis of the dollar itself. (See
very secret agent (Asia Times Online, July 27,
2011). Comments poured in, and the subsequent
discussion and debate has been both intense and
Having peeled away all the
layers of the onion, the debate reached the
bizarro world of the Federal Reserve Bank's
balance sheet. Manoj Singh explains the Fed's
Looking Glass World in an Investopedia article.
"Taking a look at the balance sheet of
the Federal Reserve Bank, or for that matter, any
central bank, is like seeing the eighth wonder of
the world. Unlike any other business enterprise
can expand its balance sheet
by printing as many dollar bills as it wants. It's
like creating winds merely by waving your hands."
So we are asked to believe that the
accounting definitions and rules of double entry
book-keeping which apply to every other business
entity are suspended at the Fed.
are assets and liabilities... For any
business enterprise - and the Fed is no exception
- there are two types of financial claim. There is
the claim of the owner, generally known as equity,
and there is the claim of a third party against
the business, generally known as debt.
the days when gold coins were used as money, they
began to be taken in by goldsmiths and held for
safe-keeping on benches or bancs in the
goldsmiths' vaults. The goldsmith as custodian
would issue a receipt which was a document of
title to the gold coins. Note that the obligation
of the goldsmith was not a debt to the owner, but
was an obligation to deliver the gold coins to him
upon presentation of the title document.
These convenient paper receipts rapidly
came to be used instead of gold coins in exchange
transactions while the gold coins, as the
goldsmiths were not slow to observe, remained
sitting indefinitely on their bancs. So
goldsmiths began to create more receipts than they
actually held in gold and by lending them to
borrowers - creating interest-bearing debt
obligations by the borrower - became the first
generation of proto-banks.
private banks were always susceptible to a loss of
confidence by depositors, who could demand the
return of their deposited gold at any time,
whereas the loans the banks made based upon their
gold deposits were for defined periods of time.
Over the centuries this mismatch led to a series
of banking crises and collapses, which in turn
resulted in the evolution of state-owned or
state-controlled central banks. The first modern
example was John Law's Banque Royale in France in
1719, accompanied, appropriately enough, by the
first modern bubble fuelled by such manufactured
bank credit - the Mississippi Bubble.
….and Fed assets and
liabilities The last vestiges of gold
backing for US credit creation disappeared in
1971. When the Fed now creates credit as the agent
of the Treasury it is still creating an ownership
claim as before, but this ownership claim is now
in respect of a different, and virtual, monetary
object which is inserted into the Fed credit
creation process almost by magic.
reality happens when the Fed creates credit as an
agent of the Treasury is that it manufactures a
facsimile or look-alike Treasury bill of credit:
this is the virtual equivalent of a United States
Note or "greenback". Such Treasury bills of credit
are redeemable in payment of taxes, in precisely
the same way that a Frequent Flyer Mile is
redeemable in payment for flights. These are by
definition not liabilities of the Fed, but are non
interest-bearing liabilities of the Treasury,
whereas dated Treasury Bonds and Treasury Bills
bear interest directly or implicitly.
These undated Treasury bills of credit -
generally known as cash - are then deposited by
the recipient bank with the Fed as custodian.
These reserve deposits are described by the Fed as
liabilities, but this description is misleading at
best and deceptive at worst, since the Fed is not
in debt to depositors. It is the Treasury which
has the debt obligation to depositors. The Fed's
obligation to depositors as credit creating agent
of the Treasury is that of a custodian, but this
reality has been obscured.
believing two contradictory thoughts at the same
time. (1984 - George Orwell)
Statement One: when the Fed
creates credit it acts as the fiscal agent of the
Treasury. Statement Two: the Fed
has a conventional banking counter-party and
checking relationship with the Treasury.
In a principal/agency relationship a
credit issued by the agent is equivalent to a
credit issued by the principal.
But in a
banking counter-party relationship - as anyone
with a checking account will know - a debit entry
in the Treasury's books is reflected by a credit
entry in the Fed's books and vice versa. So a Fed
account receivable mirrors a Treasury account
payable and vice versa: a Fed term-loan asset
mirrors a Treasury term-loan liability and vice
It is not possible for both
statements to be true because these two accounting
relationships are mutually exclusive. In respect
of a particular transaction you can be a
counter-party or an agent, but you can't be both.
The reality is that Statement One is true,
and the proof is that a Federal Reserve Note
emitted by the Fed is accepted in exchange in
exactly the same way as a United States Note
emitted by the Treasury, of which a few still
remain in circulation in the US.
Statement Two is false, because the Fed's balance
sheet does not reflect reality, and distorts the
true nature of the obligations between the
Treasury, the Fed and the people.
vanished with a wave of Fed chairman Ben
Bernanke's hand are the virtual undated Treasury
bills of credit which are created by the Fed on
the Treasury's behalf and deposited with the Fed
Esoteric though it may be,
this accounting smoke and mirrors - which
completely invalidates almost the entire body of
conventional economics built upon the misconceived
understanding of money which results - is indeed
the Eighth Wonder of the World.
Note 1. For Manoj Singh's
article, "Understanding The Federal Reserve
Balance Sheet", see here.
Chris Cook is a former director
of the International Petroleum Exchange. He is now
a strategic market consultant, entrepreneur and
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