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I find myself regularly amazed about the sheer amount of myth and misinformation continually circulated by people when it comes to money.  Whether progressive or conservative most people think of the US dollar as a commodity.  Because to any user of a currency, a household, business, city, or state, money is by definition a scarce resource that can be exhausted, one of the defining attributes of a commodity.  However, this personal relationship with money has no bearing whatsoever on the relationship between the issuer of our currency, the consolidated Federal Govt (Fed and Treasury) and the US dollar.

The US dollar is most definitely NOT a commodity.  The US dollar is not something we can grow, mine, or harvest.  The US dollar is an invention, its all been created out of thin air.  For all of human history, modern US dollars (more accurately known as Federal Reserve notes) did not exist, then in 1913 the Govt created the Federal Reserve Bank and effectively the modern US dollar.  All US cash and NET dollar denominated financial assets can only legally and operationally be made by the Federal Govt.  Private banks are not legally allowed to print US cash but the Govt does empower them to create new dollar denominated financial assets AND debts.  But we have to remember that all privately, called horizontal or endogenous, money nets to zero, by definition.  This is why banks CANNOT create any new NET financial assets.  When a private bank extends a loan it creates a liability and an asset for both the bank and the borrower.  

Asset: Loan contract
Liability: the claims in the borrower's deposit account (can be withdrawn for cash or transferred to any other party)

Asset: The money in their deposit account
Liability: Loan contract

The sum of all these transactions must continuously net to zero.  As the borrower repays the loan, both sides of the ledger get extinguished in a mirror fashion.  At the end of the loan contract, the bank will have net interest income that will have come at the expense of the borrowers future income or borrowing so that also nets to zero.  Assuming the borrower did something productive with the money, they should be left with a real asset, maybe a home, car, small business, etc.  This is a micro description of how the private money supply grows and shrinks over time....... as more people take out net loans or debt, the money supply grows and conversely when people deleverage or pay down their debts, the private money supply shrinks and this is what causes deflationary events, better known as depressions.  If the private sector doesn't want to accumulate any more debt (RE: grow the money supply), than economic activity=GDP must too decline.  

The Govt grows the money supply by increasing the number of NET financial assets (NFA) that the private sector has.  A net financial asset for the private sector is any financial asset held by the private sector that is a liability for the federal Govt and not another private sector actor.  This includes Treasury bill, notes, bonds and of course cash.  The only way the Federal Govt can increase NFAs is to deficit spend.  All deficit spending is newly created money that the Federal Govt gives to the private and foreign sectors.  Contrary to popular myth, the US govt doesn't borrow money, there is absolutely no operational or economic law that says the Federal Govt must issue Treasury bonds in order to create money and deficit spend.  The issuing of Treasury bonds, how many, the manner, and when is a wholly political decision.  It began as a way to make sure there wasn't too much banking reserve or foreign-held cash around that could be traded in for the Fed's gold, and after August 15, 1971 the gold standard was ended and now the bonds are issued for only one hit the Fed's target interest rate.  This is because deficit spending actually creates bank reserves as the new money flows through the recipients' bank accounts and some portion of it must be held in reserve by the banks at the Fed.  And as the amount of bank reserves increase relative to the amount of reserves the banks are required to hold by the Fed's ratio of reserves to deposits on the commercial side of bank ledgers, the lower the interbank or overnight lending rate will go....down to zero.  

So deficit spending drives the federal interest rate down, not up. In order for the Fed to maintain a positive interest rate, it needs the bonds the deficit allows them to create in order to soak up the excess reserves and keep the interest rates up.  We can clearly see the proof of this in action as this is exactly how the Fed's Quantitative Easing or QE works to set the Fed's zero interest rate policy or ZIRP.  The Fed bank creates reserves that they use to buy outstanding Treasury securities which increases the reserves in the banking system relative to the previous baseline and this surplus of reserves means they are more abundant relative to the demand for them which of course drives the price (RE: interbank lending interest rate) down.  

So as we can see by this very limited and simplistic explanation of how our Govt, CB, and banking financing operations work make the notion that the Federal Govt's budget is like a household, business, or state is grossly misleading.  The Govt is the monopoly issuer of all our cash and net financial assets and as such its clear that the Govt in no way needs our hard earned money in order to create and spend its own invented fiat currency.  The whole concept of running out of an invented paper bill or digital entry on a computer spreadsheet is preposterous.  Like I said in the title.....the US dollar does not grow on trees!

Originally posted to Auburn Parks on Fri May 10, 2013 at 03:42 PM PDT.

Also republished by Money and Public Purpose.

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Comment Preferences

  •  Tip Jar (7+ / 0-)

    "The Earth is my country and Science my religion" Christiaan Huygens

    by Auburn Parks on Fri May 10, 2013 at 03:42:01 PM PDT

  •  Excellent diary! (1+ / 0-)
    Recommended by:
    Auburn Parks

    I already had a fuzzy idea of most of this, but it's helpful to have you explain these concepts with additional clarity.

    Wouldn't it be wonderful if these basic concepts could be taught to all High School students before they graduated? But that won't happen, because it would be seen as politicized content. It is in the best interests of the 1% that the average joe does not know how the financial world really works. It's that much easier to hoodwink them and get them to vote against their interests (austerity and tax cuts).

    "If you've heard this story before, don't stop me, because I'd like to hear it again." Groucho Marx

    by Ruh Roh on Fri May 10, 2013 at 03:53:51 PM PDT

    •  Hey thanks (0+ / 0-)

      Unfortunately, the economic textbooks still teach the gold standard based neo-liberal economic thinking....I.E. The Loanable Funds Theory where the banks can only get money from inside the private sector.....the old using deposit savings from patient spenders to lend to farmers and impatient spenders.  This is patently ridiculous.  I know Bill Mitchell and Randy Wray are working on a Post-Keynesian Economics Textbook right now the problem is of course political.  If the nation has a hard time getting some states to teach evolution accurately its going to be just as difficult to change the paradigm with regards to the reality of our national currency.  But we can make progress and we must make progress otherwise progressive social policy is always going to be a loser because Americans would almost always rather have lower taxes than more social programs.

      MMT = Reality

      "The Earth is my country and Science my religion" Christiaan Huygens

      by Auburn Parks on Sat May 11, 2013 at 04:23:38 AM PDT

      [ Parent ]

  •  True. Money is a figment of the imagination, which (1+ / 0-)
    Recommended by:
    Auburn Parks

    for convenience sake we incorporate in a tangible form. The dollar, the official currency of the United States, is a certified IOU and, in that sense, not very different from a marriage certificate, albeit much more numerous. Both monetary certificates and marriage certificates represent an obligatory relationship. That is, somebody is obligated to someone else and the community attests to that with a certificate. The obligation may or may not exist, regardless of whether it is certified. However, when it is certified, the community has an interest in seeing that the obligations are carried out. A man's word is his bond, but a witness makes it firmer, so to speak. Moreover, monetary certificates make it possible for the obligations to be passed around and even carried out by someone else. So, in effect, the currency acts like a middleman.
    To appreciate how it works, one has to understand symbols. In that sense, currency is like the alphabet which renders meaningful sound visible. Symbols do that. The translate the invisible into something we can see and, in some cases, touch. Reading involves the sense of sight; writing the sense of touch. It is likely that much of the power of the written word is derived from the fact that it brings information into the brain via various pathways. Touch may well account for why we are not becoming a cash-less society, despite all the economist's predictions. People like the feel of money in their purses and pockets.

    When currency was tied to gold, a relatively scarce commodity, it was easy for the issuers and their banker buddies to argue that money is scarce. But, the rationale for the argument was always because rationing the currency put the money changers in control. In the U.S., where the management of the currency was assigned to the Congress, the Congress delegated that function to the Federal Reserve Bank, perhaps as one of its first acts of privatization a hundred years ago for the purpose of disguising its responsibility. Why would Congress do that? Because the pretense that money is scarce lets them advantage some populations and deprive others. In a sense, this behavior is akin to denying reading and writing skills to some people. Deprivation or the threat of punishment are potent instruments of control and, unlike gifts and physical punishments, cost the perpetrators nothing and insure them against revenge. Congress is employing the currency as an instrument of deprivation and, for that matter, it employs the law in a similar fashion because Congress is a den of petty potentates with no interest whatsoever in being public servants. That the people govern strikes them as preposterous. So, they wield both money and the law as instruments to demonstrate their power. "Sequester" is just another euphemism for the impulse to deprive.

    We organize governments to deliver services and prevent abuse.

    by hannah on Sat May 11, 2013 at 03:23:49 AM PDT

    •  Its hard to know exactly just how much"conspiracy" (0+ / 0-)

      is behind the drive to perpetuate the myth that the US dollar is a finite physical good.....I think alot of it has to do with how much cynicism someone has and to project that onto our interpretation of why The Big Lie keeps on being repeated even 40 years after the gold standard is over.  I am usually a pretty cynical person so I often find myself thinking that this misinformation is spread from a central cabal of greedy bankers and capitalists.....but I am always grounded in this thinking by my atheism.  How can so many smart people believe some of the religious things that I perceive to be so silly?  Is it one big conspiracy?  Life is complicated.  Surely, some of the wealthy must know that neo-liberal economic thinking is defunct but they would probably be just as afraid to come out as monetary realists in polite company as they would to come out as godless heathens (maybe?).

      MMT = Reality

      "The Earth is my country and Science my religion" Christiaan Huygens

      by Auburn Parks on Sat May 11, 2013 at 04:33:32 AM PDT

      [ Parent ]

      •  Well, given that Congress, under the rubric of (0+ / 0-)

        smaller government has been in effect rationing the distribution of dollars to the states, much as the European Central Bank is now doing for the countries in the recently created euro zone, and "revenue sharing" has been associated with policy considerations or "strings," while the private financial sector alternately hoards or speculates, what should be as readily available as any measuring tool has been made artificially scarce.
        Exclusivity don't just apply to physical venues. The impulse to segregate can be more easily satisfied by denying access to immaterial assets such as education or information or even locomotion than by setting up territorial restrictions. Moreover, if deprivation (subtle torture) is the objective, there is more psychic satisfaction to be gained from depriving people of a plentiful resource than of a scarce one.
        I don't think one has to posit a conspiracy to explain deprivation and other sadistic behaviors. After all, the deprivation of another's rights is the central characteristic of crime and criminal behavior arises all on its own. Crime needs no external prompt. However, the prospect of legal crime, imposing deprivation without the risk of revenge is likely particularly attractive and amply supported by precedent in the U.S. After all, the Constitution enshrined the deprivation of all human rights from enslaved Africans and Native peoples and, for that matter, the humans rights of women and minors and recent immigrants were not given much respect, either. Humans exploiting their own kind has been a staple of the U.S. legal system. If it can be done indirectly by depriving some populations of access to money, why not take the opportunity?
        The U.S. is an ownership society. People either own or get owned. Property rights trump human rights. Always have.

        We organize governments to deliver services and prevent abuse.

        by hannah on Sat May 11, 2013 at 06:39:41 AM PDT

        [ Parent ]

        •  I certainly agree that deprivation is the result (0+ / 0-)

          of said policies but what I was referring to was more closely related to the motivation for why people hold the views they do.  And don't get me wrong, I wasn't inserting the word conspiracy in order to delegitimize the notion that there are plenty of the wealthy elite who know better but still want to deprive the people.  Thats the technical definition of a conspiracy and its right on.  Obviously there is no way to know for sure, but I think the number of .1% who really understand how our monetary system works and yet actively contrive to keep The Big Lie going is a minority position amongst the number of people in the group.  Ask the same question about the number of elected politicians who know better and actively lie and I believe the number is very, very small.  Such is the extant of the 'brainwashing' through A) misinforming education B) media mis-reporting C) plain old lack of the intelligence needed to comprehend banking, monetary systems, and national finance.  
          It's all terrible in my opinion also.....I think its criminal to subject so many millions of people to so much completely unnecessary hardship.  I wish that economic thinking wasn't so religious for people that they reject reality itself, but alas, humans have a great ability for mass delusion

          "The Earth is my country and Science my religion" Christiaan Huygens

          by Auburn Parks on Sat May 11, 2013 at 02:49:59 PM PDT

          [ Parent ]

  •  Good Diary (0+ / 0-)

    Auburn. Glad to have you aboard the MMT train.

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