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Liability: the claims in the borrower's deposit account (can be withdrawn for cash or transferred to any other party)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