Delivered to Doctors for Disaster Preparedness Scottsdale, Arizona, July 12, 1998

Suppose I were a United States Congressman. And suppose I were not a particularly principled United States Congressman. (Although for most of this audience, that may be redundant.) And suppose my congressional buddies and I decided to spend $900 billion on the "general welfare." Or, for those of you who are more cynical about these things, suppose we decided to shower $900 billion on particular constituent groups in order to buy their votes and thus assure our continued reelection.

Since Congressmen are astute politicians—if they were not astute politicians they wouldn't be in the Congress to begin with—they know that if they were to raise taxes to pay for this largesse, there would be resentment and their purpose would be defeated. But, with our fiat "funny-money" monetary system—fiat money being money that is created out of nothing--politicians don't have to do.

They merely pass the enabling legislation, and send it over to their employees at the Treasury Department. They, in turn, type up a Government bond; think of it as an IOU. Then, in this instance, their agents take the $900 billion bond to a small group of private companies called commercial banks and ask them to buy it. As I speak, according to the Federal Reserve's Flow of Funds Reports, banks in the U.S. have in fact bought $900 billion worth of U.S. Governments for their own accounts and have them on their balance sheets. It is at this moment that this presentation begins to get interesting. Because, where do you suppose the banks got the $900 billion to pay for these bonds?

Before continuing, let me dispose of two places where they most certainly did not get the money. Most people in this country and around the world are under the mistaken impression that banks merely re-circulate deposits. That is, that they lend money that has been saved by others. But, when the banks bought these $900 billion in U.S. Government securities, was anybody's bank balance reduced? Did you ever have the experience that one day your bank balance was inexplicably reduced and when you inquired the bank told you that they had lent your money to someone else? Of course not.

One of my colleagues, who is a director of a small bank, once suggested to me that banks got the money from bank capital. But, the banks in this country never had even a third of this amount in bank capital. So, if they didn't get the money from depositors or from capital, where did they get it?

The answer is that they simply created it out of nothing! If the notion of a small group of private companies creating $900 billion out of nothing is confusing to you, it is only because the concept is so blatantly outrageous. Why, in a democracy, should a small group of private companies have this power? By the way, they don't call it creating money. No one would stand for that if they understood what is happening. They use jargon to confuse you. They call it "fractional reserve lending."

And physically how do they work this magic? It is simple. Little fingers go to a computer keyboard and type "900" followed by nine zeroes, and miraculously, beyond the dreams of any sixteenth-century alchemist who might have spent a lifetime trying to turn a lump of lead into gold, these bankers created $900 billion. Amazing!

For those of you who are into accounting, the T-accounts look like this: on the left side, the assets, are the $900 billion in Government bonds that the folks at the Treasury Department typed up, and, on the right side, the liabilities, is the $900 billion that the banks created out of nothing. So, the books are in balance.

But, one might ask, don't the books get out of balance once the money is taken out of the banks? This is part of the genius of the system. The money never leaves the banking system. Consider what you do with any check that you get from the government, whether it is a Social Security check or payment for whatever. Every check must eventually be deposited in a bank.

For our erstwhile politicians, this is a wonderful arrangement. In effect, they can act unilaterally without bothering the people to pay for whatever they want to do. This has led to some monstrous excesses. For example, the Vietnam War could never have happened if President Johnson would have had to raise taxes to pay for it.

It was acceptable to most people because mostly the kids of poorer families had to go fight, and "no one had to pay for it." That is, taxes were not increased. If Johnson had proposed legislation to raise taxes the more than thirty percent needed to finance the war, there would have been much more oversight as to what was happening with the money. This is true for almost all government expenditures.

If politicians don't need to raise taxes to pay for their programs, people are much less concerned than they might otherwise be. In the case of President Reagan, he was able to actually lower taxes while increasing government spending.

But, as good a deal as this is for politicians, it is a fantastic deal for the banks, because they get almost $50 billion in "interest" year in and year out on the $900 billion U.S. Government bonds that they "bought." Since there was virtually no work in creating the $900 billion (how much extra work is needed to create $900 billion as opposed to just $9 billion? One has only to press the zero key twice!), they are, in effect, getting the $50 billion each year as a gift. And since money on deposit in commercial banks pays virtually no interest—last I looked my checking account paid .8% interest, the interest that they get from the government on their bonds is virtually all theirs to keep.

Now, there are some people in this country, perhaps even in this room, who decry the so-called "Welfare State." They object to the notion of transferring wealth from people who earn it to people who don't earn it. Typically, one hears them complaining about things like the School Lunch Program whereby the government subsidizes lunches for children who might otherwise not get enough to eat. Sometimes the object of their ire is the Food Stamp Program whereby adults are subsidized who might otherwise also not get enough to eat. Very definitely, they complain about Aid for Dependent Families whereby women who have kids without another breadwinner are subsidized by the government. And always they complain about payments to people who arguably could and should work.

But, what about this not inconsiderable amount of wealth transfer to banks? Where are the libertarian, conservative and Republican voices being raised against this bit of injustice? I have listened very carefully, and I have never heard them. And since people in banking are generally more well-to-do than the rest of us, isn't this a case of transferring wealth from poorer people to richer people? I call it "stealing from the poor to give to the rich." It's Robin Hood in reverse.

And what about the constitutionality of this kind of wealth transfer? Where are organizations like the Federalists, who believe that judges should interpret the Constitution the way it was written and not the way they wish it was written when it comes to this bit of injustice? Here is an instance where the Congress has delegated to the banking system a power that the Congress itself does not have. Virtually all of those who believe in the Rule of Law have been silent. How come?

Let me interject that FAME Foundation Scholar Edwin Vieira, a Harvard-trained attorney who has devoted most of his life to these issues, has written a wonderful monograph on this matter called "The Forgotten Role of the Constitution in Monetary Law." It appeared in the Fall 1997 issue of the Texas Review of Law & Politics. It is also available in full text on FAME's website, www.fame.org.

Let's continue. Suppose now our political friends decide to raise another $450 billion. As before, they pass the enabling legislation, send it over to their employees at the Treasury Department who type up a bond. But, this time, instead of having commercial banks monetize—turn into money—this debt, they take it to their quasi-employee, Alan Greenspan, at the Federal Reserve, and they ask the Federal Reserve to buy it. Being the fiscal agent of the Treasury, the Federal Reserve is happy to oblige.

And where does the Federal Reserve get the $450 billion? The same place the banks got it. Little fingers go to a keyboard, type "450" followed by nine zeroes, and the $450 billion miraculously appears in the government's checking account. Obviously, I am using a bit of hyperbole here. Both the $900 billion and the $450 billion were not created by eighteen keypresses. They are the result of many such transactions over a period of years. If all of this happened at one time people would catch on and would object.

But, in the case of the Federal Reserve monetizing U.S. Government debt, there is an important distinction as opposed to when banks create money. The Federal Reserve does not keep the interest for its own account. After subtracting its "expenses," a portion of which is used to buy off critics, especially economists, the Federal Reserve returns the interest back to the Treasury.

So, in effect, it is as if the U.S. Government created the $450 billion itself. Further, when the $450 billion is spent and becomes deposited in commercial banks, it becomes the "reserves" about which you have heard so much. The truth of the matter is that this is so much gobbledygook. The reserves themselves are created out of nothing and act as a constraint only on small-bank money creation. As a practical matter, big money-center banks are not limited by reserves.

Now, this story gets even better, or worse, depending upon your point of view. Not only do banks create money when they lend to the government; they create money when they lend to anyone! For example, if you get a $100,000 mortgage from Citibank, where do you suppose Citibank gets the $100,000, which they credit to your account? Again, after they lend you the money, there is not a single depositor in the bank who has any less money in his account than before they lent you the money. As with the $900 billion, the bank creates the money with a simple bookkeeping entry.

And how much money have the banks in this country created? According to the Federal Reserve's Flow of Funds Reports, since 1950 they have created something in excess of $5 trillion. Just in the last six years, they have created $2 trillion, and in the last two years, they have created $1 trillion. To put this another way, if they can find someone to borrow, they can create more money on which they get interest and fees. Thus, they are fully motivated to create all the money they can, which is why they sent out three billion credit card solicitations last year.

But what about credit risk? If they lend wantonly, won't they be penalized? In fact, this is a growing problem for them. In the last thirty years, as the capital markets have become more efficient, the more credit-worthy borrowers of the world, such as IBM or the Ford Motor Company, bypass banks when they need money. They go directly to the commercial paper market where they get better terms and pay less interest.

As a result, to continue to generate fees and interest, banks have had to lend to less credit-worthy borrowers, such as "emerging countries," and for more illiquid investments, such as real estate. This means that the quality and liquidity of bank assets has been decreasing as the amount of money they are creating has been increasing. This is an unstable situation and everyone in the banking industry knows it.

In order to protect themselves, bankers have negotiated with, or to use a less friendly term, colluded with, politicians over a long period to legislate two safety nets for the banks; and, today, for many Wall Street firms too. Federal Reserve Chairman Greenspan has identified these safety nets as true subsidies. Since by definition every subsidy is in fact wealth transfer, this is another instance whereby wealth is being transferred from working people to the financial sector. In effect, these safety nets protect and subsidize the banks' balance sheets. They come in two flavors.

First, and most important, bank assets are protected by what is commonly known as the "lender of last resort" facility at the Federal Reserve. In the event that bank assets systemically, not individually, start to deteriorate, i.e., become "illiquid," or not marketable, then the Federal Reserve—read: the ordinary taxpayer—stands ready to convert those possibly worthless assets into cash. And where does the Federal Reserve get the cash to purchase these assets? You guessed it. Little fingers go to a keyboard and they create it out of nothing. Folks should know that every time money is created out of nothing, it dilutes the purchasing power of money that has been saved or promised for future payments, such as pensions.

(Final Part next week)

FAME
Foundation for the Advancement of Monetary Education
211 East 43rd Street
New York, New York 10017-4707
Tel: 212-818-1206 Fax: 212-754-6543
E-mail: LPARKS@FAME.ORG
Website: http://www.FAME.org

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