The ability of banks to issue money raises some interesting questions about the nature of money and about the legal aspects of its issuance in the United States. On these topics I will now briefly digress. Money is nothing more than a common numeraire which reduces the search costs associated with conducting beneficial trades. Money is also a psychological abstraction. Literally anything can serve in this capacity as long as people are willing to accept it as a medium of exchange, if it maintains its purchasing power reasonably over time, and if it can serve as a convenient unit of measure. An official government edict is not necessary to create money.
The Constitution contains only two sections dealing with monetary issues. Section 8 permits Congress to coin money and to regulate its value. Section 10 denies states the right to coin or to print their own money. The framers clearly intended a national monetary system based on coin and for the power to regulate that system to rest only with the federal government. The delegates at the Constitutional convention rejected a clause that would have given Congress the authority to issue paper money. They also rejected a measure that would have specifically denied that ability to the federal government (Hammond, 92). Although the Constitution does not state that the federal government has the power to print paper currency, the Supreme Court in McCulloch vs Maryland (1819) ruled unanimously that the Second Bank of the United States and the banknotes it issued on behalf of the federal government were Constitutional.
If the federal government only is permitted to issue money, coin or paper, then how could state banks issue money? State banks did not coin money, nor did they print any "official" national currency. However, state banks could print bills of credit in exchange for specie deposits. These notes would bear the issuing bank's name and entitle the bearer to the note's face value in gold or silver upon presentation to the bank. State bank notes were a form of representative money; they were not gold or silver, but they represented it. The notes were more convenient for conducting large transactions than their specie counterparts, and, more importantly for the extension of credit, could be produced easily whereas the gold and silver stock of the nation was relatively small and for the most part declining (Hixson, 12-13). The Supreme Court ruled in 1837 in Briscoe vs Bank of Kentucky that state banks and the notes they issued were also constitutional.
One potential problem with such a system is that banks may issue notes far in excess of their specie deposits. Customers appeared from time to time wanting to exchange their banknotes for specie. The banks, of course, made allowances for this by keeping some of the specie on hand at all times. If the specie/banknote ratio was too low, even a small unexpected increase in the withdrawal rate could force the bank into insolvency. Remaining depositors who had not withdrawn their specie would be left with worthless banknotes.
The public accounted for this risk of non-redemption by discounting the notes of banks that were considered risky. For example, a $20 banknote issued by a bank with a reputation of redemption problems might carry a 5 percent discount off its face value. In other words, a local merchant might only give a customer $19 worth of goods for a $20 note with the difference compensating the merchant for the risk of accepting the banknote. Discounts on notes among functioning banks ranged from about 95 percent for the riskiest banks to zero for banks with a high degree of public confidence. On the advent of the free banking era, there were 712 state banks in operation in the United States, each with its own currency (Kidwell, 59). Imagine the difficulty for a local merchant in tracking the riskiness and value of perhaps dozens of different banknotes in addition to the other concerns of his business.
So, my question might be more philosophical than economical, but it's wracking my brain and I can't seem to find an answer.
It is about currency and how our money is no longer backed by "gold." Money (i.e. coins and bills) in essence is the same as chips at a casino. At the end of the day, if I choose, I could cash in my chips and get something of value for them. MONEY.
Back in the day, before Jimmy Carter, it was the same way, that, at any time, I could cash in my MONEY for GOLD. (which although has no intrinsic value, is determined to HAVE value.)
So, here is my question.....and I hope I explain it well. A lot of people out there are asking "why can't we just print more money and solve the poverty problem?" Terms like "inflation" and the "devaluing of the dollar" are the usual buzz answers to that question. Also, people give the example that if the government were to print more money and just give everyone $50,000, then everyone would go out and buy things, thus making THINGS more in short supply, thus driving up the price of things. (simple supply/demand economics) But this is where I'm curious. With TRUE unemployment probably somewhere around 15% in this country, if DEMAND rose, then companies would WANT to hire more people and build more processing plants to keep up with demand and raise their profits. So, the influx of cash (printed money) would seem to solve the unemployment problem.
So, here is where I'm confused.....if I apply the same idea of "printing more money and handing it out to the public" to my casino example, then that would be like the casino giving everyone at the poker table an extra $100 in chips to play with. But here's the catch. I understand the PROBLEM with doing that at the casino, because if you give people all these extra chips, then at the end of the night, when people CASH OUT, there will not be enough money in the vault to pay for all the chips. Hence the problem.
But how does that relate to American economics since there is no "cashing out" procedure. If the government gave everyone a bunch more money, there is no "checks and balances" since no one, at the end of the day, goes to the cashier station and exchanges their "chips" (money in this case) for something of value.
Exchanging your chips at the end of the day for MONEY back (which has value in our eyes) makes sense, hence why you can't give out more chips than the money you have in the vault. But it seems the American dollar is not a paper representation of the "money in the vault" no one goes to cash in their money in America.
So I don't understand how currency works and why we can't just print more money since it really isn't representative of anything of value.
Please explain, as I cant find a good answer anywhere online.
(I hope this question wasn't convoluted.)
Thank you so much for your time
“Large government deficits exist and will almost certainly increase substantially, which will require huge amounts of more debt to be sold by governments — amounts that cannot naturally be absorbed without driving up interest rates at a time when an interest rate rise would be devastating for markets and economies because the world is so leveraged long."
- Ray Dalio (2019), founder of Bridgewater Associates, a hedge fund, and author of Principles: Life and Work
“It is a sobering fact that the prominence of central banks in this century has coincided with a general tendency towards more inflation, not less. [I]f the overriding objective is price stability, we did better with the nineteenth-century gold standard and passive central banks, with currency boards, or even with 'free banking.' The truly unique power of a central bank, after all, is the power to create money, and ultimately the power to create is the power to destroy.”
— Paul Volcker (1994)
Our future will be determined by five transformative forces: The Five FATEs
Graphic by Dez CesariniFrom the New York Times on October 16: “The federal budget deficit soared to a record $3.1 trillion in the 2020 fiscal year…The federal government spent $6.55 trillion in 2020, while tax receipts and other revenue trailed at $3.42 trillion. Much of the spending came from the $2.2 trillion economic relief package that Congress passed in March…The deficit — the gap between what the U.S. spends and what it earns through tax receipts and other revenue — was $2 trillion more than what the White House’s budget forecast in February. It was also three times as large as the 2019 deficit of $984 billion.
Here's a quiz question: do you really understand how the U.S. Government can spend so much more than it receives? If so, no need to read further.
For those of us willing to admit that we don’t really understand how the U.S. Government can continue to fund its deficit spending…for the first time U.S. debt is now about equal to GDP (Gross Domestic Product), like the sound barrier we once thought if we hit it we might explode…this column will try to explain.
Our trusted guide is not an academic economist, who tend to be….academic. Ian Shepherd, a fellow classmate from Stanford Graduate School of Business (1978) is an Australian, although a knowledgeable and caring United States “outsider.” Ian is principally an inventor of new systems in financial markets, an activity that resulted in him appearing before the United States Supreme Court in its ground-breaking 2014 “patent eligibility” case, Alice Corporation v. CLS Bank International. Ian has a deep understanding of financial markets; he worked in international banking, was a partner at McKinsey & Company and has been an advisor to the Australian Treasury and the Australian Office of Financial Management. Ian has a particular professional interest in monetary policy design.
What’s different this time? The U.S. has had large deficits in the past. And we endured the 2008 financial crisis much better than many predicted.
“There were specific villains in the 2008 Financial Crisis; take your pick: Lehman Bros, AIG, Countrywide, Goldman Sachs, and so on. In mid-March 2020, there was a run on liquidity in financial markets worldwide. Yes, most companies in America then had a dependency on debt. But, to market outsiders, the financial markets functioned as well as they do usually. Still, the March liquidity run involved no (obvious) specific villains.
“The extraordinary demand for market liquidity in the United States in mid-March principally manifested itself as non-Government sales of U.S. Treasury securities (treasuries). It quickly became clear to the Federal Reserve (the Fed) that its Primary Dealer banks (large global banks) lacked the balance sheet capacity to buy (and then sell to others) these securities quickly; the Fed needed to immediately become the principal buyer of treasuries. Had the Fed not done this, the price of treasuries would have fallen, possibly precipitously, and their yield or interest rate would have risen just as dramatically; this would have then put upward pressure on the Government’s borrowing costs…and then, likely inflation and higher interest rates for everybody.
WASHINGTON, D.C. - October 27: A general view of the Federal Reserve Building in Washington, United ... [+] States on October 27, 2014. (Photo by Samuel Corum/Anadolu Agency/Getty Images)
Getty Images“The Fed soon began purchasing treasuries at a scale never seen before; it became a buyer of all treasuries its banks wished to sell. These sales saw the Fed rapidly increase its balance sheet assets and, correspondingly, increase the “excess reserve” liabilities of its banks. Looked at from the perspective of the Fed’s banks individually, these “excess reserves” simultaneously became their new assets, replacing their sold treasuries.
“Soon after this, the Fed began purchasing any and all other assets that its banks wished to sell, at prices that held before the mid-March liquidity crisis, allowing banks to escape taking losses. Meanwhile, the Fed, because it is, well, the Fed, didn’t need to account for the assets it purchased as losses.
“In short, the Fed’s “excess reserves” became new and high-quality assets of the banks. The popular term for what the Fed is doing is “printing money,” and at a rate rarely seen before; in fact, most of this printing is by the banks.
“This process repeats itself; every time this happens the banks are able to purchase the unwanted assets of other market participants, using their money creation powers to do so, backed by their ‘excess reserves” with the Fed. In turn, the Fed purchases these assets in return for providing further increased “excess reserves” to its banks.
“The effect of the Fed’s actions has been to keep interest rates lower than they would have been, benefiting all borrowers, including the Government, in the process.
WASHINGTON, DC - SEPTEMBER 24: Federal Reserve Board Chairman Jerome Powell testifies during a ... [+] Senate Banking Committee hearing on Capitol Hill on September 24, 2020 in Washington, DC.
Getty Images“A feature of the Fed’s asset purchases by “printing money” is that Wall Street firms and their large corporate clients have been the primary beneficiaries of its actions. The Fed has contributed to programs to directly support Main Street too, although nowhere near as much, or as effectively, as its Wall Street programs. The net effect of this strategy has been to increase societal inequity within the United States; it has also exposed the average U.S. citizen to future inflation risks.
“With the Covid-19 pandemic appearing likely to persist for longer than we had hoped and the economy showing few signs of improving, the Fed’s actions will likely continue. With interest rates now close to zero, there is really nothing else the Fed can do. The Fed’s balance sheet will continue to grow, possibly to tens of trillions of dollars. Financial asset prices could be expected to continue increasing too, particularly in the equities market, if it continues to be stable, supported by technology companies, led by FAANG (Facebook, Apple, Amazon, Netflix, Alphabet/Google).
“But we are on a collision course with another force, as we see further increasing Main Street insolvencies, unemployment and the weakening of the finances of ordinary households and businesses. If the Fed were to ease up “printing money,” we might see significant deflation, like Japan in the 1990s. Worst still, we might see rapidly increasing inflation. This would produce the secular stagflation former Treasury Secretary Larry Summers has spoken of—remember President Jimmy Carter?”
Why can the U.S. confidently “print money”, but other countries cannot (necessarily) do the same?
“The short answer is because the U.S. dollar is the global reserve currency. In other words, most countries and companies from other countries usually need to transact business in U.S. dollars, making them exposed to the value of their currency relative to U.S. dollars. The United States and the Fed in particular, doesn’t face this “currency risk.
“Some contend that the United States is at risk to other countries, particularly China, not buying treasuries, or even aggressively selling the treasuries they already hold. At least in the short-medium term, the Fed could directly purchase all of the treasuries the Government issues. Under worse case scenarios, the banking industry would contract.
Freshly printed 100 dollar bills from the Federal Reserve
getty“Nevertheless, the United States should be in a position to fund itself for a very long time. All other things being equal, the U.S. dollar status as the global reserve currency could be expected to progressively decline. But the United States global position need not decline relative to most other countries. If, in particular, China were not a variable in this equation all this might be a reasonable bet for the United States to take; however, China is a variable in the equation.”
How could China’s emerging new monetary policy threaten the sustainability of the United States’ current approach?
“The notion of central bank digital currency (CBDC)-based new monetary policy rests on the radical idea of every individual and business in a country having a bank account with its central bank (the equivalent of the Fed) rather than with a commercial bank. Interest on balances in these accounts could be at positive, zero or negative rates. By way of such an account, entities would be able to electronically transact with others, typically using their phones, Paypal, WeChat Pay, credit or debit cards – effectively, a government-underwritten type of bitcoin, on steroids. The government could credit payments, including money its central bank simply “prints”, and debit payments, like for taxes.
“Monetary policy based on such an account system would allow a government to by-pass having to issue bonds to raise debt in order to spend the bond’s proceeds as they do now. Any government would simply “print money” and use it to buy the goods and services it needs or make payments to individuals or businesses. In such a world, all the actions we described the U.S. Fed doing above become outdated.
“A distinctive aspect of CBDC-based new monetary policy is that the money it “prints” is no longer “fungible,” meaning one US dollar or Euro isn’t necessarily equiuvalent to another. Rather, every unit of CBDC-type money that is issued by a country can have specific rules electronically attached to it. These rules can include: how quickly the money must be spent; on what goods and services it can be spent; which individuals or businesses it can be spent with.
“CBDC-based monetary policy would be completely different to current monetary policy, in which the U.S. dollar’s status as “reserve currency” allows the Fed to do all the things we described above. A risk any government faces from simply “printing money” is, of course, inflation. However, this could be mitigated by a government, reducing the CBDC units available or limiting their use. Similarly, faced with the risk of deflation, a government could increase the CBDC units it makes available or limit the period of time within which these units must be spent.
“If a CBDC-based monetary policy was implemented by China, Japan and/or the Eurozone, it could reduce their exposure to the U.S. dollar and weaken its unique role as the global reserve currency. And, the U.S., as the dominant even monopoly player may be slow to react to the “attacker’s advantage”. Ironically, the U.S. might also be constrained by hundreds of existing U.S. patents, many of which owned by inventors/assignees that are not U.S. entities.”
The Great Wall of China
Artyom Ivanov/TASSWith hopes that our trusted guide has led you this far, one must ask: how real is this threat? Consider this:
October 13, 2020: China news outlet Xinhua reports that China's central bank and the municipal government of the southern tech hub Shenzhen have finished handing out "digital yuan red packets" totalling RMB 10 million (USD 1.49 million) in what is seen as the first public test of the country’s official digital currency.
In simplest terms, as Modern Monetary Theory economists assert, perhaps the Fed can “print money” forever. Well, unless China can demonstrate it has the technological know-how, political will and economic strength to threaten the U.S. dollar as the global reserve currency, of course.