1.0... INTRODUCTION
(Continued)
1.3 -
MONEY & MYTHS by Carmen Pirritano 5/93
First, let us define what we mean by "money".
Among its other definitions, money is anything that is acceptable both as payment for goods and services anywhere in the country, and to governments and banks as payment for taxes and loans.
Only three things fit this description:
1) Federal Reserves Notes (cash);
2) coins; and
3) checkbook money.
Everyone is, of course, familiar with the first two; they are also familiar with the last one, although maybe not by that name.
Checkbook money is circulated via checks - it is the money that banks create for the following purposes: to pay their expenditures, to make loans, and to make investments.
Interestingly enough, checkbook money is not legal tender, only cash and coins are (see 'Your Money - A Review of Money in the US' by the Federal Reserve Bank of Richmond),
but checkbook money is so widely acceptable that it serves almost as legal tender (virtually everyone has had at least 1 experience where a vendor would not accept a check - and of course checks must be endorsed whereas cash and coins obviously are not).
Gold, silver, and other types of wealth, are not money; they must first be converted to money in order to be used.
The only place that your wealth can be legally used to retire a bank debt is bankruptcy court.
How much money is in circulation?
Well, according to Federal Reserve statistical data, there was $935 billion in the M1 by 3/31/92. Of that amount, checkbook money represents about 68%, cash is around 30%, and coins represent only 2% of the M1. "When most people think of money, they think of currency. Contrary to this popular impression, however, transaction deposits [checkbook money] are the most significant part of the money stock." (from the Chicago Fed, in 'Modern Money Mechanics'.)
Now that we have established the types of money in our economy, let us look at how these moneys are actually created and injected into the money supply.
First, Federal Reserve Notes:
Many myths surround cash. Among them are the following:
1) The government owns Federal Reserve Notes;
2) The government prints them to finance itself;
3) The government is responsible for the amount in circulation;
4) Federal Reserve Notes do not cost the taxpayer anything; and
5) Cash increases the money supply through multiple deposits and withdrawals.
1) Federal Reserve Notes are owned lock, stock, and barrel by the 12 privately owned Federal Reserve Banks.
"These notes are produced by the Bureau of Engraving and Printing and turned over to the Federal Reserve Banks" ('How Currency Gets Into Circulation'- NY Fed)
"Reserve banks 'buy' new paper money and coins from the Treasury" ('The Federal Reserve Today' - Richmond Fed)
"Federal Reserve Banks pay 2.5 cents for each note produced by the Bureau" ('Your Money...) Note that this 2.5 cents is per bill, regardless of the denomination - it is the cost of paper, ink and labor.
2) Now, if you still believe that the government prints cash to pay its bills, then why do we run a deficit every year? The New York Fed supplies the answer in 'I Bet You Thought',
"The Bureau of Engraving and Printing ... is responsible for printing the nation's currency, but, its orders come from the twelve Federal Reserve banks, not the president or Congress. The Reserve banks, not the Treasury, determine how much currency is printed ... Under this arrangement, the government cannot print more Federal Reserve notes to pay its bills or reduce its debt."
3) As far as the supply of cash in circulation, it is determined by the public through their withdrawals, up to a limit. If a bank is short on cash and has excess reserves, they can "arrange to draw currency directly from their reserve accounts at their district Reserve Bank." ('How Currency...)
The public can only withdraw as much cash as the banks have, and for any bank in particular, this amount is the bank's reserve total. Banks are required to have reserves equaling only 10% of their transaction deposits.
If every person who possesses a checking account were to simultaneously withdraw, say 20% of their money in cash - every bank in the country would close overnight.
4) All cash is a debt that is owed to the 12 Federal Reserve banks.
Why?
"Before being issued to the public, Federal Reserve notes must be secured by legally authorized collateral, most of which is in the form of U.S. government and federal agency securities held by the Federal Reserve Banks." ('Your Money...)
"What this means is that for every dollar bill ever put into circulation, the Fed owns a dollar of interest-earning government securities.
The sum of money owed to the Fed will always be greater, than the amount of Federal Reserve Notes that they distribute, due to the interest that the securities pay.
Where does the Fed get the money to buy these securities?
They create the money to buy them - "...the Fed has no bank deposit of its own.
...when the Federal Reserve buys government securities, it is by the mere stroke of a pen putting new money into the banking system." ('Putting It Simply' - Boston Fed)
5) Federal Reserve notes travel from the Fed to a bank's vault, and then to you. They are not directly injected into the money supply; instead they must be "bought" with an equivalent sum of checkbook money.
The Chicago Fed explains with an example,
"Suppose a bank customer cashed a $100 check ... Bank deposits decline because the customer pays for the currency with a check on his or her transaction deposit. ...The public now has the same volume of money as before, except that more is in the form of currency and less is in the form of transaction deposits. ... After ... currency returns to the banks ... the banks gain reserves as 100 percent reserve money"
('M.M.M.')
What this means is that in order to get cash into circulation, "the public ... converts checkbook dollars into paper currency" ('How Currency...).
The Richmond Fed verifies this in 'Money', "When people want more coin or paper money, they cash checks - exchanging one form of money, checkbook money, for another, cash."
The cash then assumes the debt status of the checkbook money it represents. In this way cash can not increase the money supply through multiple deposits and withdrawals.
Secondly, coins:
It would be logical to assume that the rules held concerning Federal Reserve notes apply to coins also. There are exceptions to every rule, and coins are the exception. For some strange reason, the government has decided to stand its ground and demand to be fully reimbursed for the coins they mint. "Reserve Banks pay the Treasury for coin at face value" ('How Currency...')
This payment is in the form of an increase to the government's checking account held at the Federal Reserve. At this point the coins are not even in circulation yet. Coins are injected into the economy in the exact same manner as Federal Reserve notes, thus the physical metal in your pockets is actually a placeholder for the checkbook money it represents. The debt-free nature of coins arise from the one-time credit the government receives, therefore multiple deposits and withdrawals of coin money will never increase the amount of debt-free money in circulation.
Lastly, checkbook money:
There is a popular myth that banks lend money from the pool of their saver's deposits. The Federal Reserve Bank of New York knows better (actually best);
"Institutions such as the Federal Reserve and commercial banks create money every day. Do commercial banks create the money that they lend? Yes. One institution --the commercial bank-- creates new money -- checkbook money -- when it lends." (From 'The Story Of Money')
This is reinforced by the Chicago Fed, "they do not really pay out loans from the money they receive as deposits ... What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers' transaction accounts." ('M.M.M').
This means that a bank is monetizing your collateral and not, in any way whatsoever, lending out some other depositor's money.
If they were, then, every dollar loaned out would be backed by several people's tangible assets.
From this we learn that checkbook money is always bank created money, which is created and injected into the money supply in one fell swoop.
However, this is only 1/3 of the story of checkbook money; as I stated earlier, banks also make investments for themselves with checkbook money. In this way the money supply can increase without the need for people to be granted loans.
But is this amount really significant?
Well, according to the "Federal Reserve Statistical Release (H.8)", on the assets and liabilities of domestic banks, the ratio of loans to investments is 7 to 3.
I would venture to say that is a significant number.
Most people have the mistaken, but understandable, belief that a bank would pay for investments out of the profits they make via interest charges.
Not so: the San Francisco Fed in 'Monetary Policy in the United States' state that "banks and other depository institutions have the power to create new deposits and either lend them out to customers or use them to purchase investments".
New deposits can only be created as checkbook money, and checkbook money gets created through bank reserves.
The Chicago Fed explains further:
"Reserves ... may be used to increase earning assets - loans and investments. Suppose that the demand for loans at some ... banks is slack. These banks would then probably purchase securities. If the sellers of the securities were customers, the banks would make payment by crediting the customer's transaction accounts; ...More likely, these banks would purchase the securities through dealers, paying for them with checks on themselves or on their reserve accounts".
Do banks wait for a lull in consumer borrowing before making investment purchases?
No, "Because excess reserve balances do not earn interest, there is a strong incentive to convert them into earning assets (loans and investments)" (all from 'M.M.M')
From this, we learn that banks create checkbook money, when they wish to make investments, and that a bank's interest earnings play no part in this (exactly why will be explained shortly).