Sunday, January 29, 2012

Money, Banks, and National Debt Unmasked - I

Although we often worry about money, we seldom think about money and its connection to banks until we are short of money or balancing our check books. This series of blogs is intended to bring to consciousness some facts about money and banks that relate to almost everyone’s obsession, national debt.
US dollars enter the economy through the banking system. Money actually has three faces, which are bank reserves, Treasury bonds, and cash. Reserves stay in the banking system and are controlled by the government, treasuries are assets held primarily outside of government, and cash is what we carry around in our pockets or stuff in our mattresses.
We use money and banks every day without thinking very much about what they are or the mechanics of how they work. We know it is usually better to have more money than less and banks are better than mattresses for holding it. Yet we have just had bank bailouts that seem suspicious, we live in fear of deficits and debt that we don’t understand, and we hear of printing money and quantitative easing that appear to go on in the dark corners of the Federal Reserve Bank (Fed).
In this and following blogs, I’ll try to tie some ideas together in a way that is readily understood by anyone, who knows how to balance a check book. 
Money is Debt
In an earlier blog, we introduced the idea of money as debt and introduced my former friend Fred. If you, the reader, would like to take a look at that short blog, we’ll wait here until you get back and then recap.
OK, let’s recap. This big bully, Fred, buys things from me with IOUs and then takes some of those IOUs back as a “friendship” tax. What is left I get to keep. We recognized that this is analogous to the way our government buys goods and services and levies taxes.
Sticking with Fred just a bit longer. Suppose Fred does this with other people, so there are lots of people with Fred’s IOUs, and we can trade with each other using those IOUs. Then Fred’s IOUs will have become money. And, instead of trying to pass off these IOUs, I might like to accumulate them. The more Fred owes me the more I am able to buy things with Fred’s money (IOUs), but I’ll need to save some for his damn tax.
One last thing about Fred. He keeps a spreadsheet (a computerized electronic ledger) of the IOUs he has issued. When he gets them back through his coercive taxes or redeems them with dollars, he cancels them from his ledger. So, he always knows how many dollars he must have in the bank ultimately to redeem the IOUs.
Most money is found on a computer spreadsheet
Purposefully, Fred was invented to play a role analogous our own central bank, the Fed. He has introduced us to the following realities:
    • The Fed issues IOUs, so the government can buy goods and services from us.
    • The government taxes back some IOUs, which decreases their number. 
    • If government taxes less that it spends, we get to keep the difference; if it taxes more, we have to get some more IOUs somehow somewhere.
    • Taxes make it necessary for us to keep US IOUs, if only to pay taxes.
    • We can trade with each other using these IOUs to accumulate more of them and, thereby, increase our wealth.
    • Finally, the Fed keeps track of the IOUs it issues on it’s own spreadsheet. These spreadsheet entries are the Fed liabilities that form the basis for our currency..
Fred was not a nice guy to do business with, so we can tell him to shove off. We can’t do the same with our government, because it is empowered by our Constitution (Article 1- Section 8) to coin money and regulate its value.
Fred backed up his IOUs with dollars. When the US was on a gold standard, IOUs were backed up with flecks of gold. Now, our IOUs are backed up with numbers on a spreadsheet. That might bother some, who sensibly ask,  “What is the value of a dollar, if it is backed up only by a piece of paper or, worse, a computer data base entry?”
We’ll consider the value of the dollar in a future blog, maybe the next one.
The story of Fred gives us a very simple basis for understanding how money and our government works. In subsequent blogs, we will try to flesh out some details that might influence our thinking about government fiscal policies.
Related Reading
Look at Myth #6, the others may tantalize you, also.
A more sophisticated discussion than we are offering.

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