Sunday, October 30, 2016

Debt crisis, what debt crisis?

I submitted this to the ABQ Journal Oct 20, still no joy. An earlier version in response to the Anthony Davies’ OpEd on October 5 is now past its use-by date. In addition, I have included below links to verify attributions I made and one to John Harvey, who is one of many from academia whose views I share. 

The federal debt has almost everyone in a panic. Most pundits and politicians including those from President Obama to Sara Palin and from The Peter Peterson Foundation to The Committee for a Responsible Federal Budget have agreed that the federal government should manage its debt just like a household. “Government must stop spending more than it earns.” This note disputes that job-killing, intuitive myth.

Since President Nixon took our country and the world off the gold standard in 1971, we have had a fiat monetary system. All our money comes from the US government. Bank loans or federal spending bring money into the economy. 

Under a gold standard the amount of gold held by the government limits the amount of money in the economy. Under a fiat system only our productive capacity, our workforce and facilities, limits us. This is completely contrary to old economic thinking. 

Limited only by our productive capacity, we can afford anything we can do. Because our economy can have all the money it needs, our politicians need not worry about funding but how to grow our productive capacity and where to deploy it for a prosperous future. 

Gross Domestic Product (GDP), which is the monetary value of all the goods and services sold in our country, measures our economy. The elements that contribute to GDP are household consumption, business investment in the means of production, net exports, and the government deficit. 

To grow GDP, we must have people employed in productive activities. In a poor, slow-growing economy household consumption is low, because people choose to pay off debt or otherwise save rather than buy stuff. Also, business investment is low, because inventory is not needed when people are not buying stuff. In our country, net exports are negative, because we have net imports. All this results in slow growth and too many people being either unemployed or under employed.

The only choice remaining for growth is government deficits to increase employment and add to GDP. 

Deficits are not under the complete control of government. They depend on household decisions about saving and business decisions about investment. Additionally, a poor economy increases the deficit through unemployment insurance for more people and continuing support for the poor and disabled. 

Deficits add to our economic growth and well being. Reduced deficits would make our economy worse. Deficits alone do not cause inflation until demand for goods and services exceeds our ability to produce them. Only when all able bodies are employed do we reach our limit of production.

Private debt is larger than Federal debt. Private debt is the problem; it has to be paid back to creditor.

Government austerity represents an outdated economic view. After eight years of sluggish economic performance using the old views that rely on monetary policies to stimulate growth, many economists are looking at fiscal measures, which means more deficits. Recently, Jason Furman, Chairman, Council of Economic Advisors, published a conference paper advocating fiscal stimulus as part of a “New View” to replace the “Old View.” 

Empirical evidence of the dangers of too-small deficits exists in the Eurozone where the Maastricht Treaty limits deficits to 3% of GDP. Only countries with strong exports such as Germany can comply readily with that constraint. Eurozone countries are compromised further by having given up their sovereign currencies to the Euro. Consequently, they suffer under a de facto gold standard. So grave is the Eurozone crisis that the eminent economist, Joseph Stiglitz, has advised both Greece and Portugal to exit the Eurozone, and he predicts that Italy may exit in a few years. These economies are decimated, because they have not been able to run enough deficits to prosper.

Fiscal deficits, used productively, will expand our economy. The resulting federal debt is not a crisis. We never have to pay it off; we outgrow it by keeping our GDP growing.

Recent Furman paper:

Stiglitz Greece and Portugal advice and prediction for Italy:

Prof. John Harvey:

Friday, October 7, 2016

There is no federal debt crisis

I tried again to counter conventional wisdom with this submission to the Albuquerque Journal. It drives me nuts if I don't keep trying.

In his article in the Journal on October 5, Anthony Davies claims we must cut federal spending to solve the debt crisis. There is no federal debt crisis. Our crisis for over eight years has been slow growth of the economy and too few good jobs. 

First, Davies writes that when interest rates rise to pre-recession levels, the federal government will owe an additional 500 billion dollars in interest. Actually, it would be more than that, but let’s not quibble.

More importantly, we must understand to whom the interest is paid. That would be the holders of all US Treasury securities, which comprise the federal debt: banks, pension funds, mutual funds, wealthy individuals, and foreign central banks. Also, higher interest rates mean more income to our bank accounts.

In short, federal interest payments are income to the private sector. Income to the foreign sector provides dollars to foreigners that can be spent in our economy. 

Second, and more consequential, Davies apparently thinks that government spending can manage the federal debt. Our federal debt is the accumulation of deficits since the beginning of the republic. Deficits are largely determined by choices made in the private sector.

Conventional wisdom is wrong. Our debt provides assets for the future.

Our economic output is measured by Gross Domestic Product (GDP), which is the monetary value of all the finished goods and services produced in our country. The elements that contribute to GDP are household consumption, business investment in the means of production, net exports, and the government deficit.

To grow GDP, we must have people employed in productive activities. In a poor slow-growing economy household consumption is low, because people would rather pay off debt or otherwise save rather than buy stuff. Also, business investment is low, because inventory is not needed when people are not buying stuff. In our country, net exports are negative, because we have net imports. All this results in too many people being either unemployed or under employed.

Consequently, the only choice is government deficits to increase employment and add growth to GDP. Those deficits depend on household decisions regarding consumption and business decisions regarding investment. Additionally, a poor economy increases the deficit through unemployment insurance for more people and increased support for the poor and disabled. 

Clearly deficits add to our economic growth and well being. To reduce federal spending would make our economy worse.

Davies’ position represents an outdated economic view. After eight years of sluggish economic performance using the old views that rely on monetary policies to stimulate growth, many economists are looking more favorably upon fiscal measures, which means more deficits. To that point, on October 5, Jason Furman, Chairman, Council of Economic Advisors, published a conference paper advocating a fiscal stimulus as part of a “New View” to replace the “Old View.”

Empirical evidence of the dangers of too-small deficits is found in the Eurozone where deficits are limited to 3% by the Maastricht Treaty. There, only countries with net exports such as Germany can comply readily with the treaty. These countries are compromised further by having given up their sovereign currencies to the Euro. Consequently, they can not “print” money to pay their debts. So grave is the Eurozone crisis that the eminent economist, Joseph Stiglitz, has advised both Greece and Portugal to exit the Eurozone, and he predicts that Italy may exit soon. These economies lie in ruin because they have not been able to run enough deficits in their own sovereign currencies to prosper.

Fiscal deficits, used well, will benefit our economy. The resulting national debt is not a crisis. We never have to pay it off; we outgrow it by keeping our GDP growing.

Monday, September 5, 2016

Next President must employ fiscal policies

Today, I submitted this to the Albuquerque Journal. I'm sure they won't publish it, because they highlighted the Macguineas article with a complementary Editor's note. Gotta keep trying.
Unless we understand what our fiat money is and how it works in our economy, we will continue to think we must balance our national budget or suffer dire consequences just like a household. That leads to the confusion of the Journal editor, who praised a “policy expert,” Maya Macguineas, for her column on September 3rd as the answer to, “What should the next president’s plan be for the national debt?” Both the editor and Macguineas are misinformed.

This quote from another expert, Warren Mosler (Soft Currency Economics II, 2012), tells us almost all we need to know.

“The concept of fiat money can be illuminated by a simple model: Assume a world of a parent and several children. One day the parent announces that the children may earn business cards by completing various household chores. At this point the children won’t care a bit about accumulating their parent’s business cards, because the cards are virtually worthless. But, when the parent also announces that any child who wants to eat and live in the house must pay the parent, say, 200 business cards each month, the cards are instantly given value, and chores begin to get done. 

“Value has been given to the cards by requiring them to be used to fulfill a tax obligation. 

“Taxes function to create the demand for federal expenditures of fiat money, not to raise revenue per se. In fact, a tax will create a demand for at LEAST that amount of federal spending. A balanced budget is, from inception, the MINIMUM that can be spent, without continuous deflation. 

“The children will likely desire to earn a few more cards than they need for the immediate tax bill, so the parent can expect to run a deficit as a matter of course.”

That was then. Now credit is money, and gold is just another commodity.

The children may trade among themselves exchanging cards for services or real goods. However, they can not create cards. So, the net financial resources that children can save come from parental deficit spending. 

If there are not enough chores or the wages are too low, some children will not be able to pay their rent. Then we have involuntary unemployment and deflation. There is no need for unemployment as long as there is work to be done and workers available, the parents can always come up with more cards.

We could push the model further to include banking and trade with the neighbor’s children. In a fiat monetary system, the prosperity of the children is managed by the parents making sure that there is full, productive employment. To prevent inflation parents can increase taxes, which take cards away from the children. Then the deficit will take care of itself.

The deficit hawks cite scary consequences due to high private savings, but those consequences just don’t happen. 

Deficits drive interest rates down not up, because federal spending puts money into private bank accounts, which in turn increases reserves in the banking system. Then to maintain interest rates, government has to pay interest on bank reserves and/or sell Treasury securities to reduce the reserves. 

Interest on treasuries, which constitute the “debt,” stimulates the economy as it is income to the private sector not a cost.

We can always have enough cards for entitlement programs as long as we invest in the facilities and personnel necessary to staff them. 

Our economy is not about having or not having cards, it is about allocating our productive resources. We can not afford to continue to let those resources go to waste; we always have enough cards to employ resources productively. Then GDP and private savings will grow appropriately, and the deficit hawks can find something better to do.

The next President and Congress must employ fiscal policies to invest in the education, employment, and well being of the people. And, if they must, war. Our nation can achieve shared prosperity.

Saturday, July 2, 2016

Austerity is at the heart of our discord

Submitted this to Albuquerque Journal. Wow, Journal published on July 6 with title "US must embrace federal deficits, denounce austerity." I like my title better.

Austerity foments discord. The discord that drove Brexit, the vote for the United Kingdom to leave the European Union. The discord that led to the rise of Donald Trump and his fear mongering over immigrants. The discord that led to the groundswell of support for Bernie Sanders, who highlighted wealth inequality.

Austerity is the way countries around the world manage their economies. Based on outdated gold-standard thinking most people believe that there is a limited amount of money in our economy. When we had an actual gold-standard monetary system the amount of money depended on our supply of gold reserves. If the government spent too much, private business investment would languish, interest rates would rise and ruin business profits. When government spending is curtailed, we have austerity.

Think of this when folks tell you federal deficits are unsustainable. Or, ask them when we paid off the World War II debt.  We didn't. 

Everybody “knows” that government deficits are unsustainable. But, that is just not true. Politicians, pundits, the Peterson Foundation, and all who profit from gold-standard thinking tell us that austerity is necessary. Long ago, in the gold-standard days of 1863, the London Rothschild brothers wrote their New York conspirators:

“The few who understand the system will either be so interested in its profits or be so dependent upon its favours that there will be no opposition from that class, while the great body of people, mentally incapable of comprehending the tremendous advantage that capital derives from the system, will bear its burdens without complaint, and perhaps without even suspecting that the system is inimical to their interests.”

At last, people are comprehending their disadvantage and are looking for alternatives to relieve their burden. Feeling our discord, we lash out at the establishment, and our tribal instincts make us suspicious of anyone not like us. The behavior is natural but both unproductive and unnecessary.

Every two years we have elections and can vote against the politicians in power, but nothing changes. Changes can’t happen when both political parties sing from the same economic songbook. The only difference is that one sings, “We have a spending problem;” the other sings, “We have a revenue problem.” Both are wrong.

There is an alternative. But, it has taken a long time for enlightened economists to realize it. President Nixon took the world off the gold standard in 1971. In 1973, nations abandoned the Bretton Woods Agreement that tied international trade to gold. But, it wasn’t until 1976 that our government gave up all pretense of tying our currency to gold.

That was the dawn of our present fiat currency with a floating foreign exchange rate. It took almost another twenty years to realize the significance of this momentous change.

That change made a huge difference. A fiat monetary system turns a gold-standard system upside down. A fiat currency is limited in quantity only by our productive capacity not a commodity. Government has the ability and responsibility to employ the productive capacity left idle by the private sector. That means, we need not endure high unemployment.

When the economy struggles, government must increase deficits. These deficits provide income and private sector consumption, which stimulate the economy. Federal deficits are always sustainable when they put idle resources to work for the public good like infrastructure and health care.

A sovereign nation must live up to its means, which includes its work force and facilities. Households and businesses must live within their means, which is what they can earn.

Any accountant can tell you that the national debt, which is the total of US Treasury securities, represents assets in the private sector. The famous National Debt clock could just as well be called the Private Savings clock. Deficits are the only source of private-sector financial savings.

Our broken economy and its resulting discord will not recover until we make full use of our fiat currency and embrace federal deficits. That is to say, denounce austerity. 

Thursday, April 21, 2016

A Public Bank would benefit Santa Fe

After an earlier submission to the New Mexican failed, I submitted this shorter, punchier version.
The question is not, “Why should we have a public bank?” but, “What is taking us so long?”

Private banks provide investment capital for productive enterprises that generate profits to repay loans. Also, banks provide capital for public projects for the common good, and taxes repay the loans. A public bank returns profits to the public instead of private investors. So, public banks offer a way for banks to serve the people rather than make people serve the banks.

Public banks are not new. The Bank of North Dakota is a century-old, public bank that is an essential element of that state’s economy. In Germany public banks garner 40% of all bank assets. In other parts of the world public banks are common. 

My own skepticism toward a public bank turned to enthusiasm upon working with the Brass Tacks Team of Banking on New Mexico. We modeled the first five years of a hypothetical public bank. Also, we calculated the savings to the city of refinancing existing bonds and loans through a public bank. We showed that a public bank can reduce City borrowing costs significantly.

Generally, this is how a public bank could work. The public bank would be the City’s bank chartered by the State. The City would own the bank as it would provide the capital to be leveraged for loans. The City would deposit its income in the bank and pay its bills from the deposits. We assumed $100 million in city deposits, $10 million in capital, and a $50 million loan portfolio. These amounts are consistent with City assets and liabilities reported for FY 2014.

Public bank benefits the people.

Over the five years our model yielded $10.5 million in profits and reduced City debt by $4.85 million.

The bank would minimize its own expenses. It would not handle individual citizen deposits. And, it would use neither tellers nor ATMs. The bank staff would be few and other overhead would be austere.

The City would only use the bank not manage it. Banking professionals would manage the bank day to day with an appropriate oversight board. Employees would be hired and paid by the bank not by the City.

A bank depositor is an unsecured creditor of a bank. To be a safe haven for City deposits the bank must make conservative investments of its assets. Founded not to satisfy private investors, the bank would not take risks to chase high profits. 

A public bank would offer the City an alternative to expensive, omnibus bonds and provide transparency to funding. Instead of large bonds, the city could take out loans for individual projects as needed.

In the future, the bank could participate with community banks and other lenders for local development efforts. Currently the City is in a budget crunch and looks for ways to save money. A public bank would have helped.

A public bank would return to the City interest on loans that would otherwise go to private investors and Wall Street. It would provide a safe haven for City funds against the turbulent environment of private banking. And, it would provide better transparency of City spending. This would be good stewardship of public funds.

Financial Considerations for Starting a Public Bank or What We Learned in Santa Fe


There are many considerations in establishing a public bank that must be answered. This paper addresses only financial issues.

A public bank like any other bank must have a state or federal charter. A bank, unlike non-depository, financial institutions, is allowed to accept deposits. The public bank then becomes part of the nationwide banking system but has a mission to serve the public rather than private investors. 

As a member of the banking system a public bank will have an account at the Federal Reserve Bank (Fed). The Fed is a bank’s bank, and funds deposited there are called reserves. Banks also have securities accounts to hold Treasury bonds, and other government securities. Switching from reserves to securities and back occurs readily upon decisions by bank management.

Not only will a public bank return profits to the public owners, it will distinguish itself by maintaining low-risk operations. Without the need to satisfy investors with high profits, a public bank need not engage in the kind of high-risk operations and investments that can threaten private banks

Initially, A Public Bank for Santa Fe will loan to and accept deposits from its owner, the City of Santa Fe. When it becomes well established, the bank may participate with other banks and credit unions in loans to community development projects. And, it may accept deposits from other public institutions.

Owners of a public bank will be some government entity; municipality, county, state, tribe or a combination of them to amass sufficient assets and liabilities to operate profitably. To achieve its modest profit a bank must make loans, have deposits, and the owners must provide initial capital. We will briefly discuss each of these below and outline an hypothetical example. Also, we will take a closer look at “federal reserves.”

First, let’s briefly summarize what we have learned with our modeling efforts.

The Bottom Line

Our modeling suggests some minimum financial criteria for starting a public bank that can grow and thrive. Our numbers indicate that at start up the bank will need an opening loan portfolio of $40 million, $5 million in capital, and about $80 million in deposits. A community that does not have this minimum financial capacity might partner with another local public institution like a school district or a county.

Our analysis begins with considering income from loans. As interest rates change and we negotiate loan rates, we try to maintain an average “spread,” which is the difference between the rate our bank pays depositors and the rate the bank charges borrowers. If we can achieve a 3% spread, we will make $1.2 million on a $40 million loan portfolio. This is pretty close to a minimum amount for a staff of four people and a small office space. Some additional income will accrue from other investments

The $40 million loan portfolio implies minimums for capital investment and deposits. Needed capital investment should be, at least, $5 million. Federal regulations require owners to invest capital in amounts related to assets. And, deposits should be about twice the loan amount, $80 million.

These will be discussed further below. First, we will discuss the rudiments of federal reserves.

Federal Reserves

The idea of reserves is easy to understand, and paradoxically is easy to misunderstand. Simply, as stated above, reserves are a bank’s balance in its account at the Fed. Reserves can be thought of as a checking account balance. And, just as a deposit in a bank is a liability(1) of the bank and an asset of the depositor. So, federal reserve balances are liabilities of the Fed and assets of our public bank.

Reserve balances are often called more appropriately “clearing balances.” Their sole purpose is to connect all banks together so that as checks are cashed funds are transferred electronically from a sending bank to a receiving bank at the face value of the checks. When a check is written on one bank and deposited in another, the Fed decreases the reserve account at the originating bank and increases the reserve account at the receiving bank(2). The two banks then appropriately decrease and increase the accounts of their depositors. 

Central banks around the world “clear” checks in this manner. The U.S. system processes trillions of dollars every day.

To be complete, reserves are the balance in a bank’s reserve account plus actual vault cash on hand. The balance of my bank account is my bank’s promise that when I write a check the bank will make reserves available so that the Fed can electronically credit them to the check recipient’s bank. When I receive a check, the reverse happens.

When a bank needs reserves it can borrow them from another bank or the Fed will create reserves on demand. As people write and receive checks to buy goods and services, reserves circulate around the banking system.

Only a few operations can change the total balance of reserves in the banking system. As discussed later, bank lending increases reserves, because it increases bank deposits. Likewise, repayment of loans decreases reserves, because it decreases bank deposits.

Also, other government monetary and fiscal operations beyond the scope of the present discussion change the quantity of reserves in the banking system.


No business, not even a public bank can endure without making a profit. Of course, income must cover salary, benefits, office space, and equipment for personnel. But, there is more.

Income must also pay for interest earned on deposits and loan losses. The latter occur when loans fail to provide the income originally anticipated. Although a loan to government is considered low-risk, it will underperform upon refinancing or early payoff. Loan loss provisions are both prudent and required by federal regulations. 

We must not forget taxes on bank profits, unless the bank would qualify as a not-for-profit business. We expect that the public bank will be set up as the City of Santa Fe doing business as the public bank. That would be a tax-free arrangement.

In the course of doing business it may be necessary for the bank to take out loans which will add to operating costs. Debt service(3) on such loans is another addition to expenses.


The main money-making engine of a bank is its loan portfolio. A public bank has an advantage over other banks, because it doesn’t have to market itself to make loans. The government entity that founds the public bank refinances its debt through the bank. It might seem easy to just assume enough of the government’s loans to guarantee a good profit. But, we must consider other realities.

First, municipal or state bonds and some loans can be refinanced without penalty only on specific “call dates” that are written into the loan agreement. Generally, bonds cost more to issue than loans. So, it is often prudent to finance spending through loans. 

Second, as discussed below, federal regulations use the bank’s capital(4) to limit the amount of loans a bank can issue. This differs from the view commonly held that regulatory loan limits are based on deposits. 

Double entry bookkeeping requires four bookkeeping entries for a loan. For the bank, a loan deposit is a liability and the borrower’s promissory note(5) is an asset. For the borrower, the promissory note is a liability, and the new loan deposit is an asset.


Deposits received by a bank are liabilities. Also, a deposit resulting from a bank loan is a liability. The distinction between them is that deposits received bring with them reserves as assets transferred by the Fed from the originating bank. When the bank lends, it does not automatically create reserves. But, when a borrower withdraws loan deposits by writing checks on the account, the bank must find and deposit reserves so the Fed can credit them to the receiving bank. These reserves must come from either the bank’s existing assets or borrowing.

Banks need deposits, because they are the most inexpensive way to acquire reserves. Other ways to acquire reserves are borrowing from money markets at less than 1% or from the Fed Discount Window(6) at 1% to 1.5%. Profits improve when a bank has abundant deposits. The more deposits we have the longer we can delay borrowing. 

Strictly speaking, the Fed cannot loan its liabilities (reserves) any more than a bank can lend its liabilities (deposits). Instead, the operation is accomplished through Repurchase Agreements (repos) where the “borrower” (public bank) sells a government bond to the “lender” (another financial institution or the Fed). And, the borrower promises to repurchase the bond at the same price plus interest the next day or a few days hence. 

Public banks have an advantage in acquiring deposits, because the existing government deposits from taxes and fees are immediately available. Again, the public bank does not have to incur the costs of marketing itself (give away toasters) to acquire deposits.


Core capital is what owners of a bank invest in the bank. Stockholders’ equity is the difference between assets and liabilities. Bank management invests financial assets in securities such as government bonds, municipal bonds, mortgage backed securities, and the unmentionable, derivatives. Core capital can grow by retaining some part of earnings.

Governments always have tight budgets. To find the millions of dollars to capitalize a bank will seem like a tall order. Even when the funds are found, it may be a tough sell to the taxpayers. However, the major selling point is this; banks make profits, and in a public bank profits go back to the people.

A bank leverages its equity to make loans and grow. For that reason, we consider core capital to be essentially an endowment that will grow and provide benefits far into the future.

As equity grows, the loan portfolio can grow, and the bank could offer lower rates. However, lower rates mean lower profits. As the loan portfolio grows, a given spread in interest rates will yield more income. Then management can consider lower rates. The choice depends on whether bank management gets more kudos for low rates or larger year-end returns. 

Generally, federal regulations use Capital Adequacy Ratios to limit the amount of lending a bank can do. One such ratio is total capital to risk-weighted financial assets. The denominator of the ratio is the sum of assets, each asset is given a risk-weight multiplier of 0 to greater than 1. For examples, a government bond would have zero weight and would add nothing to the sum. A municipal bond might have a weight of 0.5, and a home mortgage a weight of 1. So, a bank with a lot of government securities would have a smaller denominator, hence a higher ratio. Higher is better. 

According to present rules, the above ratio must be greater than 10% for a well-capitalized bank(7). 

Another important ratio is  (Tier-1 capital) to total assets ratio, called Leverage(8), which must be greater than 5%.

Tier-1 capital includes retained earnings in addition to core capital. Tier-2 capital includes long-term debt, and loan-loss reserves. In addition to limiting the amount of lending, capital is important, because it absorbs any bank losses. 

The detailed Basel III rules and penalties for failing to follow those rules are complicated and beyond our present scope(9).

Day-to-Day Operations 

During any business day multiple deposits to and withdrawals from the bank occur. At the end of the day a bank will have net deposits or net withdrawals. The latter means that reserves will be credited to the accounts of other banks by the Fed. During the day the Fed will allow overdrafts of a bank’s account. But, at the end of the day those reserves must be there or else!

If the adequate reserves are not on deposit at the end of the day, the Fed will supply them and charge a hefty penalty rate of interest. 

To avoid overdrafts and penalties a bank must obtain reserves. Standard practice is for a bank needing reserves to borrow them on the overnight Federal Funds Market at the going Federal Funds Rate without collateral. Other sources of reserves are US government agencies, savings and loan associations or any financial institution having an account at the Fed. 

When banks have excess reserves they may attempt to loan them in the overnight market. Currently, there are excess reserves in the banking system. This should make reserves easy to borrow but hard to lend, which might cause bank management to retain more reserves than needed or wanted.

Management of day-to-day operations involve how much to hold in reserves, what mix of securities in kind and in maturity to have, whether and how much to borrow and from whom. These decisions have an impact on profitability and require expert attention.

An Hypothetical Example

Let us look at a bank with $5 million in capital and $80 million in deposits of which $10 million. The capital should allow $40 million in loans. For simplicity, we will assume a single $40 million loan for 8 years at 4.2% interest with semiannual payments. With only $10 million in demand deposits, no reserves are required, but we put $1 million in as a place holder. The bank will have an initial balance sheet as shown in Table I.

Also, we used $200,000 of assets for computer and office equipment to get started.

Table II shows the situation immediately after the loan is made and deposited in the bank. Both assets and liabilities are increased by the amount of the loan. This is the operation whereby banks “create” money. Banks create most of the money in our economy by this simple operation. 

Currently, the reserve balance required by the Fed is 3% of demand deposits in excess of $15.2 million(10). We regard the new loan deposit as a demand deposit. So, to comply with regulations some securities ($44,000) were converted to reserves. Table II shows shows this increase in reserves.

The next operation assumes that our borrower withdraws the whole $40 million loan deposit to build something wonderful for public benefit. When the $40 million in checks are deposited in other banks the Fed will decrease our Fed account by $40 million. We immediately convert $40 million from securities to reserves so that our Fed account is not overdrawn. In Table IV we show that the loan deposit has been withdrawn.

During the following year principal and interest are paid on the loan. Principal paid reduces the remaining loan balance, and interest both reduces outstanding interest due and flows to income. In addition we have income from investments in securities, 0.5% on reserves and about 1.5% on a mix of 2- and 5-year treasuries.

In Table III we tabulate our income, expenses, and net profit. These data are integrated into Table IV which shows our balance sheet after one year. We have assumed that when our borrower’s assets were drawn down to make loan payments additional deposits were made to maintain $80 million in deposits. Also, we show the $700,000 that the customer earned in interest.

The retained earnings are available as a dividend to the owners, as an increase to Tier-1 capital, or a combination of both options.

Finally, let us note from the balance statement in Table IV that we have about $50 million in assets against some $80 million in deposits. Whether or not that is adequate depends on the magnitude of withdrawals the depositor may take in the future. In the unlikely event, that the depositor would withdraw all funds on deposit, we would be short $30 million. 

To decrease the margin between assets and deposits bank management might decide to shop for a long-term loan, which is a more expensive liability than a deposit. But, we expect additional reserves will be available in the overnight funds market.


It appears that public banks can find a niche in the national banking system by returning profits to the public rather than to private investors. Because they need not cater to private investors’ desires for profit, public banks can be very conservative in their investments. They promise to reduce borrowing costs for local public projects and provide funding at the time it is needed. Public banks will provide transparency and accountability to the public for bank decisions.


1) Liability is not a pejorative term, it just means that liabilities are a promise of something owed to the depositor. 
3) Principal and Interest borrower pays to lender.
4) Stockholders' equity.
5) Agreement to repay the loan.
7) We have chosen a more conservative 12.5%.
8) Leverage may be the most limiting ratio.


Table I  Initial Balance Sheet
Liabilities and Equity
Cash reserves at Fed
Demand deposits
Time deposits

Loan loss allowance

Net loans

Bank premises and equipment



Table II Balance Sheet After Loan Deposited
Liabilities and Equity
Cash reserves at Fed
Demand deposits
Time deposits
Loan deposit
Loan loss allowance

Net loans

Bank premises and equipment



Table III Income & Expense Statement
Interest Income
Operating Expenses
Salaries & Benefits
IT Support
Interest on Deposits
Loan Loss Expense
Debt service

Total operating expense
Taxes @ 15%
Net Profit

Table IV Year After Loan Withdrawn
Liabilities and Equity
Cash reserves in Fed
Demand deposits
Time deposits
Loan deposit Withdrawn
Loan loss allowance

Net loans

Bank premises and equipment

Retained earnings


Bank References

Although not referenced in the text, the following references informed the above discussion.

McLeay, Michael, et. al., Money creation in the modern economy, Bank of England, Quarterly Bulletin 2014 Q1: 

Coppola, Frances, Banks Don’t Lend Out Reserves, Forbes/Investing. January 21, 2014

Werner Richard A., How do banks create money, and why can other firms not do the same? An explanation for the coexistence of lending and deposit taking, International Review of Financial Analysis, Vol 36, December 2014, pp. 71-77

Bell, Stephanie, Can Taxes and Bonds Finance Government Spending?, Levy Economics Institute, Working Paper No. 244, July 1998

Wray, L. Randall, Endogenous Money: Structuralist and Horizontalist, Levy Economics Institute, Working Paper No. 512, September 2007

Fullwiler, Scott T, An Endogenous Money Perspective on the Post-Crisis Monetary Policy Debate, Review of Keynesian Economics, Vol. 1 No 2, Summer 2013, pp. 171-194

Fullwiler, Scott T, Modern Central Bank Operations - The General Principles, Warburg College: Bard College - Levy Economics Institute, June 2008

Wray, L. Randall, Modern Money Theory, Palgrave Macmillan, 2012, Chapter 3

A Nascent Text on Money & Banking, Eric Tymoigne, Associate Professor of Economics, Lewis and Clark College, Portland, Oregon

Mosler, Warren, Soft Currency Economics II, Valence Co. 1996

Many thanks for helpful suggestions and comments to Nichoe Lichen and Elizabeth Dwyer of the Brass Tacks Team for Banking on New Mexico.